Tadas Viskanta outs himself as the indispensible Abnormal Returns
China Unicom will build more 3G base stations in 1 year than all the operators in Western Europe have rolled out ever
Matt Taibbi takes down Evan Newmark
The $9.50 bond valued at $98.53
The jobs report: just more reasons to be depressed, macroeconomically speaking.
If GM were to be liquidated, unsecured creditors would get nothing. So they should quit whining already.
I spent some very pleasant time this afternoon with Larry Coben, a man who seems to spend most his life making the world a better place by globetrotting around sites of extreme architectural interest. Nice job that man! His Sustainable Preservation Initiative is all about taking architectural sites in poor countries and making them generate cash for the locals — thereby giving them a real monetary incentive (rather than a high-minded lecture) aimed at preserving archeological treasures. It’s “economic development in an archeological guise,” he likes to say.
A lot of the money comes from tourism, in communities where a little tourism money can go a very long way. You can start with simple admission fees, but then scale into all manner of other money-making schemes: replica handicrafts, for instance, or even, in the case of one site in Armenia, making wine as the ancients did. There’s a huge amount of opportunity here, says Coben: “I’ll be dead before we’re through the low-hanging fruit”, he reckons, just because the costs of these schemes are low (in the $10,000 to $30,000 range) and the number of possible architectural sites is enormous. The slogan of his organization is “saving sites by transforming lives”.
One intriguing aspect of Coben’s initiative is its use of debt finance: he wants the schemes, where possible, to take not only grant money from donors but also to borrow funds from local microlenders. Having to pay back a loan is “a great discipline”, he says — and when microlenders are invested and want to get their money back, they also act as semi-formal overseers of the project, obviating a large amount of the need for foreign donors to keep an eye on things. Essentially, Coben is outsourcing supervision of the projects, and recycling funds into the community at the same time. He does intend to keep a substantial equity stake in the projects, just so that he can intervene if things go wrong, but at no point will dividend any money out of the local community.
Coben’s starting out with one project in Peru as well as the one in Armenia; he’s already demonstrated what’s possible with a similar scheme he organized himself in Bolivia, which involved little more, at the outset, than simply putting up a toll gate. The universe of architectural tourists isn’t particularly large, but it doesn’t need to be: just a handful of tourists per day, paying maybe $10 apiece, can transform the economics of many remote villages. That’s the kind of money, as a tourist, that you want to spend — as opposed to huge luxury-hotel bills most of which go straight to multinational corporations. This is a great idea, and I hope that it really takes off. Even the worst-case scenario — where the projects fail — is a significant improvement on not trying at all.
For D.A. Coffin, maybe you were looking for this article from Archaeology Magazine, “Forging Ahead,” May/June 2009 by Charles Stanish.
I applaud the efforts of SPI and Larry Coben. I hope the communities are able to run these sites in order to strengthen the local economy and inspire a greater appreciation for their heritage.
EMTA, the erstwhile Emerging Market Traders Association, hosted an in-depth session today on the debt markets in developing countries, both sovereign and corporate. And it’s the corporate bonds which are by far the biggest worry: emerging-market corporate loans are now five times the size of the corporate bond market. And JP Morgan’s Joyce Chang came out with one of the scariest sets of datapoints I’ve come across in a while. Get this:
It’s not just Latvia that’s in serious trouble: as Joyce said, a devaluation in Latvia could easily spill over to Bulgaria. At that point there are risks of 1997-8 all over again, only this time starting in Europe rather than Asia.
There was quite a lot of talk of how come the IMF and other multilateral institutions aren’t encouraging emerging-market countries in fiscal distress to reduce or attenuate their liabilities — there’s your answer right there. If emerging Europe started restructuring its debts, the pain in the EU would be enormous — and of course the G8 essentially controls the IMF and the multilaterals.
