From My Ivory Tower
Posted: May 11, 2009 Filed under: Bailout Blues, Equity Markets, Global Financial Crisis, U.S. Economy | Tags: fiduciary responsibility, Financial Crisis, lend and hold mod 1 Comment(Note: I’m knee deep in end of the semester stuff so I thought I’d share with you my standard academic speech on the current financial meltdown. 
Don’t fall asleep now!)
While the underlying causes of the current mortgage and housing crisis cannot be perfectly elucidated at the moment, there appear to both micro and macroeconomic factors at work. The macroeconomic factors can be traced to a prolonged period of excess global liquidity. The was induced by relatively low interest rates set by the Federal Reserve Bank and other central banks following the US recession in 2001 and the events of 9/11/2001. This excess liquidity went into the demand for residential investment and triggered large increases in housing prices.
The roots of microeconomic crisis can be found in industry practices by financial intermediaries including the ‘originate and distribute’ lending model. Other factors included poor regulation of Fannie Mae and Freddie Mac, major players in the residential housing markets, and the loosening of underwriting standards for loans and leverage requirements for investment banks. This encouraged banks to provide house loans to folks ill-suited for them that were securitized to meet an increasing demand. The inherent risk in these loans was mispriced. The loan origination process was especially weak as many mortgage originators were more concerned with producing volume to ensure bonuses than soundness. Agents securitizing these mortgages did not audit individual loans for soundness. Additionally, rating agency models seemed completely unable to discover underlying default risk. Prudent auditing practices were missing at all levels of the lending process.
As the demand for houses increased, prices of those homes increased which increased the number of construction companies building homes and speculation in the housing market. Many of the people that bought homes did so at inflated house prices. Given the lax lending standards, these folks did not necessarily have down payments or the credit history and income to pay for these loans as the economy slowed and interest rates began to rise. Many did not even care about the terms of the loans since they were not planning on holding them very long. Regulators missed the build-up of vulnerabilities as much of the risk was perceived to be transferred to other, unregulated securities markets. Home buying and financing became a speculative activity with many buyers that were unaware of the risk and unprepared to handle the consequences of a downturn.
At the time of the failure of Fannie and Freddie, they were leveraged at a level of 150 and poorly capitalized to handle loan losses. Since many of the loans originated at this time were packaged and sold on the secondary market, an increasing default rate brought down the value of these bonds as well as other types of derivatives created from mortgage related assets. Since it is difficult now to value these assets and there appears to be no bottom set in the market, banks are now reluctant to lend to each other in the interbank markets and prefer to maintain high liquidity to cover potential losses and deposit withdrawals. At the moment, we’re seeing governments injecting capital into banks as well as the end of investment bank as a standalone entity. While this situation should be temporary, banking laws should be changed to prevent any future occurrence.
Regulations are likely to change as the crisis winds down. Both Fannie and Freddie require a complete overhaul, something that was tried in 2000 by the Clinton Administration and then by Congress in 2003 and 2005. It is unseemly in a market economy that extraordinary profits be privatized while losses resulting from bad management and accounting practices should be turned over to the taxpayer.
Additional Regulation over the derivatives market is also likely to result. These markets have largely been ignored until the meltdown. The government should ensure that sound underwriting practices are not undermined to achieve ‘affordable’ housing—especially not by the GSEs and other organizations that carry implicit taxpayer guarantees. Encouraging old fashioned “lend and hold” banking would help this. Affordable Housing initiatives most likely require target funds and programs that ensure transparency in the origination process and place borrowers in appropriate loans. Additionally, secondary markets must be more transparent, more standardized, and more accountable. It is possible that a revision of the mark to market accounting practices will be narrowed to asset classifications that are rich with asset valuation information only. It is also possible that certain short-selling practices may see restrictions.
Past crises have also show that regulation in the U.S. is reactionary. One example is the reaction to the bank runs during the Great Depression. A further example is the thrift crises in the 1980s. Sophistication of the markets, increased options for saving and investing, and borrowing went farther than the Fed’s ability to monitor and manage bank performance. As these crises occur, regulators respond and frequently must wait until laws catch up. The current crisis is no different.
