Micheline Maynard has a good 1,000-word article today on the surprising fact that both GM and Chrysler managed to exit bankruptcy in record time. But who or what should get the credit? Steve Rattner? The two judges involved? Section 363 of the federal bankruptcy code? And is this a heartening precedent for the wave of future bankruptcies which seems inevitable when all those leveraged loans mature over the next four or five years? Or is it a one-off, linked to extreme levels of government involvement, which is unlikely to be repeated?
Paul Collier is worried about the skewed incentives built in to any bonus system: the upside of taking risk — a big bonus — is much bigger than the downside if the risk blows up:
The inherent problem facing shareholders is that incentive payments cannot go negative. However much damage a manager inflicts, wiping out both shareholders and depositors, the consequences cannot be remotely commensurate.
Collier has a solution: a new crime, called bankslaughter.
With bankslaughter, when the bank blows up – even if it is a decade later – a criminal investigation traces back to determine whether crucial decisions were reckless. If a reasonable banker faced with the information available at the time would not have taken those risks, the person responsible is dragged off the golf course and jailed.
Once bankslaughter was on the books, bonuses would be less dangerous. Managers would have to weigh the balance between risk and return and take defensible decisions. I doubt hyper-caution would be a problem: the overly cautious would not get bonuses. Surely we can rely on our bankers to exhibit the necessary degree of greed.
Is it reasonable to hold professionals criminally liable if they take reckless risks with other people’s money? I don’t see why not. Especially if they work at a leveraged and systemically-important institution. After all, people can be jailed for insider trading, which is far more of a victimless crime than bankslaughter.
Update: Jeff had more on this — including crediting the name to Timothy Garton Ash — last week.
A couple of very interesting comments have appeared on my blog entry on regulating bank fees in general, and overdraft fees in particular. J Mann asks what exactly I’m proposing, and what I think the consequences might be:
Are you thinking about (1) requiring banks to allow customers to opt-out of overdraft protection (or maybe requiring opt-in);
(2) setting maximum overdraft fees, but permitting banks to decline to provide ovedraft financing altogether; or
(3) requiring banks to provide overdraft financing to all checking customers and setting maximum rates for that financing?
It seems to me that the likely consequences would be some combination of
(a) banks declining to offer overdraft financing, which would leave people paying bounced check fees to their payees;
(b) banks reinstuting minimum balances for checking accounts; and/or
(c) banks removing interest and other benefits from checking accounts.
Those consequences might be worth it, but I’m curious which reform you think would get us the maximum benefit/cost ratio.
My proposal would be that banks be given a choice: they can offer automatic overdraft protection, but only if it’s free. (They can charge an annualized interest rate on the overdraft, but no set fees.) If they want to charge fees as well as an interest rate for overdraft protection, then that protection would have to be opt-in rather than opt-out, and the fees should be prominently disclosed at the opt-in stage. And yes, fees would be capped: I would say a $20 cap was reasonable, with a limit of one such fee per day.
What would the consequences be? Yes, for sure there would be more bounced-check fees. (Which should also be capped.) But checks can and should be increasingly rare things. We’re moving into a world where debit cards are replacing checks, and transactions simply don’t go through if funds aren’t available: there’s no such thing as a bounced-debit-transaction fee. Similarly ATM withdrawals would simply be declined, rather than triggering overdraft fees.
Would banks reinstitute minimum balances or otherwise stop banking the kind of poorer customers who currently generate lots of fees but who otherwise aren’t very profitable for the banks? That’s a danger, yes. We don’t want these regulations to result in a large increase in the unbanked. Maybe banks should be required by law to offer simple no-frills checking accounts for customers who can’t meet minimum-balance requirements and don’t want to pay monthly checking-account fees.
As for interest-bearing checking accounts, those beasts are rare enough to begin with that I doubt many people would notice their passing altogether. So yes, there will be costs, but I’m pretty sure the benefits would be much greater.
J Mann’s comment was followed up by one from Argel, who got very excited about the fact that a previous commenter had revealed his account number at Citibank. Is this a particularly dangerous thing to do? In Europe, people give out their account number all the time — if I want to pay you some money, I just wire the money into your account, which is free, but does require my having your account number. In the US, by contrast, people are very protective indeed of their bank account numbers. Is that for good reason? Or is it something which will just change slowly if and when we move from checks to electronic transfers?
David Warsh has a good profile of Mark Thoma, who doesn’t get paid for blogging:
“I lose money on the blog,’ says Thoma. “The state pays me to do this, to be an economist. It would be wrong to take money for it. And if you take advertising, it just feels as though you’re captured.”
I don’t think it’s wrong to take money from outside sources for being an economist, just because the state pays you to be an economist. Is Mark implying that Tyler Cowen is wrong to run ads on his blog? That Mankiw is wrong to make millions of dollars writing textbooks?
