Too Little Too Late (about Too Much Too Soon)

Aug 28, 2011 by

20081113_federal_reserve While the entire eastern seaboard was obsessed with Irene, Gretchen Morgenson wrote in the New York Times this weekend about the Federal Reserve efforts to save the financial sector during the Great Recession, at enormous cost to the taxpayers and little benefit to Main Street.  Talk about burying the lede!

Based on information generated by Freedom of Information Act requests and its longstanding lawsuit against the Federal Reserve board, Bloomberg reported that the Fed had provided a stunning $1.2 trillion to large global financial institutions at the peak of its crisis lending in December 2008.

The money has been repaid and the Fed has said its lending programs generated no losses. But with the United States economy weakening, European banks in trouble and some large American financial institutions once again on shaky ground, the Fed may feel compelled to open up its money spigots again. (emphasis added)

This is NOT the TARP money bailout that was publicly debated and ultimately Congressionally approved, but additional amounts of money that were lent by the Federal Reserve to large banks (including foreign banks) largely in secret and at minimal interest rates in order to make sure that these banks could meet their minimum liquidity requirements so as to avoid bankruptcy. 

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2008 Redux?

Aug 8, 2011 by

 

Following Standard & Poor’s cutting its rating on US long-term debt late Friday from AAA to AA+, the US stock market fell significantly today: the Dow Jones industrial average had a one-day decline of more than 600 points (over 5 percent) and the Nasdaq dropped close to 200 points (nearly 7 percent).

Let’s take a deep breath.  Some refreshers:

  • S&P is only one of the three big credit ratings agencies.  The other two, Moody’s and Fitch, did not downgrade US debt (though they did change their outlooks to “negative“).  However, remember that the ratings agencies played a significant role in their overly optimistic ratings of structured debt securities which were instrumental in the 2008 crash.  It’s arguable that having been caught with their pants down, S&P is reacting rashly in the opposite direction, seeing danger where there is none.  But ratings are as much a dart game as they are a science and have been called, among other things, “substandard and porous.”
  • However, because of the interconnectedness of the US financial sector, the downgrade of US debt will have (and has had) direct follow-on effects: specifically, the downgrade today of the debt of Fannie and Freddie Mac, and of DTCC, the central depository for United States securities, all of which rely significantly on the US government.
  • Downgrades are significant because many “safe” investment vehicles (such as money market funds and low risk pension funds) have mandated investment rules, which may include, for example, a rule that such funds invest only in AAA rated securities.  The downgrade of US debt (and subsequent downgrade of other US backed securities as well as the as-yet-unseen ancillary effects of the downgrade) may lead to massive sell-offs by these funds, fueled by nothing but their mandates.
  • Despite all of the above, IF investors are genuinely worried about default by the US government (which is what a downgrade signals), then the interest rate on 10-year Treasury bonds should be soaring (because the likelihood that the US government will continue to honor its debt in 10 years should have just deteriorated significantly).  Instead, that interest rate has actually edged down today.
  • What happened today is generally being seen as a flight from securities to “safe havens” (which includes US Treasuries and gold, which broke all-time highs again today).
  • The fear is most likely driven by a renewed sense that the global economic outlook is bleak.  Most are speculating that the continued deterioration of Eurozone sovereign debt is the main driver of this fear, but the botched debt deal (see below) and the S&P downgrade are likely contributing to an overall sense that a double dip is imminent.
  • There is definitely an element of psychological fear in today’s market gyrations.  Volatility, measured via the VIX (or fear index) was off the chart today.
  • But in the end, it may be helpful to remember that the stock market is not the economy.

Even if the main driver for the market gyrations these past few days lies squarely in Europe, the US government is far from blameless.  There are real, grown-up ways to deal with the continued economic instability, and real steps that could have been taken to fortify our domestic economic situation while we brace for the inevitable from Europe.  And yet, Congress has consistently shied away from taking such steps over the past 3+ years.  One view, from the Economist:

[The US government’s] prescription for a weak economy [through the debt deal] is a large slug of austerity. Thanks to the expiry of a payroll-tax credit and extended jobless benefits in December, the United States is on course for a fiscal contraction of some 2% of GDP next year, the biggest of any large economy—and enough to drag a weak economy into recession.

The debt deal, which implies only modest new spending cuts in the short term, is not directly responsible for this. But Congress could, and should, have stopped this potentially ruinous trajectory. There was a deal to be had: keep up spending in the short term, with a stress on much-needed infrastructure investment, as well as extending the temporary tax cuts, in exchange for a big medium-term reduction in the deficit, centred on entitlements and tax reform. Congress did precisely the opposite, failing to support the economy now and failing to find enough cuts over the next decade to stabilise America’s debt.

Worse, the poisonous politics of the past few weeks have created new sorts of uncertainty. Now that the tea-partiers have used default successfully as a political weapon, it will surely be used again. The refusal to compromise, rapidly becoming a point of honour for both parties, is wreaking damage … At best, the politicians will have slowed a sputtering expansion; at worst they will have killed off the recovery and inflicted lasting harm on the world’s most impressive prosperity machine. (emphasis added)

Kady is back from a self-imposed sabbatical and may be persuaded to occasionally pop back on her other blog.

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Vanilla Iced

Sep 26, 2009 by

Vanilla soft serve copy

I love plain vanilla ice cream.  Love it.  My favorite is the soft serve vanilla at Carvel’s.  The rest of my family doesn’t understand my vanilla compulsion.  My husband is a ice-cream omnivore.  My oldest daughter favors the fruity sherbets, and my youngest has already demonstrated a strong disposition towards anything that includes chocolate.

