Month: September 2008

Should we worry about liquidity traps?

Well, short-term T-Bill rates were very close to zero yesterday.  But I’ve long felt that the liquidity trap argument is overrated in its import.  Here is my previous post on the topic.  (As you may know, I don’t like "re-runs" but I’ve received many requests for this.)  Here’s one bit from the post:

Open market operations, when tried, seem to have worked in 1932.
Was Japan in a liquidity trap in the 1990s?  They could have printed
more money and given it to me.  With an interpreter at my side, I would
have spent it right away.  Who knows, maybe you could have helped me.
Here is a good critique of Krugman on Japan.

…What is the evidence for a liquidity trap?  Low nominal rates and the
absence of a recovery?  That’s not much evidence.  I suspect real
coordination problems are at fault in most of these settings, and
hoarding is at most a secondary issue.  Few serious economic problems
are purely monetary in nature, yet the liquidity trap encourages us to
embrace that dangerous idea.

By the way, some sources (now verified) claim that Treasuries "traded negative" for a brief while yesterday.  T-Bills are standard collateral for many kinds of transactions, so for very brief periods of time they can have a shadow value higher than that cash, even apart from the possibility of earning a nominal interest rate.

The liquidity trap is most likely a problem when the Fed is restricted to open market operations, namely trying to trade cash for T-Bills.  A less orthodox Fed (and yes, that is what we have) has many ways around the trap, if indeed it was ever a trap in the first place.

The culture that is French, a continuing series

“I fear the government has passed the point of no return,” said Ron Chernow,
a leading American financial historian. “We have the irony of a
free-market administration doing things that the most liberal
Democratic administration would never have been doing in its wildest

While they acknowledge the shock of the collapse of Lehman Brothers, the bailout package for A.I.G. on top of earlier government support for Bear Stearns, Fannie Mae, and Freddie Mac has stunned even European policy makers accustomed to government intervention in the economy.

“For opponents of free markets in Europe and elsewhere, this is a wonderful opportunity to invoke the American example,” said Mario Monti, the former antitrust chief at the European Commission.
“They will say that even the standard-bearer of the market economy, the
United States negates its fundamental principles in its behavior.”

In France, where the government has long supported the creation of
national champions and worked actively to protect select companies from
the threat of foreign takeover, politicians were quick to point out the
paradox of what is essentially the nationalization of the largest
American insurance company.

“Today the actions of American
policy makers illustrate the need for economic patriotism,” said
Bernard Carayon, a lawmaker of President Nicolas Sarkozy‘s center-right governing party, UMP. “I congratulate them.”

Here is the story.  Since I am not a policy maker, I cannot claim that I am being congratulated personally.  Still, I believe I am receiving a kind of indirect congratulations.

The economic fallout from these events is dominating the headlines.  The intellectual and ideological fallout we are just beginning to contemplate.

The good news

There is some.  First, it seems (knock on wood) the Fed and Treasury may make money off the AIG deal, at least over a time horizon of one to two years.  Felix Salmon explains some detail.  The company has assets and if it needs to borrow money it is paying the Fed at Libor plus 850 (!). 

Second, the size of a guarantee does not represent the cost of the bailout.  I have been getting many emails about "the cost of the bailouts" and in truth we still don’t know what those costs will be.  But think in terms of balance sheets to start on the problem, not numbers in headlines. 

Third, if the Fed needs to "print money" to make good on various guarantees (NB: this has not been the case), this need not be as disastrous or as inflationary as it sounds.  If it came to this, the Fed is creating money to protect against potentially deflationary events so the inflationary impact of that money creation is blunted.  (That said, you don’t usually want to trade in bank-created higher monetary aggregates for an increase in borrowed reserves.)

You might wonder if AIG is (possibly) a money-making deal, why no one else wanted in on the action.  Think of it as a prisoner’s dilemma among the lenders.  No one of them wants to put up money at non-exorbitant rates and so the company — which has partially illiquid assets and profit-maximizing, weakly capitalized shareholders determined to take advantage of lenders — fails.  But with the guarantee the company can borrow cheaply and the lending continues.  The company can continue and oversee an orderly liquidation.  That’s not a pretty picture and it does mean that, in the bad world-states, losses continue to stack up precisely because the guarantee was extended.  But the good world-states are there too and the expected value of the guarantee and purchase may well be positive.  To give an example, Argentina in its crisis days had net positive value but no one wanted to lend to them either.

