Month: March 2009

Maybe the owners deserve TARP funds as well:

The bed manufacturer reckons that finding someway to keep your cash safe is
becoming increasingly problematic. So it has come up with a new divan bed
that conceals a safe.

That's for the UK, of course, where standardized deposit insurance has not attained the heights seen in this country.  I thank Michael Cleverly for the pointer.

Explained here.  Excerpt:

Let’s say that Citigroup were restructured – via bankruptcy, or via
government conservatorship – in such a way that creditors did not get
all their money back. (None of this applies to FDIC-insured deposits or
to recently-issued senior debt that is explicitly guaranteed by the
government.) They might be forced to convert debt for equity, or they
might be stiffed altogether. The first-order concern is that this would
have ripple effects that could take down other financial institutions.
According to Martin Wolf,
bank bonds comprise one quarter of all U.S. investment-grade corporate
bonds; losses would be spread far and wide, hitting other banks,
pension funds, insurance companies, hedge funds, and so on. If
Citigroup did not support its derivatives positions, then institutions
that bought credit default swap protection from Citi would face further
losses. (I believe that most U.S. banks were net buyers of CDS
protection, however.) The fear is that it will be impossible to predict
how these losses will be distributed and who else might go down.

The second-order concern is bigger. After all, Lehman did not seem
to force any major financial institution into bankruptcy, although it
may have twisted the knife that AIG had already stuck in itself. Once
investors figure out that bank debt is not safe, they will refuse to
lend to any banks, and we are back in September all over again. Or
almost: it is possible that the Federal Reserve’s massive efforts to
provide liquidity to the banking system will be enough to keep banks
functioning. But who wants to take that risk?

You're comparing that to spending a great deal of extra money on credit bail-outs; choose your poison.

From Simon Johnson:

The credit default swap market is a modern Delphic Oracle.  It speaks
loudly and profoundly – these days at regular intervals – albeit using somewhat arcane terminology.

…The most plausible interpretation - and here I’m willing to debate what
the Oracle meant exactly – is that people expect the government will
force the conversion of junior bank debt into equity.  The treatment of
private preferred shareholders at Citigroup, last week, is seen as the
harbinger of further losses for investors.

…The events of mid-September 2008 were traumatic and awful to behold.  I
saw that trailer and I don’t want to see the movie.  But it is exactly
into that scary future that we now head.

Addendum: An excellent follow-up.

The always-keen John de Palma sent me this:

(…)policy multipliers
are likely to be disappointingly small compared with historical
estimates of their importance. Many of you will remember from Econ 101
the idea of the Keynesian multiplier, which is that the impact of
traditional macro policies is "multiplied" by boosting private
consumption by households and capital investment by firms as they
receive income from the initial round of stimulus(…) Policy
multipliers are greater than 1 to the extent the direct impact of a
policy on GDP is multiplied as households and companies increase their
spending due to the increased income flow they earn from the
debt-financed purchase of goods and services sold to meet the demand
generated by the initial round of stimulus. Historically, multipliers
on government spending are estimated to be in the range of 1.5 to 2,
while multipliers for tax cuts can be much smaller, say 0.5 to 1. But
these estimates are from periods when households could – and did – use
tax cuts as a down payment on a car or to cover the closing costs on a
mortgage refinance(…)With the credit markets impaired, tax cuts, as
well as income earned from government spending on goods and services,
will not be leveraged by the financial system to nearly the same
extent, resulting in (much) smaller multipliers(…)

Yves Smith offers a very good critique of the mortgage modification plan.  Excerpt:

So effectively, the borrower gets a teaser that over time adjusts to a fixed rate mortgage at current (low) interest rates.

Let's
think this through a second. The borrower is still under water (of
course, Bernanke & Co. regard this as temporary misvaluation
resulting from irrational pessimism, but the more data driven crowd
sees housing prices as having moves way out of line with incomes. And
the outlook for incomes isn't exactly rosy either). The borrower
therefore has no reason to invest in the house, including routine
maintenance (assuming he can somehow scare up the dough). If the boiler
goes, the roof leaks, he has no incentive to fix it. Similarly, if he
were to sell the house (let's say he got a good job elsewhere), he's
still faced with either negotiating a short sale or walking and leaving
the bank with the property. Thus for the bank all this does is kick the
can down the road, unless we assume a recovery from these levels.

But there is much more, read the whole thing.  In my view the plan is bad news and will not work.  It is a waste of taxpayer money and even progressives should be highly critical of this weak initiative.

I am reluctant to embrace write-downs of mortgage principal, but if you wish to consider a major plan that is the direction you must look.  John Geanakoplos and Susan Koniak had an interesting piece in the NYT today:

For these non-prime mortgages, there is room to make generous principal
reductions, without hurting bondholders and without spending a dime of
taxpayer money, because the bond markets expect so little out of
foreclosures. Typically, a homeowner fights off eviction for 18 months,
making no mortgage or tax payments and no repairs. Abandoned homes are
often stripped and vandalized. Foreclosure and reselling expenses are
so high the subprime bond market trades now as if it expects only 25
percent back on a loan when there is a foreclosure.

Again, read the whole thing and consider also the diagram.  This is a critical passage from the piece:

It shows that monthly default rates for subprime mortgages and
other non-prime mortgages are stunningly sensitive to whether a
homeowner has an ownership stake in his home. Every month, another 8
percent of the subprime homeowners whose mortgages (first plus any
others) are 160 percent of the estimated value of their houses become
seriously delinquent. On the other hand, subprime homeowners whose
loans are worth 60 percent of the current value of their house become
delinquent at a rate of only 1 percent per month.

Despite all
the job losses and economic uncertainty, almost all owners with real
equity in their homes, are finding a way to pay off their loans. It is
those “underwater” on their mortgages – with homes worth less than
their loans – who are defaulting, but who, given equity in their homes,
will find a way to pay. They are not evil or irresponsible; they are
defaulting because – for anyone with an already compromised credit
rating – it is the economically prudent thing to do.

Is that what "the ownership society" has come to?

Here is more bad economic news from Asia.  Yet those countries don't have banking crises as many other nations do.  So what exactly is up?

The usual story is that these nations are "heavily dependent upon exports."  But if I may wear my Don Boudreaux hat for a moment (or more), is not the state of Kentucky also heavily dependent upon exports?  Is not the Cowen household heavily dependent upon exports?  Why is being dependent on exports so especially bad for parts of Asia?

One answer is that Asian exports, which travel great distances, are often consumer durables and such purchases are especially easy to postpone. Services are often more robust.

Another answer is that many Asian producers have chosen high fixed costs in a way that requires steady or rising revenue over time.  That is their version of being highly leveraged without taking on much explicit debt.  Again a central lesson of this depression will be how many different ways there are to leverage.

Last week I was surprised to read this:

“For a long time, Harvard had a negative 5 position,” she said. “That
means that 105 percent of the assets are invested at most times.”

So far it seems that the least leveraged parts of the world — all things considered — are South America and sub-Saharan Africa.  Brazil, Chile, and Peru are a few of the countries which, in relative terms, are suffering least.  If you wish to understand the course of events, keep your eye on those locales.