I am simple, uncomplicated.  And to me, it is the simple, and uncomplicated repetition of vanilla that draws me to it again, and again, and again.  I know what I’m paying for, and I know what I’ll get.

So needless to say, that I took it as a personal affront this week when my favorite comedian-politician, Barney Frank,announced that the House has revised the administration’s proposal for a new consumer financial protection agency by removing the requirement that banks and other financial services companies offer “plain vanilla products”, like 30-year fixed mortgages and low-interest, low-fee credit cards.  My favorite comedian-secretary, Timothy Geithner, came around quickly, announcing the administration’s acquiescence in the deletion.

On what planet does it make sense that I could walk into any ice cream store tomorrow and find out that vanilla is no longer available?

The libertarians out there would argue that this is an unfair comparison.  That the removal of this provision is not so much eliminating the availability of the plain vanilla financial product as preventing unnecessary governmental INTRUSION through the FORCING of financial companies to offer such products.

There is this attractive, and *quaint*, idea that the financial services industry is competitive.  That because financial companies compete for my dollars and yours, they must offer the best product to us or risk the loss of our dollars.  This may (or may not) be true in other industries, where our dollars are given up in exchange for goods and products.  But think about where the financial services, especially right this moment, make their money: FEESPENALTY CHARGES, and any one of the multitude of different “hidden” costs that are now attached to many financial products.  Under this incentive structure, it is always good business to tack on as many fees and charges as possible, and then hide them well.

After all, if it was true that a bank would absolutely positively offer plain vanilla products in order to attract customers, why exactly are they quaking at the boots over the requirement that they offer such products?  I hardly think that the ice cream industry would be up in arms if they were required to provide vanilla in their shops – they might find such regulation a mite irritating and vaguely incomprehensible (why require something that all shops already have), but I hardly think that it would be the first target in a 600 page long list of potential regulations that includes, among other things, regulating derivatives.

How is it anti-competitive to make it possible for the average finance-illiterate person to walk into a bank and leave with a credit card where he knows exactly what his interest is, what the fees are (and what they are for), and what the penalties for late payment are?  Oh, unless by anti-competitive they mean, “not giving the banks the best possible conditions to make the most money possible.”

The banks argue that the better approach would be more “disclosure” and more “transparency”.  As my friend at Interfluidity explains:

One of the great errors in modern policy is to confuse disclosure with information. It is not the case, currently, that banks secretly take your money without itemizing the charge on some statement. (Sometimes when they take your money they call it “service fee” or something equally nondescriptive, and it’d be nice if that practice went away.) Rather, banks intentionally define contracts in such a way that the cost to many customers of understanding and competitively shopping all the dimensions of the product seems higher than the cost of terminating the search and signing the dotted line. More detailed disclosure doesn’t eliminate, and can sometimes exacerbate, the real information costs customers face…. You might think there’d be a market for ostentatious simplicity, and there might be. But no bank’s lawyers would sign off on a single page, 12 point text, no-extratextual-incorporation-or-unilateral-modification contracts. When routine contracts get more complex than that, it’s just gibberish competing with gibberish for people who have lives.

Disclosure is simply not good enough.  We need the vanilla.

See more eulogies herehere and here.

Kady is an attorney and even she can’t be bothered to read the legalese.  She blogs at Wonkess.

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When Theft Met Profit

Jul 21, 2009 by

20000_squid_holding_sailor-1 Last week Goldman Sachs reported a spectacular quarterly profit — close to $3.5 billion — and according to the company, it is on track to award an average of about $700,000 in bonus for each employee by year end.  Right before Goldman released its quarterly earnings, Rolling Stone published a scathing article by Matt Taibbi about the financial giant called “The Great American Bubble Machine,” pointing out that Goldman has miraculously been on the win side of every major speculative bubble in America since the Great Depression.  Following the earnings release and the Rolling Stones article, not a few economic pundits have weighed in on the profit-machine that is Goldman Sachs of America.

Of course, by this weekend, it was the Washington Post to the rescue, calling the various sources clamouring about the inherent injustice of the Goldman profit and compensation scheme as “braying,” full of “conspiracy mongering” and “priming the pump of outrage”.  And in the great tradition of calling everyone who doesn’t see the world your way a “socialist”, WaPo then passively aggressively insists that the Goldman detractors simply have a problem with profit-making ventures.

Excuse me, but it’s not profit when it is theft.

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Bonfire of the A.I.G.

Mar 18, 2009 by

AIG CDS payments
The Congressional hearing over the AIG bonuses today may have been the most circus-like experienced by the normally staid House Financial Services Committee.  But theatrics aside, what we find is a deeply nuanced situation, full of half-details suggesting shady subterfuge, and not a person to trust as far as the eye can see.

First, the $165 million in bonuses/retention fees paid to employees (and apparently, a handful of ex-employees) of AIG.  There is an enormous amount of public outrag at this incomprehensible rewarding of the very people who have contributed (and not in a small way) to the financial crisis (certainly, on a per head basis, are far more culpable that the irresponsible mortgage holder that those of other side of the political spectrum love to hate).

But peel aside the outrage and this is the situation we are left with: if we assume that AIG has a contractual obligation to fulfill the terms of what can only be characterized as criminally generous compensation contracts (and you can read this op-ed, as well as this recent post by Pundit Mom, for some critical discussion about the legal grounds which AIG may have to not perform on their obligations), then (1) breaking that contract may in fact cost AIG more than simply paying out on the obligation and (2) the government has already tied its hands with respect to the degree of its involvement allowed.

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