One of the most significant studies of systemic banking crises has just been produced by the IMF this fall. Laeven and Valencia (2008) identified 124 systemic banking crises over the period of 1970 to 2007. Their study evaluates crisis resolution policies put in place to contain the crisis as well as the challenge of long-run system stabilization. They have found that nonperforming loans tend to be high during the onset of a banking crisis. During a Crisis in Chile in 1986, non-performing loans peaked at 36% of total loans. These were the result of unsound banking practices such as a high level of connected loans. The authors found that the percentage of non-performing loans ran as high as 75% of the total loans in one country and averaged about 25% across country. They also found that banking crises were frequently preceded by credit booms. This was also the case in Chile where the average annual growth of private credit to GDP prior to its crisis was as high as 34.1 percent.
In the case of Turkey in 2000, the trigger of the crisis was the collapse of the interbank loan market. It especially failed in loans from large to small banks. Any bank that depended heavily on overnight funding failed. Authors pointed out that Turkey widely exhibited problems in macroeconomic factors. At the time, inflation was growing at 80 percent per annum in the 1990s. The government also ran high fiscal deficits. There was large public debt, high current account deficits and a generally weak financial system. Because of these macro vulnerabilities, the banks had exposure through holdings of government securities. There were also the micro risks of maturity and exchange rate mismatches coming from market risk. It is possible that these factors are present in the current global financial crisis. This could extend the period of crisis beyond normal expectations.
Living La Vida Nada
Posted: April 29, 2009 Filed under: Bailout Blues, Equity Markets, Global Financial Crisis, U.S. Economy | Tags: Financial Crisis, Financial Times., FOMC, GDP, Martin Wolf, Quantative easing, recession, Willem Buiter, zombie banks 7 Comments
From the Federal Open Market Committee’s (FOMC) policy statement earlier today:
Information received since the Federal Open Market Committee met in January indicates that the economy continues to contract. Job losses, declining equity and housing wealth, and tight credit conditions have weighed on consumer sentiment and spending. Weaker sales prospects and difficulties in obtaining credit have led businesses to cut back on inventories and fixed investment. U.S. exports have slumped as a number of major trading partners have also fallen into recession. Although the near-term economic outlook is weak, the Committee anticipates that policy actions to stabilize financial markets and institutions, together with fiscal and monetary stimulus, will contribute to a gradual resumption of sustainable economic growth.
In light of increasing economic slack here and abroad, the Committee expects that inflation will remain subdued. Moreover, the Committee sees some risk that inflation could persist for a time below rates that best foster economic growth and price stability in the longer term.
In these circumstances, the Federal Reserve will employ all available tools to promote economic recovery and to preserve price stability. The Committee will maintain the target range for the federal funds rate at 0 to 1/4 percent and anticipates that economic conditions are likely to warrant exceptionally low levels of the federal funds rate for an extended period.
It goes on to state that its goal is to bring long term rates down farther by buying “up to an additional $750 billion of agency mortgage-backed securities”, “$300 billion of longer-term Treasury securities over the next six months” and “agency debt this year by up to $100 billion”. The Fed is aggressively using its balance sheet to inject liquidity into the financial system since the already low fed funds rate target is technically as low as it can get now. The Fed is hinting that we may be looking at the recession’s trough soon. Given the release of today’s 1st Quarter GDP, we can only hope and pray.
From Market Watch:
The central bank’s Federal Open Market Committee said that spending has stabilized and that the pace of the downturn appeared to be somewhat slower. The economy could remain weak in coming month but policy actions and “market forces” were aligned to create a gradual upturn, the statement said.
Fed watchers saw little drama in today’s announcement.
“The only major difference between today’s statement and the previous one on March 18 is that today’s cited the fact that most evidence points to a slowing rate of economic decline. Anyone with two eyes and a brain knows this to be the case,” wrote Josh Shapiro, chief U.S. economist at MFR Inc. in a note to clients.
Economists had expected the policy-setting panel to maintain the status quo. The FOMC kept its target interest rate unchanged at an ultra-low 0%-to-0.25% range.
The economy has fared dismally over the past six months — collapsing by the sharpest rate in more than 50 years. The unemployment rate has spiked and business investment has slowed.
