Paul Krugman offers this today:
"The rescue of Bear Stearns, in particular, was a paradigm-changing event.
Traditional, deposit-taking banks have been regulated since the 1930s, because the experience of the Great Depression showed how bank failures can threaten the whole economy. Supposedly, however, “non-depository” institutions like Bear didn’t have to be regulated, because “market discipline” would ensure that they were run responsibly. "
In 2004, the SEC offered dealers the option of going to Basel (bank) capital requirements, which they anticipated would result in a REDUCTION of required capital from the standard SEC rule that applied to all dealers. Several major dealers adopted this including Bear Stearns, Merrill Lynch, Goldman Sachs and Morgan Stanley.
No doubt Dr Krugman will say that the Fed has a sharp eye on all those banks and that's the difference. But you wouldn't know from his remarks that the standing broker-dealer capital requirements were stricter than those for banks. Is there any other formal part of regulation? As we, know dealers are marking to market a larger share of their assets so they are less likely to be fudging capital than banks are.
Monday, March 31, 2008
Monday, March 24, 2008
Malthusian Catastrophes. Here We Go Again
The WSJ had a front page article today on fears of running out of resources. They say water is hard to find substitutes for. The difference in water consumption per calorie or protein unit between meat and grains is enormous. A cultural shift to vegatarianism not only provides a big substitute for scarce water, but also results in enhanced global health. Economics, as usual, can drive this cultural shift. It's nice to have an easy solution to this problem, drive by economics, with ancillary BENEFITS.
Then there is energy. At least in the United States, it is impossible to imagine that in a future of high bandwidth and high resolution video conferencing that people will still spend time in steel boxes commuting to sit in larger steel boxes to do what can be done electronically. Another substitute with ancially BENEFITS (commuting is one of those few things that doesn't exhibit hedonic adaptation).
My favorite quote from the article:
"history is littered with examples of societies believed to have suffered Malthusian crises: the Mayans of Central America, the Anasazi of the US Southwest, and the people of Easter Island."
Pretty powerful stuff.
There is a problem that the very poor are experiencing rapid inflation since they have a very high food weighting in their basket. Perhaps we should focus on how to make them rich enough to afford food.
Then there is energy. At least in the United States, it is impossible to imagine that in a future of high bandwidth and high resolution video conferencing that people will still spend time in steel boxes commuting to sit in larger steel boxes to do what can be done electronically. Another substitute with ancially BENEFITS (commuting is one of those few things that doesn't exhibit hedonic adaptation).
My favorite quote from the article:
"history is littered with examples of societies believed to have suffered Malthusian crises: the Mayans of Central America, the Anasazi of the US Southwest, and the people of Easter Island."
Pretty powerful stuff.
There is a problem that the very poor are experiencing rapid inflation since they have a very high food weighting in their basket. Perhaps we should focus on how to make them rich enough to afford food.
Saturday, March 22, 2008
FT Notes Need for Regulator Who Knows More
I have enclosed below an article in the FT suggesting that if only regulators knew everything that was going on, they would have stopped the subprime excesses.
There are numerous errors of reasoning or fact in the article. Some of them are:
1. "Subprime lending has long loomed as one of the financial world’s less savoury activities, involving as it does the provision of higher interest loans to lower income people, generally speaking." This is an odd one from a business paper. It is hard to know what, generally speaking, is unsavory about lending to credit risky people at credit risky interest rates. The only flaw of the rates it appears is that they were too low for the credit risk.
2. "Everyone involved had the same incentive – to produce more mortgages." Not exactly right. The investors, who were obviously very involved, had no such incentive. The obvious question is why they didn't adequately protect their interests and Mr Silverman would do a service to discuss the reasons for this.
3. "The rating agencies trusted in the procedures of the banks." How does Mr Silverman know this? Could it be that they had no such trust but nevertheless either incentives to act as if they trusted or were not competent otherwise?
4. "What was missing was a proper supervisor – an entity that could observe the entire process and keep it running smoothly." It is hard to know where to start with a sweeping non-obvious claim from an author who has disestablished his credibility earlier in the article. One wonders what exactly such an overarching supervisor would have seen that wasn't already visible to supervisors. For example, large buyers of mortgages such as banks are highly supervised and it wasn't a secret that subprime loans that those banks were buying had 50% not fully documented as to income etc loans, that house prices had rushed up, that LTVs were very high, that there were loans with very low initial rates, and so on. In fact, some of the biggest losers as investors (like Citi) were also functioning as the terrible securities creators. What information were their regulators missing due to their lack of breadth? Yes, we should have better regulators. And I should be taller.