If the official sector is becoming friendlier to private-sector creditors, however, the big news today was the degree to which Lee Buchheit, the godfather of sovereign debt, has followed suit. Buchheit is an institution, both within Cleary Gottlieb, his law firm, and the sovereign-debt community more generally. He has represented dozens of sovereign debtors, and is known as the inventor of the exit consent — a tool by which countries can eviscerate the legal rights of minority bondholders. Up until very recently, he was considered by most private-sector bondholders to be the enemy; one of them described him to me once as an “evil genius”.
But Lee was singing a very different tune today, and unloaded with both barrels on his former client, Ecuador, and its president, Rafael Correa. Ecuador is a “rogue debtor”, he says, and its most recent default is pretty much the first time in 30 years that a country has defaulted without at least “a colorable claim to distress”.
Ecuador’s offer to its bondholders, said Buchheit, was “an extraordinary document unlike anything I’ve ever seen in this business”. Where most countries in distress at least pay lip service to the idea of wanting (just being unable) to pay, Ecuador repudiated its bonds outright, and said that it considered itself to have no legal or moral obligation to pay so much as a penny for them. That strategy was, no doubt, highly effective. But a large part of its success was due, said Buchheit, to the fact that the bondholders’ trustee — US Bancorp — “was bovinely passive” in the face of extraordinary provocation.
Buchheit did suggest that future sovereign bond issues will likely include clauses barring countries from defaulting and then buying back their distressed debt — not that such a clause would be remotely sufficient to stop a country like Ecuador which has little if any respect for international law. The bigger issue, said Buchheit, was those trustees. “What do you do to motivate the trustees to behave in an appropriate manner?” he asked, adding for good measure that “trustees are a species under the broader genus of invertebrates”.
One of the problems is that when trustees are chosen, they’re generally picked not on the basis of how hard they’re likely to fight for bondholders when push comes to shove, but rather on the basis of how cheap they are. But in general trustees are nearly always legally protected from bondholders, which means that if they take the easy and lazy way out and never kick up a fuss, they’re not going to be held liable for doing so. At the same time, of course, kicking up a fuss is an expensive and time-consuming thing to do. So there’s a lot of incentive to do nothing.
Buchheit was very worried about the consequences of Ecuador’s default. “Outliers tend to be infectious,” he said. “And once you establish a precedent, other countries and finance ministers will wonder why they should go through the tiresome business of negotiating with bondholders,” rather than just defaulting and buying back at pennies on the dollar.
Rafael Correa is no idiot. He has observed, said Buchheit, the tendency of the bond markets to forgive and forget much more quickly than bank lenders: “Financial markets today tend not to hold grudges the way that predecessor financial markets used to. So the traditional cost of a brutal restructuring is not one that they have to pay any more.”
And so, in the face of Correa’s provocation, Buchheit is speaking out. Most of his sovereign clients are keen to retain their access to the international capital markets; many of them are net creditors. So they no longer want their lawyer to stand up for sovereigns’ rights, so much as to repudiate actions by Ecuador which might well imperil their own ability to borrow money in future.
It’s truly a strange world, where distressed-debt investors like Hans Humes make nice noises about the IIF and formal restructuring mechanisms, while Lee Buchheit speaks out against “rogue debtors”. Might it be that out of this crisis is being forged a new consensus? I’m not holding my breath; these people almost never agree for long. But so many unthinkable things have happened already that nothing would shock me any more.
RTFA? Read the fine allegory?
Bovinely passive, just like State Street was in regards to Reserve Primary/Lehman?
Jackie Calmes got some pretty great access for her 1900-word article on how the Obama economic team works — which, as the Economist notes, “might more aptly be called ‘Larry Summers Disagrees With Everyone’”. (Welcome back to Free Exchange, Ryan, even if that wasn’t you.)
A lot of the article, predictably enough, centers on Larry Summers, the man with or against whom all economic policy seems to be made:
“I am completely comfortable pushing back at him,” Mr. Geithner said in an interview.