Is this ANY way to run an Economy?
Posted: April 4, 2009 Filed under: Equity Markets, Global Financial Crisis | Tags: bailout, DeLong, Depression, Financial Crisis, Krugman, Obama/Geithner Bailout Plan, recession, Stiglitz, Summers Hedge Fund Salary, unemployment 4 Comments
The US economy is in a fragile state right now which begs the question: Why do our policy makers seem oblivious to lessons from the great meltdowns of the past? Adam Posner of the Daily Beast asks the question out right: Does Obama Have a Plan B? Posner asserts that the administration appears to be hellbent on recreating the Japanese Lost Decade. This is something that I’ve been harping on for months as has Paul Krugman and Joseph Stiglitz–two big brained economists with Nobel prizes.
So it is with some irony if not humility that we should approach Treasury Secretary Geithner’s Public Private Investment Plan presented on March 23. A number of major American banks have lost huge amounts of money, and clearly have insufficient capital if they are not literally insolvent. Why else would they be pushing so hard to change the accounting rules to avoid showing what they really have on their books instead of raising private capital? Why else is the U.S. government taking so long to perform “stress tests” and trying to get expectations of overpayment for some of the bad assets on the banks’ books before the test results are out? In short, the U.S. government is looking to shovel capital into the banks without sufficient conditions, hiding rather than confronting the actual situation.
That is just like the Japanese government in their lost decade, or the U.S. officials during the 1980s before they really tackled the savings-and-loan crisis. In those cases, the delay simply made the problem worse over time and in the end the government had to put more money into the troubled banks directly, taking over or shutting down the weakest of them. Whatever the political culture, it would seem we have not learned from experience. Or perhaps we cannot act on our learning. The universal barrier would appear to be the political difficulty of recapitalizing banks. That seems obvious, but the constraint it puts on good policy is enormous.
That is why the Geithner plan is so complex and jury-rigged, to avoid the need for public requests for more money for banks. Unfortunately, it is unlikely to succeed absent additional public money and more-intrusive government action. The plan will buy some time and certainly some appreciation in bank share prices. Current shareholders will be getting a new lease on life with subsidies from taxpayers. For that reason alone, the plan certainly will cost the taxpayer more in the end than a more direct recapitalization with public control would have.
Dead Cat Bounce or a Hint of Bull?
Posted: October 14, 2008 Filed under: Equity Markets, Hillary Clinton: Her Campaign for All of Us, John McCain, No Obama, U.S. Economy | Tags: dead cat bounce, economic plans, Financial Crisis, market bottom, mccain, Obama, Stock Market 1 Comment
The equity markets some times experience good days even in the worst of bear times. These up days are frequently just the dread dead cat bounce. This label comes from the saying that even a dead cat bounces if you throw it. You’re going to hear two things from me today; probably in two different posts. The first is just a line by line look at the Obama and McCain approaches to the economic panic. The second is the Paulson announcement to make $250 billion available to banks to help them recapitalize. I’m watching some of the interbank lending markets unfreeze, so it might be more than a dead cat bounce. There might be a hint of the bottom which would be something to celebrate.
I was trying to read this last night as well as a some literature on the Bank Capital Channel of Monetary Policy (something only an economist could love but is important in terms of looking at the possible outcomes for this move). I unfortunately chose to do it at my local bar and became the immediate target of the shriek of the Obamatrons and all the usual stuff: “racism, Palin is a c*nt, it’s okay for us to call her that because McCain called his wife that, no Obama NEVER said women get third trimester abortions because they’re blue, do you get all your information from fox news? racism, racism, racism.” I’m beginning to wonder if they hand out an instruction card with the koolaid on how to insult the unindoctrinated?
Sigh, so I’m working on this for your this morning instead. You’ll have to give me a wide berth as I try to do this in the peace and quiet of my house over coffee instead of red wine. Oh, also, just so you know I am now Miss Perfect and Miss Know it all. It felt like high school ALL over again. I think they were trying to ensure that the other two ex-Hillary supporters who were resigned to voting for the “ONE” would not leave the fold with anything as meaningless as facts and the truth. There was also a Republican and a Ron Paul supporter in the room to make things nice and interesting. For some reason, I got the brunt of the abuse. I can’t tell you how many times I was told to just get over Hillary.