5. Financial journalists are underpaid compared to financial market participants. This is unfortunate since journalists perform an extremely important function, when they perform their function well. Anyone have any idea how I can get a job writing for the FT? I think I could add a lot.
Bigger sheriffs needed
ByGary Silverman
Published: March 21 2008 21:17 | Last updated: March 21 2008 21:17
It has been less than a fortnight since he left the New York state government, but I am already beginning to feel a certain nostalgia for Eliot Spitzer.
I can’t say I particularly miss Spitzer the man. Spitzer’s professional self-immolation – as the alleged “client nine” of a call-girl ring – underscores the questions about his character that surfaced during his years as attorney-general and governor.
But I am developing a hankering for Spitzer the spectre – the presence who became known as the Sheriff of Wall Street. As it turned out, he hadn’t been gone for more than a couple of days before we learnt again that without proper sheriffs, the local cowboys have a tendency towards self-inflicted wounds.
The latest evidence comes in the form of Bear Stearns, an investment bank that collapsed a few days after Spitzer rode off into the sunset. Worth roughly $20bn about a year ago, Bear agreed to be sold to JPMorgan Chase last weekend for roughly $230m – or less than it cost the Texas Rangers baseball team to sign Alex Rodriguez a few years back.
The exact reasons Bear bit the dust could be the subject of debate for years to come. But there can be little argument that it is the latest casualty of a credit crisis that began in the badlands of the financial world known as the subprime mortgage market.
Subprime lending has long loomed as one of the financial world’s less savoury activities, involving as it does the provision of higher interest loans to lower income people, generally speaking. However, it grew rapidly in recent years as bankers pooled payments from these loans to back securities that were sold to investors. Now, owners of these securities have lost billions of dollars and I would argue that’s because free markets, like frontiers, don’t work well without sheriffs to keep order.
The problem in the subprime world was the lack of checks and balances. Everyone involved had the same incentive – to produce more mortgages. Brokers earned fees by arranging the loans and selling them to banks. Bankers earned fees by creating securities from the mortgages and selling them to ravenous investors around the world. Rating agencies earned fees for attesting to the reliability of this mortgage paper.
Eventually, the brokers ran out of legitimate borrowers and began signing up unreliable ones, even people who could not produce a proper pay stub. Bankers quietly moved the mortgages down the bond assembly line. The rating agencies trusted in the procedures of the banks. Investors banked on the rating agencies. Only disaster stopped the subprime machine.
What was missing was a proper supervisor – an entity that could observe the entire process and keep it running smoothly. You would think we would have such authorities in the US but we don’t.
One of the big errors in this regard dates back to the last years of the Clinton administration, when the US enacted financial reform legislation that allowed financial companies greater freedom but kept the existing system of financial regulation.
It was a solution that pleased the bankers and the bureaucrats. Financial firms got to do just about whatever they wanted. But the regulators maintained control of their traditional fiefdoms, meaning different entities regulated different financial services.
This created a problem in businesses such as subprime mortgages, which involved many different activities. No one supervised the whole thing.The regulators were blind men examining elephants. They knew what they touched but little else.
One of the sad things about Spitzer was that he, too, was a creature of this fragmented regulatory system. His role, while dramatic, was limited. As New York attorney-general, he could pursue people who might have broken state laws. But he couldn’t directly address the structural problems that led to Wall Street malfeasance, and, in a sense, his brand of prosecutorial theatre served as a distraction from them.
When Spitzer resigned as governor, there was no small measure of chortling in New York, but, as the subprime debacle and the Bear collapse show, the last laugh could be on Wall Street. We not only need Spitzers here, we need better Spitzers – broader Spitzers – to keep things from getting out of hand.
I learnt as much during my years covering Wall Street for this newspaper. Indeed, as the Bear collapse occurred, my thoughts kept returning to something one of the grand old men of Wall Street had said to me and a colleague during a meeting a few years back.
It was a background conversation, a chance for us to get to know one another, and our Wall Street friend was in fine form, holding forth on politics and joking around. When the time came for us to leave, he looked at us, flexed his bicep and pointed to it with his index finger. “The only thing that matters is this,” he said.
I didn’t argue with him then and I won’t argue with him now. To get things done on Wall Street you have to show some muscle. Our elected government would be well advised to remember that.
