Month: September 2008

Tradeoffs Don’t Exist

Or so say Larry Summers and Mark Thoma who argue that we can have a bailout and a stimulus package and still have tax cuts and more spending on energy, health care, education and all the other goodies that we have been promised.  Salesman Summers explains:

Just as a family that goes on a $500,000 vacation is $500,000 poorer
but a family that buys a $500,000 home is only poorer if it overpays,
the impact of the $700bn programme on the fiscal position depends on
how it is deployed and how the economy performs. The American
experience with financial support programmes is somewhat encouraging.
The Chrysler bail-out, President Bill Clinton’s emergency loans to
Mexico, and the Depression-era support programmes for housing and
financial sectors all ultimately made profits for taxpayers…

Does this sound familiar?  I can hear it now.  A vacation sir is consumption but a home, ah a home, that’s investment.  Investments pay off.  Just look at the American experience.  Rising home prices!  Never a downturn.  Isn’t that encouraging?  Hell, at prices like these you can hardly afford not to buy.  Yes sir, a home that’s a wise investment.  And that makes you sir, a wise investor.  And a wise investor, well a wise investor can certainly afford a nice vacation.    

A new insurance proposal

From Mehrling and Kotlikoff:

Rather than ask Hank Paulson to
determine the price of each and every toxic asset, let’s have him
simply set prices for the ABX insurance policies (or credit default
swaps, as they are called). Right now these insurance policies are
selling for crazy prices because nobody can insure against systemic
risk. Nobody, that is, except the government. The government is in a
unique position to insure against system-wide risk because its own
decisions determine, to a very large degree, the extent of this risk.

Were the government to start selling the ABX insurance policies at
reasonable prices, our Cinderella mortgage-derivatives market would
suddenly wake up and start pricing every mortgage-related security in
sight based on these ABX prices. If Hank does this, the market will do
essentially all the pricing; Hank will have only a handful of prices to
set, not thousands.

Here is another explanation of the same.  And more here.  I miss the good ‘ol days of squabbling about single-payer plans and the Milton Friedman Institute.

Vulture Capitol

Much like John McCain, Rudy Giuliani, who accompanied the presidential
candidate on a campaign plane earlier today, is very interested in what
happens with the government’s bailout plan. That’s because his law
firm, Bracewell & Giuliani, is letting potential clients know it can best steer them–with its new Task Force– to deal with the bailout.

See the photo and press release, which says this:

Mr. Giuliani noted that the Bracewell Task Force includes a former
Comptroller of the Currency, a former Assistant Secretary of
Legislative Affairs of the U.S. Department of the Treasury, former
members of Congress from both political parties, former federal
prosecutors, and former SEC enforcement attorneys.

They will even have a blog, to update people on the latest revenue opportunities.  I thank a loyal MR reader for the pointer.

Labor market outcomes for transgendered individuals

Yes economists study this too:

We use the workplace experiences of transgender people – individuals
who change their gender typically with hormone therapy and surgery – to
provide new insights into the long-standing question of what role
gender plays in shaping workplace outcomes. Using an original survey of
male-to-female and female-to-male transgender people, we document the
earnings and employment experiences of transgender people before and
after their gender transitions. We find that while transgender people
have the same human capital after their transitions, their workplace
experiences often change radically. We estimate that average earnings
for female-to-male transgender workers increase slightly following
their gender transitions, while average earnings for male-to-female
transgender workers fall by nearly 1/3. This finding is consistent with
qualitative evidence that for many male-to-female workers, becoming a
woman often brings a loss of authority, harassment, and termination,
but that for many female-to-male workers, becoming a man often brings
an increase in respect and authority. These findings challenge the
omitted variables explanations for the gender pay gap and illustrate
the often hidden and subtle processes that produce gender inequality in
workplace outcomes.

Here is the article.  I’m not so sure this solves the identification problem, since it ends up looking at atypical individuals (those who switch to female may not be the same personality types as those who switch to male).  But, on this topic, what do I know?

I thank Zuzanna for the pointer.

Not from The Onion: The Teenage Put

Parents are abandoning teenagers at Nebraska hospitals, in a case of a well intentioned law inspiring unintended results.