“Larry will come to any issue and say, well, here’s all the 16 reasons why there’s problems with that proposal. If he’s got ideas, particularly if I think they won’t work, I say to him, ‘Well, why don’t you make the case against it, Larry, because you’re pretty good at making the case against anything.’ ”
The problem is that Summers doesn’t just push back at ideas in meetings, he also tries to prevent those ideas from even being heard in the first place: Peter Orszag, Tim Geithner, and Austan Goolsbee are all named as people that Larry tried to prevent from having access to the president at various times. (And we all know that Paul Volcker has been successfully marginalized by Summers.)
The upshot of all this fractiousness seems to be that the real decision-making power has ended up in some unlikely hands:
“You can’t assemble a group of really brilliant people, and deal with some of the most complex problems in our lifetimes and not have disagreements,” said David Axelrod, Mr. Obama’s senior political strategist who, with the White House chief of staff, Rahm Emanuel, plays a big role in mediating among the economic advisers and helps shape the decisions.
I’ve been fantasizing for a while about what would have happened if Obama had nominated Rahm to be Treasury secretary. Maybe he did, and just never told anybody!
One of the strategies that Obama has used very effectively is to bring all the major players on an issue into the administration, rather than having disgruntled, passed over players sitting on the side lines throwing Sunday morning stones at the administration. Summers, Volcker etc had to be inside in order to keep them from attacking the administration.
This strategy is working, the attacks come from Rush “Let them fail!” Limbaugh, not from “Today we are sitting down with former Treasury Secretary Summers who has some surprising things to say about the state of the economy and the President’s plan”.
The strategy can have problems: too many cooks in the kitchen being a major one. One way to handle this is to put the outsiders on a Presidential Advisory Commission and make sure that they get to have lunch with someone every once in a while. I think this story suggests what Summers’ role is in the administration and how much he can push back too.
When the PPIP was introduced, everybody was scared about the amount of toxic assets on banks’ balance sheets. Don’t worry, said Tim Geithner: between the stress tests and the PPIP, we’re going to be able to put a price on all those toxic assets, work out what the banks’ losses are, and ensure that the banks have enough capital to absorb those losses.
The market loved this idea, and started going up rather than down, to the point at which people weren’t scared any more about the amount of toxic assets on banks’ balance sheets. And so it didn’t matter that the adverse scenario in the stress tests is looking positively sunny these days. And it didn’t matter that PPIP disappeared with a whimper, the toxic assets no more priced now than they were six months ago. So long as the stock markets are happy, what’s to worry about?
Ezra Klein, for one, is still worried; so am I, not least because of all those leveraged loans maturing over the next few years. In other words, this is no time for banks — which, by their nature, are fragile leveraged institutions — to start repaying TARP funds. As my colleague Matt Goldstein notes:
The recent surge in the stock market and a slight slowdown in the pace of job losses should not lull anyone into believing that the economy is on the fast road to repair. If all the talk about economic green shoots is just some mirage, the banks could be in for a lot more trouble if there’s a new spike in mortgage defaults or corporate bankruptcies. And given the current public mood, it will be impossible to provide any struggling bank with a new round of financial aid.
Optimism is good, and we all hope that the stock market’s present upward trajectory proves justified and sustainable. But hope is not a regulatory strategy. And TARP funds shouldn’t be repaid with the hope that the banks don’t need them any more; they should be repaid only when the banks have demonstrated — with clear prices for their toxic assets — that they’re definitively in the clear.
if retail banking is such a turn-off, I would suggest an alternate resource for your financial needs: Credit Unions. By and large, most of your local CU are locally run and of course locally owned. Will never get your face ripped off in fees, and actually the past 10 years they have added competitive loan products.
I have used one in North Carolina for 10+ years, and recommend them (broadly speaking)
Vipal Monga breaks down the wall of debt which is going to mature over the next few years; I thought it was chartifying.
Given that historically most loan issuance has been turned into CLOs, and given that the CLO market is very unlikely to come back for the foreseeable future, there’s a lot of scope for bad news here as far as the banking sector is concerned. Remember that the stress tests only went out through 2011; they didn’t include the big spike in loan maturities, and the inevitable spate of defaults and restructurings that will result. Or, to put it another way, things are going to get worse before they get worse.