Gary Silverman is the FT’s US news editor
Chrystia Freeland is away.
There are numerous errors of reasoning or fact in the article. Some of them are:
1. "Subprime lending has long loomed as one of the financial world’s less savoury activities, involving as it does the provision of higher interest loans to lower income people, generally speaking." This is an odd one from a business paper. It is hard to know what, generally speaking, is unsavory about lending to credit risky people at credit risky interest rates. The only flaw of the rates it appears is that they were too low for the credit risk.
2. "Everyone involved had the same incentive – to produce more mortgages." Not exactly right. The investors, who were obviously very involved, had no such incentive. The obvious question is why they didn't adequately protect their interests and Mr Silverman would do a service to discuss the reasons for this.
3. "The rating agencies trusted in the procedures of the banks." How does Mr Silverman know this? Could it be that they had no such trust but nevertheless either incentives to act as if they trusted or were not competent otherwise?
4. "What was missing was a proper supervisor – an entity that could observe the entire process and keep it running smoothly." It is hard to know where to start with a sweeping non-obvious claim from an author who has disestablished his credibility earlier in the article. One wonders what exactly such an overarching supervisor would have seen that wasn't already visible to supervisors. For example, large buyers of mortgages such as banks are highly supervised and it wasn't a secret that subprime loans that those banks were buying had 50% not fully documented as to income etc loans, that house prices had rushed up, that LTVs were very high, that there were loans with very low initial rates, and so on. In fact, some of the biggest losers as investors (like Citi) were also functioning as the terrible securities creators. What information were their regulators missing due to their lack of breadth? Yes, we should have better regulators. And I should be taller.
5. Financial journalists are underpaid compared to financial market participants. This is unfortunate since journalists perform an extremely important function, when they perform their function well. Anyone have any idea how I can get a job writing for the FT? I think I could add a lot.
Bigger sheriffs needed
ByGary Silverman
Published: March 21 2008 21:17 | Last updated: March 21 2008 21:17
It has been less than a fortnight since he left the New York state government, but I am already beginning to feel a certain nostalgia for Eliot Spitzer.
I can’t say I particularly miss Spitzer the man. Spitzer’s professional self-immolation – as the alleged “client nine” of a call-girl ring – underscores the questions about his character that surfaced during his years as attorney-general and governor.
But I am developing a hankering for Spitzer the spectre – the presence who became known as the Sheriff of Wall Street. As it turned out, he hadn’t been gone for more than a couple of days before we learnt again that without proper sheriffs, the local cowboys have a tendency towards self-inflicted wounds.
The latest evidence comes in the form of Bear Stearns, an investment bank that collapsed a few days after Spitzer rode off into the sunset. Worth roughly $20bn about a year ago, Bear agreed to be sold to JPMorgan Chase last weekend for roughly $230m – or less than it cost the Texas Rangers baseball team to sign Alex Rodriguez a few years back.
The exact reasons Bear bit the dust could be the subject of debate for years to come. But there can be little argument that it is the latest casualty of a credit crisis that began in the badlands of the financial world known as the subprime mortgage market.
Subprime lending has long loomed as one of the financial world’s less savoury activities, involving as it does the provision of higher interest loans to lower income people, generally speaking. However, it grew rapidly in recent years as bankers pooled payments from these loans to back securities that were sold to investors. Now, owners of these securities have lost billions of dollars and I would argue that’s because free markets, like frontiers, don’t work well without sheriffs to keep order.
The problem in the subprime world was the lack of checks and balances. Everyone involved had the same incentive – to produce more mortgages. Brokers earned fees by arranging the loans and selling them to banks. Bankers earned fees by creating securities from the mortgages and selling them to ravenous investors around the world. Rating agencies earned fees for attesting to the reliability of this mortgage paper.
Eventually, the brokers ran out of legitimate borrowers and began signing up unreliable ones, even people who could not produce a proper pay stub. Bankers quietly moved the mortgages down the bond assembly line. The rating agencies trusted in the procedures of the banks. Investors banked on the rating agencies. Only disaster stopped the subprime machine.
What was missing was a proper supervisor – an entity that could observe the entire process and keep it running smoothly. You would think we would have such authorities in the US but we don’t.
One of the big errors in this regard dates back to the last years of the Clinton administration, when the US enacted financial reform legislation that allowed financial companies greater freedom but kept the existing system of financial regulation.
