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

Weekend Reflection Points

The lead article in the current AER is available here (gated, apparently, though the link isn’t working; h/t Tom Bozzo [on FB] and Brad DeLong; I was using the paper copy). The most interesting part so far: the authors only considered the documented costs of air pollution—not land, not water—in deriving the (embarrassingly negative) ROI figures for coal and oil.

As Cousin Lucia and Tom Zeller, Jr., note today, the cost of water pollution makes oil power plants an even worse option.

In such a context, Europe in general and Germany (the top maker of solar panels until China recently passed them) in particular rubs in our faces that they’re winning on the alternative-energy sources front (h/t Barry Ritholtz):

The 15 mile-per-hour winds that buffeted northern Germany on July 24 caused the nation’s 21,600 windmills to generate so much power that utilities such as EON AG and RWE AG (RWE) had to pay consumers to take it off the grid.

Rather than an anomaly, the event marked the 31st hour this year when power companies lost money on their electricity in the intraday market because of a torrent of supply from wind and solar parks. The phenomenon was unheard of five years ago.

Meanwhile, back in the U.S., it is no secret that Brad and Robert Waldmann are on one (affirmative) side of the TARP-was-a-success argument, and I’m on the other.* But even the Success crowd may pause to wonder if the short-term “profit” was a good long-term strategy:

Some large U.S. banks would have stronger capital bases to better deal with today’s market stresses had regulators not relaxed bailout repayment criteria in late 2009, a new government audit showed on Friday.

Bank of America (BAC.N) Citigroup (C.N), Wells Fargo (WFC.N) and PNC Financial (PNC.N) were allowed exit the Troubled Asset Relief Program without raising as much equity capital as initially prescribed by the Federal Reserve, the TARP Special Inspector General said in the report.

Following bank stress tests earlier in 2009, the Fed gave several banks guidance that they must raise $1 in common equity for every $2 in TARP bailout funds repaid — a formula meant to enable them to withstand future stresses.

But this standard — which was never previously made public — was quickly relaxed, allowing Bank of America, Citi and Wells Fargo to repay taxpayers nearly simultaneously in December 2009,** raising a combined $49.1 billion in equity capital.

Enforcement of the $1 in equity for every $2 repaid guidance would have required $57.5 billion in equity capital to be raised by the three institutions. PNC was later allowed to exit TARP under similar relaxed guidance. [emphasis mine]

The most recent SIGTARP report (28 July 2011), uses the word “Bailout” only once in its 304 pages—and that’s in the title of testimony by Sheila Bair, ““Statement of Sheila C. Bair, Chairman, Federal Deposit Insurance Corporation on The Changing Role of the FDIC before the Subcommittee on TARP, Financial Services, and Bailouts of Public and Private Programs; Committee on Oversight and Government Reform, U.S. House Of Representatives.”

Noted for the record: Patch uses the same article (with minor customization) in multiple locales, highlighting it as a “local” piece. I defer to Felix as to whether this is in keeping with the rest of their “business model.”

As Dan Becker can tell you, the small business “ownership society” is not for the faint of heart. Nor, as anyone who thinks about it for more than three seconds can tell you, is it a primary driver of employment growth. Yet when the most visible and successful Management Consultancy in the United States thinks about growth, its two primary points are “take monies from the government” and “expand small businesses.” But give them credit for recognizing a point that is often obscured by H1-B trolls technology firm leaders such as Meg Whitman:

[I]t’s not just the young who can help fill the skills gap; older, experienced workers can play a part, too. In the US aerospace sector, 60 percent of the workforce is over 45. A practical response would be for governments to remove barriers—particularly those related to the provision of health care and to benefits rules—that prevent older workers from staying in the workforce longer. Germany and the Netherlands raised the participation rate of the 55-to-64 age group by 21 and 24 percentage points, respectively, between 1990 and 2009. In the Netherlands, there were significant changes to pensions and welfare benefits to improve incentives to work longer, coupled with initiatives to change public perceptions, improve employability, and reduce discrimination against older workers. [emphasis mine]

It’s nice to see McKinsey endorsing Medicare For All.