What the chart points out, while not obviously stating, that lenders issuing the bonds are having a nice sustained income for the next few years. To overcome the credit crisis, a glut of short term loan was the answer that many entities had to maintain operations.
What’s the wisdom of crowds when it comes to the greatest-living-artist question? After 1.4 million votes cast, mainly in the UK (so an English bias is unavoidable), the consensus seems to be:
Tyler Cowen and I, last Thursday, spent very little time deciding that Jasper Johns and Gerhard Richter were #1 and #2 respectively; it didn’t take much longer to decide that Nauman was #3. So how come Richter doesn’t even crack the top ten on the Times/Saatchi list? Do people — even English people — really believe that Tracy Emin is a significantly better artist than Gerhard Richter?
Then again, the same poll puts Martin Kippenberger in the top 20 artists of the 20th Century, while Joseph Beuys languishes at #68, somewhere below Chaim Soutine. And Ed Ruscha — an easy top-10 on the living-artist list for both Tyler and me — doesn’t even crack the top 100 on this list; compare that to Hockney, at #33.
The other thing worth noting is the reputational market of Damien Murakoons. While Hirst and Koons are right next to each other in the low 50s on the list, Takashi Murakami is right at the bottom, at #190. (Warhol is at #8.) My guess is that the main difference here is how they did at auction — even if the pricetag on something like this is just as high as anything Hirst or Koons can command.
Should the US issue panda bonds, as Guo Shuqing, the chairman of China Construction Bank would like to see? Much better, I think, to start with the World Bank and a few other habitual foreign-currency issuers before suggesting that the US break with all tradition and borrow in any foreign currency.
But yes, if the World Bank can start issuing in yuan, and if it can easily swap its obligations back into dollar Libor, as Guo suggests is possible, then that’s a great idea. A benchmark yuan yield curve would do wonders for increasing the transparency of Chinese capital markets.
(HT: Alea)
Ask Iceland about the wisdom of borrowing in foreign currencies.
Couldn’t they have left themselves any leeway at all? The CBO has now costed out the Waxman-Markey act, and has come to the conclusion that over the 10 years from 2010 to 2019, it would raise $846 billion, spend $821 billion, and cost another $50 billion or so in discretionary spending. In other words, it’s at best fiscally flat, and quite possibly will actually cost the government money.
The good news, however, is that fully $693 billion of the $821 billion in direct costs is accounted for by “Outlays Associated with Emission Allowances Freely Allocated”. In other words, if and when there’s a fiscal crunch, any future government can significantly reduce the budget deficit at a stroke just by ceasing to give away carbon allowances. Which of all the different ways to raise taxes is probably likely to be one of the least politically damaging.
That’s a pretty interesting point, and almost makes me wonder if this is deliberate. After all one of the biggest criticisms of the bill from an environmental point of view is the fact that it gives away too many of the allowances for free, since that won’t change behaviour. Perhaps the idea is that if they can get the framework right, then the ongoing fiscal deficits will do the heavy work in terms of steadily forcing the proportion of free credits down and down.
In the first part of his Hoover Institution essay, Holman Jenkins tries — and fails — to absolve Wall Street from blame for the financial crisis. In the second part, he places the blame elsewhere — specifically, with the government. His argument is as simple as it is bizarre:
There may not be a national housing market, and certainly there isn’t a global one. But there is a national economy, as well as a global economy, and policy structure and political culture, and a media that communicates information and analysis and fears and expectations instantly and globally. Impossible to separate, then, are the precipitous drop of confidence in asset values and a precipitous drop in confidence in government policy, on which asset values necessarily in part depend.
I’m not sure what the media are doing here — thankfully they go unmentioned for the rest of the essay. But does Jenkins really think that it’s “impossible to separate” a stock-market crash from “a precipitous drop in confidence in government policy”? I’d say it’s very easy.
