Felix Salmon

Extra Credit, Wednesday Edition

Reuters Staff
Mar 26, 2009 00:41 UTC

Geithner to Propose Vast Expansion Of U.S. Oversight of Financial System: The Fed and the FDIC would seem to be the biggest winners here.

Gilt auction fails for the first time since 2002: A worrying datapoint, it’ll become scary if this happens more often.

Dear A.I.G., I Quit! An AIGFP executive’s resignation letter. Since he wasn’t directly involved in the CDS game, he reckons he’s being unfairly attacked.

Tough-Talking BofA Analyst Yesterday, Gone Today: Merrill’s Richard Bernstein didn’t last long at Bank of America.

Watch those baskets: Why Citigroup should be allowed to merge with Wells Fargo: Hempton wants to give all banks a license to print money. Maybe he should look at Scotland, where they literally have that right.

Modeling an FDIC Robbery: A wonderfully clear-yet-geeky post on the bank bailout plan, with charts. Says Mike: "the Greenspan put was always a metaphor – the Geithner Put is an actual put option." From the excellent Rortybomb blog, which I can’t believe I haven’t seen until now. Thanks to Nemo for the pointer.

Geithner Affirms Dollar After Remarks Send It Tumbling: It’s like a rite of passage for any new Treasury secretary: the inadvertent remark which sends the forex markets aflutter. Now, repeat after me: "A strong dollar is in the national interest".

U.S. Exchanges Propose Rule to Restrict Short Selling: I like the idea of banning shorting of any stock down more than 10% on the day.

Reprinted from Portfolio.com

Blogonomics: Jansen Throws Up the Subscription Firewall

Reuters Staff
Mar 25, 2009 16:26 UTC

Along with the likes of Paul Krugman, I’m a big fan of John Jansen, the man behind the dry-but-very-important Across the Curve blog. In a world where good bond-market information is very hard to find online, Jansen’s blog is invaluable.

Unfortunately, it’s also now disappearing behind a subscriber firewall.

Jansen knows what he’s doing. He wants — needs — to make some money, and reckons he can find 300 people each paying him $25 a month (that’s $90,000 a year) in order for him to be able to continue blogging. If he can find 1,000 subscribers, that works out to a very healthy $300k income.

This is the newsletter business model, just a little faster, with lots of intraday updates. It’s fed largely by Jansen’s own contacts: he has a Rolodex full of bond traders and analysts who are happy to give him the prices and market-insider information that he needs — and he has the bond-trading experience to be able to understand what it all means.

Jansen’s blog has been free until now, going out not only to traders and money managers but to the blogosphere more generally; many of us have been hugely grateful for that. But gratitude doesn’t pay any bills, and so Jansen has decided to concentrate very much on the tiny minority of his readers who actually monetize his blog by using it as a trading and investment tool. "I’m giving up the influence and the recognition," he tells me; "It’s been fun. I’m rolling the dice."

Even if Jansen gives free subscriptions to key influencers like Krugman and Brad Setser, that wouldn’t really help him much, because there’s no point in them linking to something that no one else can see. He’s removing himself from the conversation — although there will still be some free posts every day.

Jansen has been blogging for about a year now, and that has given him enough momentum and readership to be able to consider this move. He has no assurance of success, of course, but if he sweetens the subscription deal by telling his subscribers that they’re free to call him with questions and requests, he might well be able to tap the middle market of investors who are too small to get lots of sell-side fixed-income research or their own data terminals, yet who can easily afford $300 a year for good information.

It’s sad that Jansen is leaving the blogosphere to become a private information provider. But I did tell him that we won’t hold it against him if he ever decides to come back.

Meanwhile, I’m going to be moving over to Reuters on April 1, and they have an astonishing wealth of bond-market information at their fingertips. It’ll probably be a good idea for me to put prices and spreads in my blog entries which most other bloggers don’t have access to — and in general, as ever, I will continue to take requests. So if there’s information you particularly want, do let me know.

Reprinted from Portfolio.com

Will the Geithner Plan Produce True Market Prices?

Reuters Staff
Mar 25, 2009 15:04 UTC

The transcript of the media conference call with Sheila Bair on the subject of the bank bailout is online, and is well worth reading; many thanks to Justin Fox for the pointer. This exchange between Bair and BusinessWeek’s Jane Sasseen jumped out at me:

MS. SASSEEN: So, in other words, are you saying that the prices that will result in this will be much more realistic prices than would result right now, you know, to the extent that there aren’t any buyers?