Recent events remind me of the arguments against free capital movements for developing countries and whether those capital movements boost economic stability and growth.  Well, we have free capital movements for investment banks and insurance companies and of course the losers get hit by whipsaw effects.

Did you notice that short-term Treasuries have been trading at rates close to zero?  That’s not good news. 

In presenting all this "good news," I don’t mean to communicate a pollyannish attitude.  The bad news is indeed very bad but let’s understand it in its proper context.

I’d like to stress again that I remain worried about the rule of law in all these events.  First, the referee is on the playing field.  Second, while Dodd and others are on board, basically we have the executive branch of our government — the Treasury — operating without formal checks and balances.  (Does that sound familiar?  Would this administration do that?)  That’s why it is all being done through the Fed.  Fortunately the Fed is also a competent technocracy (as is the current Treasury) but the broader implications here are very worrying, both for governance and for the future of the Fed itself.

Maybe there is no better alternative, but these developments are a sign of just how dysfunctional American government has become.

Is central bank independence gone?

It’s another bail-out of sorts today, although you won’t hear it described as such:

The Treasury Department announced today the initiation of a temporary Supplementary Financing Program at the request of the Federal Reserve. The program will consist of a series of Treasury bills, apart from Treasury’s current borrowing program, which will provide cash for use in the Federal Reserve initiatives.

Here is the link.  How long will it take to win back Fed independence?  There used to be talk that "The Paulson Plan" would centralize various kinds of financial regulation in the Fed.  But, as it turns out, under the "beta" version of the plan, the Fed goes hat in hand to…Paulson.  I guess that’s why they call it The Paulson Plan.

The legal status of the takeover

Here is one opinion:

I imagine that the legal answer to that question depends on a nice distinction between practice and plain language. Under the plain language of the statute, interpreted imaginatively, the Fed can extend credit, upon the right showing, to any company or individual, and so why not insist on conditions on the loan?  Heck, why couldn’t EPA, in the name of fishable swimmable rivers (that’s Clean Water Act language), ban all pesticides, including dishwasher detergent, or nationalize water users like the steel industry?  Maybe it can!  Which might be good news for environmental activists.

I thank David Zaring for the pointer to this very interesting analysis.  So far I haven’t seen a more detailed post, nor has Google, but please let us know in the comments if you are aware of other serious treatments of the question.  The question is justifying the ownership, not the lending.  I’ll update this post if I learn more of relevance.  I’ve also posed the query over at  Marty Lederman adds comment.  Eric Posner thinks it is fishy and that the "collateral" for the loan would legally count as a sale.

…are doomed to repeat it

Systemic risk can render drastic action necessary.  But what about the prospects for the long term?  Will they truly look up?  David Leonhardt writes:

The Chrysler bailout may have saved the company, but it did nothing, after all, to stop Detroit’s long, sad decline.

Barry Ritholtz – who runs an equity research firm in New York and
writes The Big Picture, one of the best-read economics blogs – is going
to publish a book soon making the case that the bailout actually helped
cause the decline. The book is called, “Bailout Nation.” In it, Mr.
Ritholtz sketches out an intriguing alternative history of Chrysler and

If Chrysler had collapsed, he argues, vulture investors
might have swooped in and reconstituted the company as a smaller
automaker less tied to the failed strategies of Detroit’s Big Three and
their unions.

…Speaking of which, Detroit’s Big Three have come back to Capitol Hill
lately, lobbying for billions of dollars in handouts. This time, their
executives insist, they’ll use the money to solve their problems.


Google Heads to Sea, Will You?

The NYTimes Bits Blog reports:

The search and advertising company has filed for a patent
that describes a “water-based data center.” The idea is that Google
would create mobile data center platforms out at sea by stacking
containers filled with servers, storage systems and networking gear on
barges or other platforms.

This would let Google push computing centers closer to people in
some regions where it’s not feasible, cost-effective or as efficient to
build a data center on land. In short, Google brings the data closer to
you, and then the data arrives at a quicker clip.

Perhaps even more intriguing to some, Google has theorized about
powering these ocean data centers with energy gained just from water
splashing against the side of the barges.

Hmmm, do I spy the work of Patri Friedman, libertarian, Googler and seasteading proponent?  Perhaps the seasteaders are ensuring that they have good internet access.  As you may recall, Paypal entrepreneur Peter Theil is backing the seasteaders so there is more than one Silicon Valley entrepreneur with an eye on the sea.