So, any way, here goes the girl with the glasses again. While the market chews on the Paulson plan, I’ll start with my take on the McCain and Obama crisis plans in this post.
Obama’s plan seems centered on unemployment. This is a bit odd because the problem at the moment is not unemployment for most of the country. The only thing I can figure is this, combined with his plan to double the government’s loan guarantees for automakers, is a pander for votes in places like Michigan. Since the rust belt is important to winning the election, and the rust belt is the only place where unemployment is above normal at the moment, I have to cynically say this has nothing to do with financial crisis but everything to do with the electoral college.
I think giving employers a $3,000 tax credit for each new hire to encourage job creation is a good economic policy. At the moment, however it is not necessary and expensive. Until it looks like unemployment in the country as a whole is going to be a problem, I’m sticking with my view that this is just a pander to folks in important swing states in a not so subtle disguise.
His second idea is just plain awful and would create incredible long term problems. This is the idea that you should allow Americans of all ages to borrow/withdraw from retirementsavings without a tax penalty. One of our biggest problem right now (long and short) is that folks are NOT saving enough for retirement. Pulling anything out right now ensures those folks will be worse off in the future. Also, withdrawing funds from these accounts at the bottom of the market is like stealing future life style from people. People that do not need to do this will be encouraged to do so and it will make their lives worse in the long run. This is a stinker and I hope folks don’t follow through with it. If you’re thinking about doing this, please, please don’t.
I’m more hopeful about Obama’s suggestion of creating a mechanism to lend monies to cities and states with fiscal problems if this is done in a reasonable, thoughtful way. We’d need to see that current Treasury work in the markets is helping the municipal bond function and we need to be careful about exactly how the funds will be used. I’m afraid this could be turned into an expensive giveaway to interests rather than a real problem solver. For this suggestion, the devil will be in the details. This is my same take on his proposal to allow struggling small businesses to apply for loans from the SBA’s disaster funds to the tune of $5 billion. This sounds good on the surface and could help getting much need operating loans to some of the hardest hit players. I’d like to see the exact nature of the terms, however. You need to know what the terms of borrowing are and what kind of things the funds can be used for. Also, is this for existing businesses or new start-ups? The new-start ups would be highly risky propositions and subject to fraud.
Obama rehashed the Hillary suggestion of a 90-day moratorium on most home foreclosures. This would be geared to folks that are trying to make payments or partial payments. This is a good start, but again, it has to be followed by some kind of way to renegotiate the foreclosures or it’s basically just a few months grace. Some details are needed on what to do with the frozen mortgages. My hope is those details may be forthcoming, but I’m not holding my breath.
All of the Obama suggestions are very costly and there are no funding suggestions. At one time he was talking about windfall profits on oil companies but given the state of the economy now, I doubt there’s going to be any windfall profts on which to draw. The gas around here is running less than $3.00 a gallon. I can’t help but think the record level profits of the oil companies are not going to be around the next few quarters. Oil futures are about $80 a barrel right now, so my guess is no windfall profits to tax. So, another dimension of all Obama’s points is where is he getting the money? I always liked Hillary’s plans because they came with funding sources so they were grounded in realism and not promises.
The McCain Plan was introduced today with the Hillary suggestion of the Treasury Departmentbuying troubled mortgages at face value and giving qualified homeowners instead government-guaranteed, low interest mortgages. I’m already on the record supporting this in earlier posts since I firmly believe the short term solution is to bottom house prices. The mortgages would be based on the residences’ reduced value. We need to focus here on the details of ‘qualified’ homeowners because it does not need to be done with speculators or vacation properties. McCain has said there would be two possible funds for the valuation differences so I’m not clear which one he’s going for or if it’s giong to be some combination of both. Basically, either the taxpayer or the lenders would pay the difference.