CHAIRMAN BAIR: Exactly. Exactly right. They will still be, they will be market prices. We’re just trying to tease out the liquidity premium. What’s weighing on market prices right now is that people can’t get financing to buy assets, they can’t get financing to buy assets not many people want to buy, you don’t want to buy. And then you have to hold on to them forever because there’s nobody to sell them to. So, that’s — by providing that liquidity that’s lacking now, we’re hoping to get the prices up to what would really be a true market level.

This is certainly, then, the government’s position: the public-private partnerships won’t be able to pay a premium on the grounds that the FDIC is taking all their tail risk; on the contrary, the toxic assets are simply trading on an illiquidity discount right now, thanks to the lack of available financing. Since the FDIC is stepping in to provide the financing, the prices which come out of this scheme will be reliable market prices.

This I think misses a crucial point: the whole reason why the banks are in such trouble right now is that they provided an enormous amount of low-cost tail-risk financing to the buy-side, in the form of super-senior debt, leveraged loans, and the like. Most of us, looking back on the excesses of the 2005-6 era, reckon that the market price of loans which can be leveraged very cheaply is not a "true market level" at all, but rather something fake and bubblicious.

The fact is that no one with purely commercial motives would ever extend financing against these toxic assets on anything like the terms which the FDIC is making available. So I’m not at all convinced by Bair’s protestations that this scheme is going to be a great means of price discovery.

The government clearly thinks that it needs to inject capital into the banks, in order to prevent a systemic meltdown. That’s fine, but I’d be much happier if it did so transparently, rather than trying to pretend that all of its operations were taking place at true market prices.

Reprinted from Portfolio.com

Cognitive Disconnect of the Day

Reuters Staff
Mar 25, 2009 14:03 UTC

From the NYT report on hedge-fund paydays:

George Soros, also a perennial name on the rich list of secretive moneymakers, pulled in $1.1 billion.

You can see what they’re saying. But really, I don’t think that "George Soros" and "secretive" ever belong in the same sentence.

Reprinted from Portfolio.com

Should Healthy Banks Give Back Their TARP Funds?

Reuters Staff
Mar 25, 2009 13:55 UTC

There’s a big gap between the amount of money that the government needs to bail out the banking system, on the one hand, and the rapidly-dwindling amount of TARP funds that it has available for that purpose, on the other. Hence all the leverage in the bank-bailout scheme. But doesn’t it then make perfect sense for all the banks which got unleveraged TARP money back in October to give it back as soon as possible, so that it can then get levered up by the PPIPs and reinjected in beefed-up form back into the financial sector?

Rick Newman, for one, thinks so. But even he is alive to the downside, as explained by Andrew Ross Sorkin:

If Goldman succeeds in returning our money, it could put pressure on other banks to give their money back, too, lest they appear weak…
The problem now is that many of them may still need the money. And yet they may try to follow Goldman’s lead.

Newman reckons that if a bunch of insolvent banks will fail upon trying to give back their TARP money, so much the better:

It’s time to identify the weakest banks and let them fail if they can’t make it on their own. Capitalism isn’t like an elementary-school soccer game, where nobody keeps score and everybody wins just by participating. It’s a Darwinian ecosystem where the threat of extinction forces organizations to adapt and make smart decisions in order to survive.

The problem is that bank failures have systemic consequences. Newman is alive to the problems associated with another Lehman, but he seems to be oblivious to the problems associated with another WaMu: the US banking system can’t easily afford the cut-off in wholesale funding that would be associated with another large group of senior unsecured bondholders losing substantially all their money.

The prize, here, is to keep the financial system alive. And right now it’s simply too interlinked to be able to cope with a substantial number of bank failures. I think that handing back TARP funds is a good idea — but only insofar as it can be done without endangering the system. Otherwise, it’s a step in entirely the wrong direction.

Reprinted from Portfolio.com

Is the Geithner Plan the Least-Worst Option?

Reuters Staff
Mar 25, 2009 12:46 UTC

Matthew Richardson and Nouriel Roubini have a good and concise view of all the problems with the Geithner bank bailout plan:

Let’s not have any illusions. The government bears the risk if and when the investors take a bath on the taxpayer-provided loans. If the economy gets worse, it could get very ugly, very quickly…
There is something a little worrying about circumventing the legislative process on such a huge investment…
No one knows what the loans or securities are worth. Competing investors will help solve this by promoting price discovery. But be careful what you wish for. We might not like the answers…
We have to anticipate the likelihood that some banks will resist selling their loans and securities…
We may then have to start asking, "Why keep insolvent banks afloat?" And having asked that, we will have to search for ways to manage the ensuing systemic risk.
Either way, once the plan is fully implemented, we will be entering a new phase of the financial crisis. The water is choppy. Let’s hope we are strong swimmers.

The amazing thing is that this laundry list of problems appears under the headline "Give credit to Timothy Geithner’s new toxic asset plan": Richardson and Roubini actually consider themselves supporters of the scheme. Essentially, they say, we have to bite the bullet: it might be unpleasant, but it’s necessary.

