Category: Current Affairs

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.

Who should make this decision come January 20?

Israel gave serious thought this spring to launching a military strike
on Iran’s nuclear sites but was told by President George W Bush that he
would not support it and did not expect to revise that view for the
rest of his presidency, senior European diplomatic sources have told
the Guardian.

Here is the story, from The Guardian.  I hope you all have given this matter some thought…

A Supply Side Approach to the Crisis

Yesterday I pointed out that credit is still robust.  Growth rates are declining, however, and many people say the real crunch is around the corner.  Thus, today I want to suggest a new approach to dealing with the crisis that will have benefits regardless of how the crisis unfolds.

I see the key issue as follows: Banks bridge the gap between savers and firms.  We want to keep capital flowing to firms even when some of the bridges collapse.  One approach tries to prop up the collapsed bridges, a second approach tries to route funds across substitute bridges.  A third approach is to increase the flow pressure – in other words, I suggest a temporary but large stimulus to savings.

I suggest that for the next 12 months contributions to an IRA account will never be taxed.  We can modify this in various ways to cap contributions at a certain level etc.  We can even make the proposal progressive – for the next 12 months contributions to an IRA account will never be taxed and the government will match $1 for every $10 saved for anyone with income below a certain threshold.  The main idea is to increase savings.

The increase in savings will help deal with our current problems by offsetting any credit crunch.  (Some of the savings will also help to recapitalize banks.)  In addition, the U.S. needs a higher savings rate regardless.  During the 1990s as measured savings rates declined to zero commentators argued that rising asset values compensated.  Well asset values are now falling so true savings are negative – thus we need to increased savings.

A big benefit of this proposal – lower taxes, higher savings and a savings bonus to those with lower incomes – is that it should appeal to both the right and the left.

Betting markets in everything

Will Congress approve a bail-out package for banks before September 30?  Right now the contract is selling at about 79, which usually translates roughly into a 79 percent chance of approval. 

Note however that the marginal utility of money here does differ across worldstates.  Assume that the marginal utility of money is higher (people are poorer) with no bail-out.  That makes some people want to bet against the bail-out as a form of insurance, thereby raising the price of the "no bail-out" contract.  (Addendum: that was bad phrasing — no one has to intend insurance as long as the MUs of money differ across the world-states.)  In other words, the real implied chance of a bail-out is higher than 79 percent.

Economists Speak

An excellent Open Letter on the Bailout signed by many economists.  Hat tip to Justin Wolfers.

As economists, we want to express to Congress our great concern for the plan
proposed by Treasury Secretary Paulson to deal with the financial crisis. We are
well aware of the difficulty of the current financial situation and we agree
with the need for bold action to ensure that the financial system continues to
function. We see three fatal pitfalls in the currently proposed
plan:

1) Its fairness. The plan is a
subsidy to investors at taxpayers’ expense. Investors who took risks to earn
profits must also bear the losses.  Not every business failure carries systemic
risk. The government can ensure a well-functioning financial industry, able to
make new loans to creditworthy borrowers, without bailing out particular
investors and institutions whose choices proved unwise.

2) Its
ambiguity.
Neither the mission of the new agency nor its
oversight are
clear. If  taxpayers are to buy
illiquid and opaque assets from troubled sellers, the terms, occasions, and
methods of such purchases must be crystal clear ahead of time and carefully
monitored afterwards.

3) Its long-term effects.  If the plan is
enacted, its effects will be with us for a generation. For all their recent
troubles, Americas dynamic and innovative private capital markets have brought
the nation unparalleled prosperity.  Fundamentally weakening those markets in
order to calm short-run disruptions is desperately short-sighted.

For
these reasons we ask Congress not to rush, to hold appropriate hearings, and to
carefully consider the right course of action, and to wisely determine the
future of the financial industry and the U.S. economy for years to come. 

Ike Brannon, where is my talk?

My Wednesday evening, 6:30 p.m., Washington, D.C. talk on the financial crisis.  Both I and some MR readers would like to know, so please leave the answer in the comments.  If you know Ike, could you please forward this inquiry to him?  My email for him isn’t working and tomorrow I am on the road.

And for those of you wondering about my Bloggingheads.TV with Robin Hanson, Robin had a cold and we will reschedule it.

International public goods? Public bads?

Among the potential sources of tension is the Treasury’s ultimate
decision on whether it will buy troubled mortgage-backed securities
from non-American banks. European banks, like UBS, invested heavily in such securities.

“If
Paribas has bought a mortgage-backed security, why can’t they present
it to Treasury?” Mr. Truman said. “If the government is going to do it
for the American banks, they should do it for everyone.”

But that
could provoke a strongly negative reaction from lawmakers on Capitol
Hill, who already protested that other countries should chip in for the
$85 billion rescue of the insurance giant American International Group, because it has operations in those countries or has insured their banks.

“Are
the taxpayers in the United States going to bail out all the banks in
the world?” said Allan H. Meltzer, a historian of the Federal Reserve.
“I just don’t know how this works out.”

Here is the story.

Sentences to ponder

“It’s important to pay taxes if you want to live a normal life,” said ‘Lisa’, a prostitute who spoke with the newspaper.

That’s from Sweden (no mention of patriotism), and apparently some social benefits are attracting more prostitutes to the taxed sector.  The record of income creates or enhances rights to sick-leave pay, parental leave benefits, and a pension.  Note that in Sweden it is illegal to buy sex but not to sell it.

Thanks to a loyal MR reader for the link.

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
dreams.”

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 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.

Getahun
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.