Several other of his proposals are pretty typical of Republican approaches which focus on tax reduction. They are targeted tax reductions which is something I’m particularly big on. This is different than just throwing money at the entire market and hoping some of it trickles down and sidewise. McCain’s first proposal focuses on seniors (an important voting group) and allows them to withdraw from the IRAs or 401k’s in 2009 and 2010 while reducing their taxes to a flat 10 percent. Since this only applies to those over 59, there are no penalties so it’s different than the Obama plan. This is okay, since these folks ARE retired and a worktime of compounding is not something they will need in the future. This plan would cost about $36 billion and I’m assuming it will be financed with deficit spending because there are no specified funding sources. This would giving a few years of buying power which would be stimulatory to the economy. It also protects seniors from any unknown problems. It’s probably partially motivated to get seniors into the McCain camp but it would impact the country as a whole.
There are three other tax measures put forth by McCain. The first is a 50 % reduction in the capital gains tax on stock profits. It is currently 15% to 7.5% for a period of two years. This plan has a price tag of about $10 billion. If any one is getting many capital gains right now, I’d sure like to meet them. This probably only benefits the Warren Buffet type and is a nod to Republican business interests. The more interesting plan is the accelerated tax write off for stock losses. Americans will be able to deduct $15,000 in losses for the tax years 2008 and 2009. This is a change from the current $3,000 losses. He would also suspend taxes on unemployment insurance benefits for both 2008 and 2009. These targeted proposals may actually help the little guy who is panicking right now and pulling whatever money he has out of stocks. It would definitely help any one that does become unemployed also. I’m not sure how big the effect of these would be, but they are not bad ideas.
So, you can chomp on this while I go work out on the details of the Paulson announcement and watch what appears to be a stablizing stock market. I’ll also go check for bulls, bears, and any bouncing dead cats. Also, some earnings reports are coming out today, so that should provide some good information to the market.
Just Survive …
Posted: October 12, 2008 Filed under: U.S. Economy | Tags: bail out plans, Financial Crisis, presidential election, U.S. Economy 2 CommentsI’ve really wanted to talk about the financial crisis more. It’s been hard to write about because things on the ground are changing so quickly. The deal right now is just to survive the entire thing. Times are odd and the odd are getting odder.
The oddest of the the odds is that there are more than just one economic positions being borrowed from Hillary’s plan by BOTH the surviving presidential contenders. Both of these guys are completely clueless on the economy and it’s really showing. They are like little boys in a class room cheating off that one little girl with glasses that has all the answers.
This week, Senator McCain became the liberal by suggesting a plan similar to Hillary’s suggestion of some kind of HOLC like the one that bought up bad mortgages during the depression. Everything he’s been suggesting is so populist that I keep pinching myself to see if I’m actually awake. The Sunday morning talk shows were filled up with democratic talking heads trying to explain that buying folks’ homes at their underwater positions and renegotiating them is going to help banks more than the home owner. This program is basically a re-tooled Roosevelt New Deal idea that is geared specifically to folks living in their homes, not the speculators. If you were all for the banks, the agency would bail out ALL mortgages, not just firsts for home owners. As a progressive, I have to say, for Democrats to be taking a stand against this position JUST because McCain introduced into the debate and Obama just says no, is a little, well, odd, to me.
Another odder than odd policy suggestion is Obama’s idea to let judges work out families’ mortgage problems in bankruptcy court. This is probably a good long term solution, but wouldn’t it be nice to stop these families from showing up in the bankruptcy court? I’m actually wondering if prevention of a problem is something a lawyer can even wrap their brains around. I mean, they make money from exacerbating problems once they’ve gotten huge in a court case, not from problem prevention so is this why he’s stumping for this at a time when short term solutions are required? Even my first year economic students couldn’t figure out why you’d want to let the bankruptcy court work the foreclosures out. Why not try to prevent the foreclosures?
The next thing is the Pelosi hint at yet another stimulus package. Just about any one ought to realize now that the first one really didn’t do much but hold the recession off a few months and make folks think of other things. While it’s a nice thing to get $600 in the mail, the government can’t control what that money gets spent on. It’s one thing if you take the money and buy something American, but most folks either use it to pay down debt which is not the least bit stimulatory or they go buy something that stimulates the Chinese economy. Unless you create a no buying at Walmart rule, this is nothing but another make them feel better while we figure out what to do plan.