It was a solution that pleased the bankers and the bureaucrats. Financial firms got to do just about whatever they wanted. But the regulators maintained control of their traditional fiefdoms, meaning different entities regulated different financial services.
This created a problem in businesses such as subprime mortgages, which involved many different activities. No one supervised the whole thing.The regulators were blind men examining elephants. They knew what they touched but little else.
One of the sad things about Spitzer was that he, too, was a creature of this fragmented regulatory system. His role, while dramatic, was limited. As New York attorney-general, he could pursue people who might have broken state laws. But he couldn’t directly address the structural problems that led to Wall Street malfeasance, and, in a sense, his brand of prosecutorial theatre served as a distraction from them.
When Spitzer resigned as governor, there was no small measure of chortling in New York, but, as the subprime debacle and the Bear collapse show, the last laugh could be on Wall Street. We not only need Spitzers here, we need better Spitzers – broader Spitzers – to keep things from getting out of hand.
I learnt as much during my years covering Wall Street for this newspaper. Indeed, as the Bear collapse occurred, my thoughts kept returning to something one of the grand old men of Wall Street had said to me and a colleague during a meeting a few years back.
It was a background conversation, a chance for us to get to know one another, and our Wall Street friend was in fine form, holding forth on politics and joking around. When the time came for us to leave, he looked at us, flexed his bicep and pointed to it with his index finger. “The only thing that matters is this,” he said.
I didn’t argue with him then and I won’t argue with him now. To get things done on Wall Street you have to show some muscle. Our elected government would be well advised to remember that.
Gary Silverman is the FT’s US news editor
Chrystia Freeland is away.
Thursday, March 20, 2008
JPMorgan's Change of Price for Bear Stearns on Sunday
Secretary of the Treasury Hank Paulson appeared on a Sunday morning talk show on Fox News and said "The government is prepared to do what it takes to maintain the stability..." This is quite a change in his tone on bailouts (which was the issue at hand at that moment.)
Andrew Ross Sorkin at the New York Times writes that on Saturday, JPMorgan suggested it might pay in the low double digits. By midday Sunday, JPMorgan was "scared stiff" by what it saw in Bear's books and dropped its price to $2.
An alternative explanation is that JPMorgan heard Mr Paulson, their negotiating counterparty, declare his extreme flexibility publicly. I bet that the $30b request from JPMorgan also followed hearing Mr Paulson's prematurely offered remarks.
Andrew Ross Sorkin at the New York Times writes that on Saturday, JPMorgan suggested it might pay in the low double digits. By midday Sunday, JPMorgan was "scared stiff" by what it saw in Bear's books and dropped its price to $2.
An alternative explanation is that JPMorgan heard Mr Paulson, their negotiating counterparty, declare his extreme flexibility publicly. I bet that the $30b request from JPMorgan also followed hearing Mr Paulson's prematurely offered remarks.
Sunday, March 16, 2008
NY Fed Gives $10 billion to JPMorgan
In order to avoid the moral hazard problem of bailing out Bear Stearns's shareholders, the Fed has given the value of the bailout to JPMorgan's shareholders.
Had the Fed broadly offered the early discount window access plus the $30 billion of NONRECOURSE funding on less liquid assets (otherwise known as a free option), there would have been many takers and JPMorgan, which provides approximately nothing in exchange for this gift, wouldn't have received the benefit. The Fed, having maximised the sale price, could have charge for this benefit by taking a note from Bear Stearns for a few billion dollars.
Put another way,
in order to avoid a payment to Bear Stearns which would create moral hazard in the future, the Fed gave that payment to their friends.
The Fed and Treasury have tremendously smart, civic minded leadership. Why is it that their decisions are repeatedly either lacking in judgment or creativity or even basic good sense?
Had the Fed broadly offered the early discount window access plus the $30 billion of NONRECOURSE funding on less liquid assets (otherwise known as a free option), there would have been many takers and JPMorgan, which provides approximately nothing in exchange for this gift, wouldn't have received the benefit. The Fed, having maximised the sale price, could have charge for this benefit by taking a note from Bear Stearns for a few billion dollars.
Put another way,
in order to avoid a payment to Bear Stearns which would create moral hazard in the future, the Fed gave that payment to their friends.
The Fed and Treasury have tremendously smart, civic minded leadership. Why is it that their decisions are repeatedly either lacking in judgment or creativity or even basic good sense?
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