For one thing, confidence in government policy never crashes as vertiginously as stock prices do. It’s true that confidence in the government changes over time. But when it falls, it normally falls because the government has done something very silly, like, say, introducing a poll tax. And even in a relatively clear-cut case like that, the government doesn’t lose popular support overnight. Indeed, the fastest rate of change of confidence in a government will generally happen upwards rather than downwards, often just after the beginning of a war.
Yes, asset values do include some component of confidence in government policy. But it’s silly to assert that therefore sudden changes in asset values are due to changes in confidence in government policy. Occam’s razor alone is sufficient to deal with this: since there’s no shortage of bubbles and crashes which have nothing to do with government policy at all, one hardly needs to resort to blaming the government to explain this particular crash. Add to that the fact that blaming the government is gloriously unfalsifiable, and you end up with a thesis which is pretty much completely substance-free.
Says Jenkins:
When one bank is seen to be in trouble, suddenly all banks are in trouble — if depositors and creditors lose confidence in government’s willingness and ability to intervene effectively.
Well, yes, if there was suddenly a loss of confidence in the FDIC’s ability to make depositors whole, that would have resulted in bank runs. Except for there wasn’t, and there weren’t any bank runs by depositors. In fact, the highly-effective government intervention of raising deposit insurance from $100,000 to $250,000 was entirely sufficient to reassure depositors that their funds were safe.
As for banks’ creditors, they never had a promise from the government that they would be paid in full — which is precisely why they got significantly higher yields on their bank debt than they could get on Treasury bonds. They couldn’t lose confidence in the government guarantee of bank debt because there was no such guarantee to begin with.
Jenkins, by contrast, sees things very differently. The minute anybody says the word “Depression”, it seems, any fall in the stock market can only be blamed on the government:
The moment the media and politicians began touting the risk of a “Second Great Depression,” firms and investors around the world began treating it as a real risk. Firms and investors, for the most part, are sophisticated enough to recall that the Great Depression of the 1930s was first and foremost a product of disastrous policy choices made by governments amid what might otherwise have been a normal correction in boomtime asset prices…
At least since banker J.P. Morgan personally intervened in the 1907 Panic — only one party is responsible for systemic confidence anymore. That’s government. When systemic trust falters, all eyes turn in a single direction. Government necessarily becomes the only truly relevant actor, with all the perils and politicization that that portends.
I’m not going to get into the debate over the causes of the Great Depression. But basically Jenkins’s argument is simple:
Reduced to its bare bones like this, there seems to be precious little meat on this argument. But maybe, somewhere in his 4,800-word essay, Jenkins might care to identify which government actions were responsible for the crash in asset prices? He does, briefly, here:
Government was the only party in a position to protect systemic confidence, but instead sent mixed signals — saving Bear Stearns, telling the world that there would be no disorderly failures of important financial institutions through bankruptcy; then letting Lehman fail through bankruptcy. It stepped up to save AIG and pumped in improbable amounts of taxpayer cash — when it might just have nationalized the firm, declaring its debts sovereign debts, which would have stopped the collateral calls related to its subprime guarantees. How many more times could government possibly repeat the AIG fiasco if other large firms needed rescuing? It was a rescue, but a far from credible one.
It didn’t help that the crisis came in the middle of a presidential election, creating even more uncertainty about the future of policy. So the sinews of trust unraveled with unholy speed.
Do sinews really unravel? Never mind that. Jenkins points to three things which might have caused this devastating and precipitous drop in confidence in the government. One is saving Bear Stearns then letting Lehman fail; the second is rescuing AIG in a possibly-less-than-optimal manner; and the third is the presidential election.
The third is obviously silly: if investors “are sophisticated enough to recall” the causes of the Great Depression, one must assume that they’re sophisticated enough to know when the next presidential election is scheduled to take place. The rescue of Bear and of AIG can’t have caused a breakdown in trust in the government’s ability to prevent systemic meltdown, since even if they weren’t elegant, they did what they were designed to do, which was to prevent the collapse of the companies in question. So that really leaves just Lehman. But no, says Jenkins, it’s not really Lehman:
Investors in the global panic were responding not to the exposure of subprime losses, or even the failure of Lehman Brothers, but to what we might call a sudden, sharp explosion of uncertainty about what government might do and what principles or expectations might guide its actions amid the crisis.