I’m beginning to detect something of a pattern here: there are no really full-throated supporters of this plan outside the Administration; there’s no one who thinks it likely that nothing will go wrong. Instead, there is a group of people who have reasonably concluded that this is the least-worst option, in light of political constraints: essentially, it’s better than nothing, which is the only realistic alternative given that Congress is in no mood to pass anything bailing out banks right now.

I am though worried about the banks’ participation in this scheme — especially the Big Four. In order for this to have a chance of succeeding, they all need to participate, but they can’t overtly or covertly cooperate. I hope that Treasury is hiring some serious auction-design and game theory experts right now, because there does seem to be a large number of ways in which this plan can be gamed, especially when the banks have shown no particular enthusiasm for participating.

Reprinted from Portfolio.com

Stocks for the Long Run: Authers vs Clements

Reuters Staff
Mar 25, 2009 11:30 UTC

John Authers, the FT’s "Short View" columnist, takes a big step back today to look at the really long view, with charts going back to 1802. He notes that long-dated government bonds have outperformed stocks over the past 40 years, and he gets a great quote from Robert Arnott:

The notion that the long run will bail you out no matter what stupid things you do in the short run I think is dead,” says Robert Arnott, who examines such performance in a forthcoming article for the Journal of Indexes. “And the notion that if you have the better asset class it doesn’t matter what you pay for it is on its deathbed.”

I’m not entirely convinced by this: we’re comparing the performance of government bonds against stocks when government bonds are at the top of a huge bubble and stocks are at multi-decade real lows. But I’m equally unconvinced by Jonathan Clements:

Over the past 60 years, gross domestic product has climbed 6.8% a year–and shares prices have climbed 7%, as measured by the Standard & Poor’s 500-stock index. On top of that 7% a year, investors also collected dividends.
True, share prices didn’t climb in lockstep with the economy and, indeed, investors had to suffer through some horrendous bear markets. Still, as long as the economy continues to grow over the long haul, the stock market should remain a decent long-run investment.

Why is 60 years a useful timeframe? Very few of us invest for 60 years, no matter how early we start. And the future relationship between the stock market and GDP growth is entirely a function of the way in which future growth accrues to capital rather than to labor; I suspect the pendulum is going to swing back on that front, which means that stock-price growth could lag GDP growth indefinitely. And that’s even assuming, as Clements does, that GDP growth will continue to be relatively healthy over the long term.

Besides, Clements has lost a lot of sympathy with his poor-me column in the WSJ complaining about the hardships of earning more than $250,000 a year:

By mid-October, I will hit $250,000 in total income — and have no incentive to earn any more income in 2009.
At that point, I plan to ask Citi for an unpaid sabbatical. Forget earning more income. There’s no point. Instead, you will find me hunkered down at home, desperately trying not to spend money. This will make entire financial sense for the Clements household. What about the struggling economy? Not so much.

Actually, Jonathan, the struggling US economy really does not have a desperate need for you to earn more than a quarter of a million dollars a year — especially since you’re very likely to simply save that money, rather than spend it. Maybe Citigroup can take the money it would otherwise be paying you and give it in bonuses to underpaid bank tellers instead. Then the struggling economy gains, and you don’t need to worry about your taxes. We all win!

(HT: Chittum)

Reprinted from Portfolio.com

Is the Geithner Plan an FDIC Plan?

Reuters Staff
Mar 25, 2009 09:53 UTC

I’m beginning to come around to the idea that the FDIC will play the single most important role in determining the way that the Geithner plan plays out. If the banking system is indeed as unhealthy as everybody thinks it is, the FDIC essentially has two choices: it can either ratify high prices being paid for toxic assets by extending financing guarantees for them, or it can force lower prices to be paid for toxic assets, force banks to mark their assets down to levels at which they violate their minimum capital requirements, and intervene to close those banks down.

So I fired off an email to the FDIC this morning, asking if I could talk to someone there about the role that the agency played in constructing the plan and the role it’s going to play as the plan is implemented. I got this reply from a spokesman:

The FDIC is still reviewing the proposal. You should address your questions towards Treasury since it is their proposal.

In public, however, The FDIC gives every impression of being a big supporter of the plan. Its head, Sheila Bair, for instance, released this statement:

"Today’s actions demonstrate the strong commitment of the FDIC, Fed, Treasury and the Administration to use creative and innovative programs to address the serious economic issues facing our country. The Legacy Loans Program, while providing substantial upside potential to private investors and the government, will also clear these troubled assets from banks balance sheets – enabling them to lend and restore economic growth."