Over the last two weeks, moms or dads have dropped off seven teens
at hospitals in the Cornhusker state, indicating they didn’t want to
care for them any more.

Under a newly implemented law, Nebraska is the only
state in the nation to allow parents to leave children of any age at
hospitals and request they be taken care of, USA Today notes. So-called
“safe haven laws” in other states were designed to protect babies and
infants from parental abandonment.

..The moral of this story appears to be that safe haven
laws need to be very carefully and narrowly written to ensure they’re
not abused by parents.

From now on I will will tell my kids, "Behave! or we’re moving to Nebraska!"

Regulatory accountability

A handful of the agency’s [Office of Thrift Supervision] officials were always on the scene at an
A.I.G. Financial Products branch office in Connecticut, but it is
unclear whether they raised any red flags. Their reports are not made
public and a spokeswoman would not provide details.

Here is the story, interesting throughout.  One response to this anecdote is to think we simply needed more regulators on the scene and indeed on many other scenes as well.  A different response is to conclude that institutions of many different kinds work less well than we used to think.

What are the remaining pressure points?

Do read up on Arnold Kling before proceeding.  From my outsider’s vantage point, it seems that commercial bank failures and consolidations are already being handled (see Alex’s recent posts) and of course the investment banks are gone.  Money market funds are now (mostly) insured.  I see three key questions for the next few weeks:

1. Will there be a run on hedge funds?

2. Will the commercial paper market dry up?

3. Will the Fed have to bail out any major foreign banks?

At this point, perhaps the Paulson plan is directed against these contingencies rather than being for the commercial banking sector per se.  From this list, it is least clear how the Paulson plan would handle #2, although you could point to a short-run confidence effect.  Will that last?  #2 is the hardest to handle without implicitly socializing parts of the real economy and if you have good proposals for #2 please let us know.  How much can corporations bypass the commercial paper market altogether? 

"Recapitalization is a public good" is one key phrase for this crisis; "no natural buyers" is another.  So far debate over the plan has focused on the first phrase but not the second.

Addendum: Bruce Bartlett defends the Paulson plan.  So does Kudlow.

Substitute Bridges

Binyamin Appelbaum at the Washington Post should get an award for writing a story so much at odds with the conventional wisdom.

Banks throughout the United States carried on with the business of
making loans yesterday even as federal officials warned again that
their industry is on the verge of collapse, suggesting that the
overheated language on Capitol Hill may not reflect the reality on many Main Streets.

…. many smaller banks said they were actually benefiting from the problems on Wall Street. Deposits are flowing in as customers flee riskier investments, and well-qualified borrowers are lining up for loans.

"We collect money from local savers, and we lend it in the local community," said William Dunkelberg, chairman of Liberty Bell Bank
in Cherry Hill, N.J. "We’re doing fine. There are 9,000 financial
institutions out there, and most of them are small and most of them are
doing fine."

Dunkelberg, a professor of economics at Temple University and chief economist for the National Federation of Independent Business,
added that a recent survey of that group’s members found that only 2
percent said getting a bank loan was the great challenge facing their

Even some of the nation’s largest banks, which have pushed hard for a
federal bailout, deny that the current situation is forcing them to
reduce lending. "The strength of our core businesses, capital and
liquidity are enabling us to continue to support our customers," Bank of America, the nation’s largest bank, said in a statement. It added, however, that the bailout plan would allow more lending.

The most recent Federal Reserve
data show that the volume of outstanding bank loans declined 0.5
percent from the last week of August to the second week of September,
though it was up more than 6 percent from the corresponding time last

The article goes on to discuss some of the real problems in the industry and do bear in mind that the majority of deposits are in big banks.  Nevertheless, I found the perspective valuable.  As I have argued, we should be paying more attention to the institutions that are doing well and can serve as substitute bridges to keep credit flowing to firms with valuable projects.  I have also advocated increasing savings with a temporary savings stimulus package – this could involve expanding and making contributions to Roth IRAs tax deductible or something like promising no taxes on CD investments of 1 year maturity or longer that are made in the next year .

Is a Potential Bailout Making Things Worse?