This seems to assume that investors pre-crisis did have certainty about what the government might do in a crisis. I just don’t buy it. Does Jenkins have any empirical or anecdotal evidence that there was “a sudden, sharp explosion of uncertainty about what government might do” right around the time of the stock-market crash, and that said explosion of uncertainty was the proximate cause of the crash? Of course not, because the range of possible government responses to the crash was never particularly great. For all his overblown rhetoric, Jenkins fails to identify a single government decision as being particularly contrary to what market participants generally expected the US government to do in times of crisis. Looking back today, the closest that we came to that happening was when the House Republicans briefly derailed the bailout act at the end of September — but it didn’t take long for them to get back in line.
Jenkins ends with a series of standard-issue right talking points. Government interference in private industry is a Bad Thing, he says, and we’re doomed to suffer the consequences of “endless acts of industrial favoritism from Obamanomics”. But seeing as how he can’t even seem to get the past right, I can’t really take seriously his predictions about the future.
Coming from someone who generally likes to criticize whenever possible and who has not always agreed with what you have to say, all I can say on this one is “nice work.”
1800 words of oil-storage ultrageekery from Izabella Kaminska — I love it when Alphavillers get their nerd on.
Your daily lesson in fungibility via Norris
NY Observer layoffs include Matt Haber, Doree Shafrir, Spencer Morgan
National Review’s Wise Latina Caricature Inexplicably Asian
Why Pandit must go. It’s not new (April 24) but still relevant.
Dan Gross adjudicates the Ferguson vs Krugman debate in favor of Krugman
Felix,
Thanks for your coverage of the Chrysler-Fiat deal. Please note that this is a much larger story than it appears on the surface.
The move by the Indiana State Treasurer is not motivated by $$. Richard Mourdock is trying to follow bankruptcy law and the US Constitution.
Treasurer Mourdock is a serious man with great integrity. He is not about to disregard the rule of law with pressure from the federal government.
Please also not the consequences on our bond and capitol markets IF the court decides against the Indiana pension funds in favor of the Chrysler-Fiat sale. If rule of law no longer holds in the US will our T-bill etc. be worth anything on the global stage?
Please feel free to contact me with questions/feedback.
David Sobotka
dsobotka@purdue.edu
This is not nearly as counterintuitive as it might seem at first blush:
By my calculations, these numbers mean that you’d need to ride your bike in NYC for 7,300 days, on average, before getting injured. At 200 days a year, that’s over 35 years. And I’m quite sure that a large proportion (but by no means all) of the injuries and fatalities happen to people riding unsafely — against traffic, through red lights, without a helmet, that kind of thing. Which means that the odds of a safe bicyclist being injured in NYC are even lower than that.
Going forwards, the safety in numbers effect is going to make cycling even safer and more popular, which means that we should be able to extrapolate the blue line up and the brown line down more or less indefinitely. Good news!
riding without a helmet…anyone care to recall a certain Pittsburgh starting QB doing that a few years back ?? There is NO way I would ride without one
to quote N. Dynamite…lucky
Who on earth thought that this was a good idea?
Wilbraham & Monson Academy, a boarding school in Massachusetts, will officially unveil a classroom that simulates a stock-market trading floor. “Students can use state-of-the-art financial-markets software to learn to research, analyze, and decipher patterns in the context of a financial trading environment,” the school said.
The key word here is “patterns”. But it doesn’t take a student of Nassim Taleb’s Fooled by Randomness to know that “researching patterns” is a mug’s game. What’s more, there’s a world of difference between financial literacy, which is a good thing, and teaching kids how to trade stocks, which is a stunningly bad idea doomed to result in vast amounts of wealth evaporating needlessly. As for the “state-of-the-art financial-markets software”, does anybody think that’s a good thing any more?