*As a general rule, the Econ-first analysts are affirmatives, the finance-grounded ones are negative. If you have to think about why that would be: one group makes its living finding $100 bills on the sidewalk that the other one swears cannot exist. As the Mark Thomas of the world would note, the issue of priors might need to be addressed.

**The reason December 2009 is important is that it meant that monies that otherwise would have to have been used to shore up capital were instead paid out as bonuses by the now-uncontrolled banks, or, in Reuterspeak, “keen to escape executive compensation restrictions associated with the bailout funds.”

Sources and Uses: Kash Delivers

Two posts on European Banks and their view of what constitutes a “Safe Harbor.”

His conclusion isn’t just The Pull Quote of the Year, it’s the Pull Quote That Explains the Year:

Putting it all together yields a compelling story: European banks are shifting their cash assets out of European banks and putting much of them into US banks. (An interesting question is what European MFIs have done with the remaining money they’ve withdrawn from the European banking system… but that’s a story for another day.) This has happened at a significant rate, with a net transatlantic flow from European to US banks that probably totals close to half a trillion dollars in just six months.

If you’re wondering exactly who has been the first to lose confidence in the European banking system, look no further. It seems that at the forefront is the European banking system itself.

Go Read the Whole Things

Simon Johnson on Tim Geithner and Elizabeth Warren

Simon Johnson offers pointed criticism of the role Timothy Geithner has played to date in the Great Recession and bank regulation, in particular as an advisor and architect to the Obama economic team and how that policy is presented and pursued in Congress. Another worthwhile read.

Third Time, Someone Will Believe: Manage Risk or It Manages You

As the late Allison Snow-Jones noted, economics depends on working mathematics. Mathematics, in turn, depend on the conditions being described correctly. If I build a model in which two things are independent, they have to be independent for my model to work. Or, to quote a quoting:

Many months ago, I quoted the brilliant Janet Tavakoli‘s book Credit Derivatives and Synthetic Structures:

The trader then went on to tell me that Commercial Bank of Korea would sell credit default protection on bonds issued by the Commercial Bank of Korea.
“That’s very interesting,” I countered, “but the credit default option is worthless.”
“But people are doing it,” persisted the trader.
“That’s because they don’t know what they’re doing,” I affirmed. “The correlation between Commercial Bank of Korea and itself is 100 percent. I would pay nothing for that credit protection. It is worthless for this purpose.”
The trader mustered his best grammar, chilliest tone, and most authoritative voice: “There are those who would disagree with you.” (p. 85)

That apparently includes the Spanish government:

The Frob capital injection comes in the form of convertible preference shares from the Frob, or Spain’s Fund for Orderly Bank Restructuring. As a reminder, the Frob itself has lending capacity of €15bn and can leverage itself to €99bn by issuing bonds — guaranteed by the Kingdom of Spain — to private investors.

And the equity it lends to banks really resembles more of a subordinated loan than actual loss-absorbing capital. What’s more, it pays a coupon and is excluded from core Tier 1 calculations under incoming Basel III rules for this very reason.

Did we mention the Frob is also backed by Spain?

I realise all the attention is on Egypt right now—and it should be&mdaash;but the rest of the world is going to be there on Monday, too. And traditional “sovereign risk management” still has a ways to go.

Joachim Voth Tells the Truth and Shames the (German) Devil

Echoes of Japan, echoes of the Great Depression. One of the few economists who knows history closes a post by presenting the proper context for the choices:

A quick exit [by Ireland, from the Euro] may still be better than a decade of slow, grinding deflation combined with Zombie banks and Zombie household balance sheets being kept on artificial life support before the inevitable rise in interest rates at some point pulls the plug.

When Britain left the gold standard in 1931, the governor of the Bank of England famously declared (having been aboard a ship and out of contact when the decision was made): “I didn’t know we could do that.” Leaving the euro may seem similarly unimaginable to many, but it may be just as feasible. In the 1930s, cutting the link quickly led to a recovery of demand, by reducing deflationary pressures. Far from the shattering blow to confidence feared by many, exiting the gold standard was actually great for business. Leaving the euro may be every bit as good.