And the FDIC’s web page on the program says that it is being launched by "the FDIC and Treasury", rather than by Treasury alone.

There’s one other important consideration to bear in mind here: the massive regulatory overhaul which is going to happen over the medium term. There’s a crazy alphabet soup of regulators in Washington right now, and a lot of them are going to have to be abolished. Is the FDIC jockeying for position, here, making itself as indispensible as possible in an attempt to survive the coming upheaval? It’s entirely possible.

Update: The email I got from the FDIC was a miscommunication: they thought I was asking about the regulatory restructuring proposal, not the bank bailout plan. They tell me that they’re fully supportive of the bailout plan, and were very much involved in its construction.

Reprinted from Portfolio.com

The Complexity of the Bank Bailout Plan

Reuters Staff
Mar 25, 2009 09:02 UTC

A smart comment came from chacona in the wake of yesterday’s bailout discussion:

As for the ideas, I learned one big thing that seems to be of great importance: nobody understands the Geithner Plan.

To a first approximation, this is undoubtedly true. (It’s certainly true for me: there are large chunks of it I still don’t understand in the slightest.) For instance, during the discussion, we got into a debate about whether or not CDOs will be included among the toxic legacy assets eligible for the plan; it seems they won’t be, but it’s not crystal-clear, and if they’re not, doesn’t that leave a rather obvious weakness on banks’ balance sheets unaddressed? And that’s not even what David Reilly is talking about here:

No sooner might the Treasury Department mop up those assets than $1 trillion or more in new ones spring up to take their place.

He’s talking about off-balance-sheet vehicles: although there’s a general conception that banks have taken their SIVs back on balance sheet, Reilly says that the Big Four US banks still have a whopping $5.2 trillion in off-balance-sheet assets. That’s about 37% of GDP right there.

Reilly isn’t talking about SIVs, he’s talking about assets which the banks thought they had safely sold to external investors in the form of asset-backed securities but which they might yet be forced to take back. For instance, Citigroup has already said that it expects some $92 billion in securitized credit-card debt to come back to it.

I’m very unclear on how exactly this works, but ultimately it smells to me very similar to the notorious "liquidity put" that Citi wrote to its SIVs. We’ll sell you the assets, it basically said, but don’t worry, if they turn out to be particularly toxic, then we’ll take them back. In doing so, it retained a lot of tail risk, but didn’t need to show that risk on its balance sheet.

There are other big known weaknesses with the plan as well: even Brad DeLong, who’s making a name for himself as the most high-profile non-Administration supporter of the plan, said in the discussion that the plan "becomes very dangerous indeed" if the Big Four banks cooperate rather than compete, and also that the plan seems to be "too small to work" given the $2 trillion in expected losses on mortgage securities due to defaults.

That said, there are people — especially in Washington — who have a much stronger grasp of the details of the plan than I think any of us in the Seeking Alpha discussion had. One of them emailed me this morning, making a number of important points.

First, the FDIC will charge for its guarantee — somewhere in the region of 50bp to 100bp. What’s more, if the FDIC ends up losing money on this deal, it will make up those funds with an assessment on total bank liabilities. In other words, the banking system in general will be asked to cough up the losses, rather than the US government.

This does make it seem as though smaller, healthier banks risk being penalized to bail out the larger and more irresponsible ones — but as Brad says, someone’s got to ultimately bear the losses, and we’re all going to end up shouldering some of the burden somehow.

What’s more, the FDIC does support this plan: it wasn’t dragooned into it just to provide the extra dollars needed to get to $1 trillion. And given its guarantee fee, it might conceivably even make a profit on the whole thing. One aspect of the deal worth noting is that even if a public-private partnership and a bank come to agreement on a price for transferring the toxic assets, the FDIC can still veto the deal. You need three-way agreement for any bargain. That makes it harder for the plan to work, in the sense of money changing hands, but does make it more likely that the FDIC will avoid massive losses.

It’s also worth noting that the amount of leverage that the government allows with respect to any given asset is going to be a function of the perceived safety of that asset: maximum leverage won’t be applied willy-nilly to everything.

Finally, my correspondent says he views as a virtue of the plan the fact that regulators will push banks to mark their assets to the prices set by the auctions, even if they choose not to sell their assets at those auctions. That will accelerate failures of insolvent banks — and if an insolvent bank is going to fail, it’s better that it does so sooner rather than later.

Can this plan then be viewed as the most empirical and useful part of the stress test? Is it at heart a further step towards nationalization, or at least widespread FDIC intervention of failed banks? My feeling is that the plan is designed to maximize the prices of the toxic assets and thereby minimize the number of banks which need to be deemed insolvent. But I guess we’ll see, once the plan gets up and running.

Reprinted from Portfolio.com