Ken Rogoff says yes.  Elizabeth Warren at Credit Slips summarizes Rogoff’s discussion at a Harvard Roundtable (video):

Any liquidity crisis is caused by the promise of a government
bailout. Ken said [Actually this was Greg Mankiw, AT] that his many friends in investment banking said that
there is plenty of money to invest in financial services, but right now
it is "sitting on the sidelines."  Why?  Because the financial services
industry does not want to pay the terms required to get that money back
in circulation (e.g., give up equity).  As he put it, why do business
with Warren Buffett who will negotiate a tough deal, if you believe
that the government will ride in soon with cheaper cash? 

Ken [this is correct, AT] also talked about the need to shrink the financial services
sector. He thinks it is good that the investment banking houses are
failing and many people on Wall Street are losing their jobs because,
in his view, we have an oversupply in that sector and our economy just
can’t support it.   

Ken’s background with the IMF and on the Board of the Federal
Reserve add a certain credibility to his assessment of conditions on
Wall Street.  If he is right, the $700 bailout is saving some
investment bankers’ jobs in the short term, but overall it is just
making the financial system worse.

In a related point Felix Salmon suggests that the Ted Spread may not be a valid measure of distress when the Fed is providing lots of liqudity.

…if you’re a bank, you really neither want nor need three-month
interbank funding right now. Global central banks, led by the Federal
Reserve, have flooded the system with so much overnight liquidity that
you can get as much cash as you need, at a much lower interest rate,
directly from your central bank, overnight. The choice between that and
locking in a high interest rate for three months is a no-brainer.

The WaMu Speed Bankruptcy

The Washington Mutual "speed bankruptcy" seems like a good model for the rest of the industry.  The FDIC took over the bank, wiped out the shareholders, and immediately auctioned it off to JP Morgan who paid $1.9 billion. Depositors are secure.

Notice that to do the deal, JP Morgan raised $10 billion in the equity markets and their shares rose.  Moreover, the issue was oversubscribed so they may go back for more.  All this illustrates that at least some of the substitute bridges from savers to investors that I have talked about continue to work (on the latter point see also Arnold Kling and Steve Landsburg). 

Hat tip to Garrett Jones.

It’s a bird, it’s a plane, it’s Jetman

What we need today is a superhero.  Thus, I give you Jetman.

Fly385_404109pSwiss adventurer Yves Rossy flew from England to France Friday
propelled by a jetpack strapped to his back — the first person to
cross the English Channel in such a way.

Rossy, a pilot who normally flies an Airbus airliner, crossed the 22
miles between Calais and Dover at speeds of up to 120 mph in 13
minutes, his spokesman said.

Quoted here.  More pictures here.

What do the Republicans want?

Under the alternative Republican plan, the government would set up an
expanded insurance system, financed by the banks, that would rescue
individual home mortgages. The government would not have to buy up the
toxic mortgage-backed assets that are weighing down financial

Here is the story.  Is this the Jeffrey Ely plan (you heard it here first!)?  Do any of you have more information?  Does the Paulson-Bernanke rejection of this plan count as a very bad signal about the immediate solvency of major banks?

Another modest proposal

This one is even more modest than the last.

Let’s say you have ten banks and two of them are insolvent.  But you don’t yet know which two.  So the credit market is messed up for all ten because at some sufficiently high level of risk credit just shuts down.  The goal then is to reveal which two of the ten banks are insolvent.

I’ve been thinking of all those old puzzles where a bunch of guys enter the room and only so many of them have smudges on their foreheads and you have to find the algorithm to reveal that information.

What can be done?  Temporarily allow insider trading, with short selling of course?  (Bryan Caplan’s idea)  Make executives either resign or post personal bonds, where default of the bond follows if the bank ends up insolvent?  Change laws and make banks exhibit their books to the public and let traders sort it out?

I don’t know.  But maybe sorting out the bad banks is one alternative to finding and isolating the toxic assets.  Because once all the remaining banks are good and known to be good, the problem of toxic assets no longer seems so paralyzing.

I’m still not sure that the Treasury buying bank assets is to best way to make this sorting, and that’s leaving aside the price tag.  In fact maybe Treasury buying postpones this revelation of information.

Of course if eight of the ten banks are bad, maybe we don’t even have the luxury of asking these questions.