Let Wal-Mart be a Bank

by Tom aka Rusty Rustbelt

Consumer Finance: Let Wal-Mart be a Bank

One of the side effects of the “great recession” is damage to credit records and banking relationships for many people who get in financial trouble. Many of them will have trouble reestablishing banking relationship (that the banks caused the recession is irrelevant, of course) because the bank computers have them on a reject list, even for a savings account.

Several years ago Wal-Mart starting actively talking about becoming a bank, and the banking industry and their lobbyists went all postal insane on Congress (some Wal-Marts have a Wood Forest bank branch).

Truth is, for many people, the customer service counter at WM is already their de facto bank. They use it to pay bills, transfer money, cash checks, and use prepaid debit cards and gift cards for many purposes.

So, since Wal-Mart is already a de facto bank for millions, why not let it be a bank? The other banks do not want the business anyway.

(PS: some academic research I did a few years ago leads me to believe WM plays a major role in transferring money from undocumented workers to Mexico, although WM denied in writing the possibility of such transfers, while running a discount special on transfers to Mexico!)

Speculation and Finance: Good for you? (part III)

by Linda Beale
Speculation and Finance: Good for you? (part III)

In a couple of prior postings (Part 1 and Part 2), I considered (1) Darrell Duffie’s op-ed in the Wall St. Journal asserting that financial institution speculation in the markets is “good” for us and (2) the question of financial institution speculation in credit default swaps on Greek debt as a possible factor in the worsening of Greece’s financial situation.

Speculation seems to be on everybody’s mind these days. The Economist, for example, is running a debate on the question of the value of financial innovation, here. Volcker famously has commented that about the only financial innovation of the last century that was really worth anything was the ATM, as the moderator noted inher opening remarks.

A few years ago America’s sophisticated financial system was hailed as a pillar of its economic prowess. The geeks on Wall Street and their whizzy new products symbolised the success of American capitalism just as much as the geeks in Silicon Valley. Today things look very different. After the worst financial crisis and deepest recession since the 1930s, Wall Street has become synonymous with greed and irresponsibility in the public mind. And while no one doubts that financial innovation made a lot of financiers extremely rich, a growing number of people question whether it did much, if any, good for the broader economy. Paul Volcker, former chairman of the Federal Reserve and an advisor to President Obama, has famously claimed that he can find “very little evidence” that massive financial innovation in recent years has done anything to boost the economy. The most important recent innovation in finance, he argues, is the ATM. Id.

The debate is about cutting edge financial innovation as came into style in the 1980s–mortgage-backed securities, collateralized debt obligations, credit default swaps and other financially engineered derivative instruments and innovations like exchange-traded funds and inflation-protected bonds. So who are the voices for the Con and Pro side on “love that speculation and financial innovation” at The Economist? It’s Joe Stiglitz, Nobel prizewinning neo-Keynesian (who should, in my opinion, have been appointed to the position that Larry Summers holds in the Obama administration) arguing against the value of most financial innovation–the “right kind” he says, could help financial institutions fulfill their core functions more efficiently, saving money and therefore contributing to economic growth. “But for the most part, that’s not the kind of financial innovation we have had.” Most of the recent financial innovations have been primarily accounting gimmicks and inventions designed to game the tax system–In my terms, those are not productive investments that move technological innovation, but shell games to fool regulators and pocket the windfall for the wealthy few. Een the inventions that had the potential to stablize the financial system actually ended up destabilizing it, because of their abuse in the furtherance of greed. And in the other corner, it’s Ross Levine, Professor of Economics at Brown, who thinks financial innovation is “crucial, indeed indispensable” for economic growth.

Not surprisingly, I think Stiglitz has the winning argument here about the questionable value of most of the late 20th century financial innovation.