Economists have shown empirically with both the Ford and Bush rebates, that rebates are not the way to stimulate the economy because they don’t have the desired results. They usually just exacerbate the debt and make folks feel a little better. They are not game changers. You need underlying changes to the tax codes to do that or you need the government doing spending on something that might have a chance at creating jobs–like building roads. This is another Obama suggestion. The problem with infrastructure spending at this point is that it takes a long time to get through the system. It is needed, but how long will it take to get the program going? Infrastructure improvements are an important part of both short run economic stimulus and long run economic growth, but it’s a little late to start suggesting these things now that we’re in a full blown financial crisis and down turn in the real economy. They’d have to be coming OUT of the hopper right now to do any real good; not going into the hopper some time ‘soon’. Again, this is a preventative type of action once you see things are slowing down. It wouldn’t be soon enough at this point. This again leads me to believe that Obama doesn’t seem to grok the concept of preventative and when it’s useful. I was suggesting this a YEAR ago as a way of preventing a recession and slowing job loss when it does happen. It’s a little futile now. Hillary was suggesting this a year ago too. That and her green jobs initiative were great suggestions for the situation at that time.
Which brings me to another odder than odd. Senator Obama is now wanting some kind of tax credit to home owners for higher energy costs. What I’m waiting to hear is how this is different from just giving every one a tax holiday from gas taxes except you have to wait until the beginning of the year to file for it. Again, every time you talk about a one time deal, even if it is a tax thing, every one knows it’s a one time deal and it doesn’t really change their behavior. Any stimulus that comes from it tends to be very short-lived. Plus, by the time any tax credits would take effect it will be the spring. Not one economist will probably stick their head out to say what kind of things will be needed by then. It doesn’t make sense to try to do that now.
Right now, Henry Paulson is the most important man in Washington. It’s not the President and it’s not these two candidates. The second most important man is Ben Bernanke. Again, odder than odd because neither of these men are elected and both of these men may have very short tenures at the helm. However, I’m just hoping Dubya takes some time off at the ranch. I know I can’t wish that one for every one up for election right now, but I really would like it. It is in the hands of Paulson and Bernanke until January. I’m okay with that because Paulson, btw, is not what the Republicans or the Democrats spin would make him to be.
Paulson has always been odd for both a Wall Street and Washington insider. Paulson is a man that grew up on a farm in Illinois and got into Dartmouth the old fashioned way–good grades. He wasn’t a legacy of any one unlike our current crop of candidates AND the president. His nickname is “the Hammer” because he’s seen as relentless. He is also a devout Christian Scientist who does not drink or smoke and goes back to Illinois on the weekends. He did this even when he was on Wall Street. He lacks ideology and has been criticized by the right of being selling out free-market principles and on the left for bailing out his Wall Street buddies. I always consider being criticized by both sides a good thing in a public servant, but then that’s me.
Now we seen a joint effort from G-7 countries to contain the contagion. Almost all of these plans have to do some with some kind of nationalization of banks. This includes McCain’s suggestion to get the taxpayer ownership which oddly enough was snuck into the bailout package, unknown to many. I’m wondering where THAT came from. Perhaps we’ll find some one taking the credit for that soon, but it seems it might actually be some one like Republican Senator Arlen Specter. Again, odd, odd and odder.
Meanwhile, my strategy and tactics are just to survive with my job and my loans paid down. I’m also trying to put a little money aside in the bank. I’m trying not to look at my 401k plan because it’s telling me that I will die at the podium at this point. I haven’t changed anything about it except all my new contributions are going into bonds. That’s my suggestion to every one right now, don’t panic, we’ve been here before, we just don’t know how long it’s going to last. I actually do have faith in Paulson and Bernanke but not so much in ANYONE running for election right now. Right now, McCain is sounding like the Roosevelt liberal right now and Obama is sounding very moderate so turning to politics for economics signals right now just has me checking my hands to determine which is left and which is right. I still know which way up and down are and that we’re in for more downs than ups for awhile. Other than that, I have NO idea what to say other than it’s an odd time right now and the odd are just getting odder.
Bottom line: Just try to survive.
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