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Justin Fox came into the Reuters offices this morning to plug his book, so I took the opportunity to ask him on camera about why he seems to think the recovery has started.
Please do not mix coffee and energy drinks before doing interviews.
Holman Jenkins’s essay on financial markets for the Hoover Institution has been getting a fair amount of love from the blogosphere and the twitterverse — which means it’s worth explaining some of the many areas where Jenkins gets things very wrong. There’s so much to unpack here I’ll start just with Jenkins’s first section, where he claims to debunk certain “mythical” views of what went wrong — basically, the views which blame Wall Street. I’ll come back later to his second part, where he decides to blame the government instead.
Jenkins kicks off with this:
It isn’t true that Wall Street made these mortgage securities just to dump them on them the proverbial greater fool, or that the disaster was wrought by Wall Street firms irresponsibly selling investment products they knew or should have known were destined to blow up. On the contrary, Merrill Lynch retained a great portion of the subprime mortgage securities for its own portfolio (it ended up selling some to a hedge fund for 22 cents on the dollar). Citigroup retained vast holdings in its so-called structured investment vehicles. Holdings of these securities, in funds in which their own employees personally participated, brought down Bear Stearns and Lehman Brothers. aig, once one of the world’s most admired corporations, made perhaps the biggest bet of all, writing insurance contracts against the potential default of these products.
So Wall Street can hardly be accused of failing to eat its own dog food. It did not peddle to others an investment product that it was unwilling to consume in vast quantities itself.
There’s a nifty bit of rhetorical footwork there. Jenkins starts off trying to disprove the notion that “Wall Street made these mortgage securities just to dump them on them the proverbial greater fool”; he ends off simply noting that “Wall Street can hardly be accused of failing to eat its own dog food”.
In reality, both are true. Wall Street really did make these mortgage securities with the intention of dumping them elsewhere: every bank on the Street, when asked, would happily have told you that they were “in the moving business, not the storage business”.
The problem was that while Wall Street intended to get all this stuff off its books, it failed to do so in reality. In the case of Citi’s SIVs, the toxic assets really did get off the bank’s books, just not far enough off the bank’s books; eventually, and disastrously, it was forced back on to Citi’s books. In the case of Merrill, there was simply one of the most egregious failures of management that Wall Street has ever seen, with the mortgage-origination desk getting huge bonuses for moving bonds while quietly amassing a monster portfolio of securities they were unable to find buyers for.
More generally, Wall Street was working off of models which managed to reassure managers that there was much less risk on the balance sheet than there actually was. Yes, it ate its own dogfood, but it was for the most part utterly unaware, at the time, that it was doing so. Lehman Brothers was an exception: it willingly took huge amounts of commercial real-estate exposure onto its balance sheet. And the Bear Stearns hedge funds which collapsed in 2007 were in a similar position. But Citi and Merrill and UBS and AIG all genuinely thought they had much less risk than they actually found themselves with when things turned south.
So yes, Wall Street made mortgage securities to sell them on. And yes, they should have known there was lots of risk in these things — although they managed to delude themselves that there wasn’t. Which is why Wall Street ended up eating so much dogfood.
Jenkins continues:
Nor is it true that Wall Street executives and CEOs had insufficient “skin in the game,” so that “perverse” compensation incentives created the mess. That story also does not pan out. Individuals, it’s true, were paid sizeable bonuses in the years in which the securities were created and sold. But most also had considerable wealth in the form of stock and stock options in their firms, which bet their own capital on these securities. Many also appear to have invested directly in funds to hold the subprime securities.
They had skin in the game. Personal losses to top executives in banks that failed or whose share prices collapsed were in the millions, hundreds of millions, and in some cases billions of dollars.
Again, he conflates two issues. The problem with Wall Street’s compensation structures — which were indeed perverse — was not that Wall Street’s executives had insufficient skin in the game. There were however important Wall Street employees, on trading and origination desks, who got big annual bonuses, largely in cash, and who had every incentive to game the system to make as much money as they could before things blew up. They just weren’t executives. The fact that the executives lost lots of money only goes to show how bad their risk-management procedures were — and how little they deserved the money that they were paid over the years. (They’ve all still got plenty of money to fall back on, even after their losses.)