We should not be surprised that the so-called innovation did not yield the real growth benefits promised. The financial sector is rife with incentives (at both the organisational and individual levels) for excessive risk-taking and short-sighted behaviour. There are major misalignments between private rewards and social returns. There are pervasive externalities and agency problems. We have seen the consequences in the Great Recession which the financial sector brought upon the world’s economy. But the consequences are also reflected in the nature of innovation, which, for the most part, was not directed at enhancing the ability of the financial sector to perform its social functions, even though the innovations may have enhanced the private rewards of finance executives. (Indeed, it is not even clear that shareholders and bondholders benefited; we do know that the rest of society—homeowners, taxpayers and workers—suffered.)

Some of the innovations, had they been appropriately used, might have enabled the better management of risk. But, as Warren Buffett has pointed out, the derivatives were financial weapons of mass destruction. They were easier to abuse than to use well. And there were incentives for abuse.

More on speculation: Banks, Credit Default Swaps, and Greece’s Debt

by Linda Beale

More on speculation: Banks, Credit Default Swaps, and Greece’s Debt (Part 2)

Yesterday, I commented on Darrell Duffie’s defense of speculation in the Wall Street Journal, here. I noted that the idea that speculation is a positive because it absorbs risk others don’t want and helps reveal the “true price” by providing more information about the speculated item seems more of a stretch in the midst of this crisis than we might have thought before. Absorption of risk only works if there is a more or less even playing field, with some long and some short, but that adds little to information or price. If there is an abundance of information on price–because traders are shorting the stock or rushing for credit default swaps, then that information will tend to swing the price and make it much more difficult for speculators to absorb the risk, as the market teeters offbalance on that item and pushes the item more and more to the cliff that the speculators have predicted.

Whatever the underlying problem in Greece, financial speculation has been a factor in tilting the balance towards disaster. The price of credit default swaps has gone up, and each time that Greece tries to borrow to pay its debt, it has to pay more and the CDS cost goes up and Greece looks riskier in a vicious cycle threatening illiquidity. Thus, one commentator notes that “credit default swaps give the illusion of safety, but actually increase systemic risk. See Banks Bet Greece Defaults on Debt They Helped Hide, NY Times, Feb 25, 2010.
crossposted with ataxingmatter

Bankers Bonuses and Bank Reforms: why they are needed, what they might include, and are you angry yet?

by Linda Beale

Bankers Bonuses and Bank Reforms: why they are needed, what they might include, and are you angry yet?

A big title for a tiny little sketch of a post, I know. Not much time today folks, but if you can read only one blog posting, read the one at Naked Capitalism at the link provided at the end of this paragraph. Yves comments on the Independent’s article on bankers’ bonuses and the Wall Street firms’ incredible egos and greed. See US Banks Reject Effort by UK Bank Execs to Reign In Pay, Naked Capitalism, 022

 Beale here: As you all know, A Taxing Matter has been hitting that same nail with my tiny little hammer. I think the evidence suggests that we need to take some rather drastic actions, which might include any or even perhaps all of the following:
  • break up the investment banks;
  • regulate their leverage and their bonuses,
  • ban their flash trading
  • heavily regulate their involvement in speculative gambling with derivatives (i.e., betting on positions that they don’t own). And given that their resurging profits are due to two things–(1) resuming the same casino gambling that caused the 2008 crisis and Great Recession and cost millions their jobs and (2) feeding off the public trough for TARP direct funding (the AIG bailout, etc going directly into Goldman and JPMorgan Chase’s pockets) and implicit guarantees resulting in very cheap cost-of-funds permitting Goldman et al to make profits with federal loans–we need to add a new tax for the big banks as a charge for the government guarantee that they are getting rich off of (again). The tax should be a substantial enough bite that it will force the banks to both significantly reduce their leverage and significantly reduce their bonus payment system. It can be either in the form of an excise tax based on their leverage (since their borrowed funding is what costs the government in terms of bailout potential) or in the form of an income tax surcharge that is progressively structured so that the highest rate applies to banks with the greatest amount of leverage. It could even be a tax structured as a tax on each derivative position like credit default swaps entered into that isn’t backed by a long position (so not a true hedge but a speculative bet). I don’t knw for sure which form is best (comments welcome) but I sure as heck think some version or another should be passed, and soon, else we are in for a repeat that is more disastrous than the GOP-gifted Great Recession we are already experiencing. _________________________________

crossposted with ataxingmatter