By the way, the First Annual Seasteading Conference will be held in Burlingame, CA on October 10.  The conference is sure to be interesting but shouldn’t it have been held here

The sad saga of Almaz Moges

The National Bank of Ethiopia (NBE) has sacked Almaz Moges from her post as General Manager of the turbulent Nile Insurance.

Nana, Banking and Insurance Supervision Department head, wrote a letter
to Nile on June 19, 2008, informing them that her deputy, Dawit G.
Amanuel, would take over the post. It is alleged, however, that she
refused to hand over the office to her successor. The central bank
subsequently shut down the office on Thursday, June 26, 2008.

The letter came a week after the central bank
declined to approve two of the seven newly elected members of the Board
of Directors. Almaz had been advised by officials at the NBE that the
insurance company needed better management. Currently, the company is
in debt for more than 50 million Br following various business deals.

Yes the company had excess debt.  Here is the story.  Here is a picture of Almaz Moges.  Here, in black and white, is the authorized role of the bank in regulating insurance companies.  Here is Megan McArdle and here.  Read Felix Salmon.  Here are some cautionary words about strangers.  So can New York State now regulate the Fed?

There is more toast

Russia suspends trading with stocks down 17 percent.  There is a financial crisis and much of it is energy-related:

“The fundamental issue is oil. Russian oil companies are not producing more so their earnings are dependent on a rising oil price,” said Daniel Salter, analyst at ING. If the oil price falls, then earnings downgrades are in the pipeline for these stocks, he added.

State-backed bank VTB tumbled 33 per cent to Rbs0.03 and Volga Telecom sank 28 per cent to Rbs37.

Here is a recipe for Russian toast.  The price of oil was down to $91 a barrel last I looked.

AIG is Toast

So says Felix Salmon:

AIG’s $2.5 billion of 5.85 percent notes due in 2018
plunged 19.5 cents to 33 cents on the dollar as of 9:55 a.m. in New
York, according to Trace, the bond-price reporting system of the
Financial Industry Regulatory Authority.

(quote from here).  33 cents on the dollar? The message is loud and clear: AIG
is toast. This is the massive counterparty failure everybody’s been
scared of, and frankly I’m astonished that the broader stock market
isn’t plunging as a result. No one is prepared for the
repercussions here: the failure of AIG is likely to be an order of
magnitude more harmful than the failure of LTCM would have been. And
it’s not even happening on a Friday, where we could have yet another
Emergency Weekend to try to work things out.

Dilbert’s poll of economists on Obama vs. McCain

Obama wins, 59-31 percent, here is the story.  The individuals responding to the poll had this distribution of opinion:

48 percent — Democrats

17 percent — Republicans

27 percent — Independents

3 percent — Libertarian

5 percent — Other or not registered

In other words, Obama didn’t do as well as I would have expected, relative to the survey group.  There is much more information in the article, such as this:

On the issue of international trade, only 42 percent of our Democratic economists support Obama’s plans, with 34 percent favoring McCain. Independents favored McCain on this question by 63 percent to 16 percent, while favoring Obama overall.

Another indicator of objectivity is that the income levels of the economists have little impact on their opinions. The economists with lower incomes are no more likely to favor taxing the rich than the rich economists favor taxing themselves.

Likewise, economists in the academic world were largely on the same page as the nonacademic types in predicting which candidate would be best for the long term.

I thanks Alice Miller for the pointer.  And if you do leave a comment, note that the marginal return to being partisan in this setting is very low or even negative.

Public libraries for tools?

Noah writes to me:

Big fan of the blog.  I was wondering whether there’s a reason other than historical accident why the public library model only exists for media like books and music.  I understand the argument that books produce a social benefit that the government should be in the business of subsidizing, but surely there must be other goods with that kind of benefit that can be similarly lent out.  Take the example of tools, most of which are rarely used.  Is there a public good in having a mechanically-fluent citizenry that would justify a system of public tool libraries?  Or is there anything else you think it would make sense to build libraries around?

Reserves, it would seem, and maybe they will waive the overdue fines as well and perhaps even the lost reserves fines.  Mark Thoma ponders an AIG bail-out.

The countercyclical asset, a continuing series

A sale of pickled sharks, butterfly paintings and other pieces by the
provocative British artist [Damien Hirst] has raised more than US$125 million – a
record for an auction of works by a single artist. And there is more to
come Tuesday.

Here is the story and I thank Chris F. Masse for the pointer.  Here are previous installments in the series, including dirt for dinner in Haiti.