Jenkins then moves on:
It isn’t true, either, that Wall Street manufactured these securities as a purblind bet that home prices only go up. The securitizations had been explicitly designed with the prospect of large numbers of defaults in mind — hence the engineering of subordinate tranches designed to protect the senior tranches from those defaults that occurred.
This is simply false. The securities were not designed “with the prospect of large numbers of defaults in mind” — if they had been, then all those ultra-safe triple-A-rated bonds would still be pretty much risk-free today. Yes, there were subordinate tranches — but they were very, very thin: indeed, the banks had every incentive to make those tranches as thin as possible. A supermajority of every mortgage securitization got the cherished triple-A rating, which was meant to mean that it was protected from a spike in defaults. But of course the actual spike in defaults ate into those triple-A-rated bonds almost as soon as house prices started falling.
More generally, the world of mortgage securitization had allowed itself, over the years, to become incredibly blasé about the prospect of defaults. The only thing that buyers of mortgage bonds cared about was prepayment rates; default rates just weren’t even on their radar, most of the time. Even when there were defaults, the loss given default on any given house was tiny, since its value had almost certainly gone up since the loan was made. So really a default just counted as another kind of prepayment, rather than something potentially devastating. As a result, when prices plunged, defaults spiked, and recovery rates went down the toilet, Wall Street was caught utterly unprepared.
So when Jenkins points to a rising foreclosure rate as evidence that Wall Street knew what was going on, he’s looking at the wrong thing. He should be looking instead at recovery rates, and at total returns on mortgage bonds. So long as those were healthy, bankers reckoned they could ignore the foreclosure rate. Until, of course, they couldn’t.
Jenkins also can’t seem to get out of the Chicago-school mindset that information is reflected in market prices:
Nor is it plausible that all concerned were simply mesmerized by, or cynically exploitive of, the willingness of rating agencies to stamp Triple-A on these securities. Wall Street firms knew what the underlying dog food consisted of, regardless of what rating was stamped on it.
Of course the firms didn’t know what the underlying dog food consisted of! You try piecing together the underlying components of a CDO-squared: it’s functionally impossible, and even if it were possible no one had the time or the inclination to do such a thing. Everything — ratings, prices, the whole shebang — was based on models, not on analysis of underlying fundamentals.
Then comes a most peculiar argument:
But, you say, didn’t a handful of shrewd hedge fund managers detect a bubble and clean up from betting against it? Yes, fund managers like John Paulson and Kyle Bass made huge fortunes betting against subprime. This doesn’t prove that all the signs were there to be read and so others must have behaved irresponsibly… Those who bet successfully against subprime did so through elaborate, expensive, negotiated deals to purchase credit default swaps or buy “put contracts” on subprime indexes. Had they really seen what was coming, they would saved themselves a great deal of expense and bother by simply shorting Citigroup, Bank of America, Lehman, Bear Stearns, etc. Their profits would have been huger, their workload and hassle factor much less. The reason they didn’t, it’s reasonable to suppose, is because no more than anyone else did they foresee the catastrophic consequences we now suppose were destined to flow from excessive issuance of subprime mortgages.
There was lots of irresponsible behavior going on in the subprime market. Paulson et al saw that, bet against it, and made lots of money. Did they foresee that the banking system would implode as a result? Maybe, maybe not — that was hard to foresee, precisely because the banks were very good at hiding the risk they were keeping on their balance sheets. But in any case, it’s never a particularly good idea to bet on second-order events.
The fact is that Wall Street was out of control — out of control of the regulators, yes, but also out of control of its own executives. And excesses on Wall Street did lead to the financial crisis, which in turn led to the economic crisis we’re all living through today. Jenkins’s attempts to let Wall Street off lightly simply don’t hold water.
The same Holman Jenkins who rejected the idea that President Obama would BK GM. Wrong again, Holman.