What Warsh and Thoma don’t mention here is the legal reason that Thoma doesn’t run ads. Thoma tends to quote other people’s writings at substantial length, often with little or none of his own commentary attached. The vast majority of people picked up by Thoma are very happy about it, but inevitably there are going to be a few who get antsy about copyright. And if Thoma doesn’t make any money from his blog, it becomes virtually impossible for anybody to claim damages.
Some bloggers are much more cavalier when it comes to fair use than others; Thoma and Yves Smith spring to mind as bloggers who tend to quote at great length. But Smith’s blog has lots of ads on it, which means that she’s much more likely to find herself the recipient of takedown notices, C&Ds, and other nastygrams. Thoma, I think, has a much easier life, with much less tail risk, by making the decision to accept no advertising at all. And as an added benefit he has one less thing to worry about on the blog.
Investment banks, including Goldman Sachs and Barclays Capital, are inventing schemes to reduce the capital cost of risky assets on banks’ balance sheets…
The schemes, which Goldman insiders refer to as “insurance” and BarCap calls “smart securitisation”, use different mechanisms to achieve the same goal: cutting capital costs by up to half in some cases…
Under Goldman’s idea, it would sell an insurance product to a bank with a toxic portfolio, effectively shifting the risk of the underlying assets off the balance sheet. The insurance would require far less capital to be carried against it than the original assets.
The insight here (I believe Goldman considers it “financial innovation”) is that insurance is fundamentally more leveraged than finance. Rolfe Winkler is wrong when he says that regulating financial products as insurance would force banks to reduce leverage — quite the opposite.
Think about a pair of banks, A and B. Each has $1 billion in loans on its books, and needs $80 million in capital to be held against those loans. But then B insures A against any losses on its loan book, while A insures B against any losses on its loan book. Presto, each bank is now fully insured against loss, and needs much less capital. Each bank also, of course, has a large contingent liability should the other bank’s loans go bad. But the amount of capital that an insurer needs to hold against such contingent losses is much smaller than the amount of capital that a bank needs to hold against its own loans.
The fact that it’s Goldman coming up with this bright idea is particularly ironic since it was Goldman which revealed the way in which banks could use securitization to reduce their capital requirements. The bank even proposed a very sensible new principle:
Securitized loans should, in aggregate, face the same capital requirements as the underlying loans would if they were held on bank balance sheets.
I wonder whether Goldman’s financial innovators got the memo.
Deutsche Bank AG has agreed to sell Worldwide Plaza, a 1.8 million square-foot skyscraper in New York City, for $600 million to developer George Comfort & Sons and partner RCG Longview…
The sale price works out to roughly $330 a square foot.
Worldwide Plaza is a very high-class office building, home to, among other tenants, the swanky offices of Cravath, Swaine & Moore. It also has what until recently would have been something extremely attractive: a huge amount of unleased space (709,000 square feet, to be exact), vacated by the departing Ogilvy & Mather.
A year or two ago, long-term leases were poison for commercial real-estate valuations, since they reduced landlords’ ability to hike rents. Vacant space, by contrast, was like gold dust: prime midtown office space was leasing at well over $100 a square foot.
Today, everything has been turned on its head: those 709,000 square feet aren’t generating any income, and therefore have very little value. As a result, the 1.8 million square feet of Worldwide Plaza are worth just $600 million: by contrast, the $1.5 million square feet of 666 Fifth Avenue sold for $1.8 billion — or $1,200 per square foot — in 2006. On a price-per-square-foot basis, that’s a decline of more than 70% from the peak of the market.
There’s a meme doing the rounds — I fear it may have been caught by my colleague Rolfe Winkler — that credit default swaps are insurance products, and that therefore they should be regulated by insurance regulators. So before this nonsense spreads any further, it’s worth explaining just why that’s a very bad idea.
First, credit default swaps are not insurance, they’re swaps. A lot of journalists talk about them being “like an insurance contract” when they try to explain what they are, and that’s true, as far as it goes — they do share certain characteristics with insurance. But that doesn’t mean they are insurance. It doesn’t mean that some foolish law should be passed forcing buyers of protection to have an “insurable interest” in some underlying debt instrument, and it certainly doesn’t mean that all CDS should be regulated by some insurance commissioner somewhere.
Many swaps can be thought of as being like an insurance contract, should one be so inclined. For instance, when Larry Summers entered into a massive interest-rate swap while president of Harvard, he essentially locked in a fixed rate on the university’s debt: he was insuring Harvard against the risk that rates would rise. But insurance contracts can’t blow up in the way that the Summers swap did: when rates fell, the university ended up losing a cool $1 billion.
Now let’s say that Harvard had bought credit protection on the state of Massachusetts instead — perhaps Summers, worried about the state running out of money, feared that in an attempt to make up a budget gap, it would start (sensibly) taxing the university’s endowment. Just like with the interest-rate swap, if the spreads on Massachusetts’ CDS had tightened in, then the CDS contract would have cost Harvard a lot of money — protection buyers are just as subject to margin calls as protection sellers are (but as buyers of insurance products are not). It’s the same reason why airlines take large one-off gains and losses from their jet-fuel hedges, even if the purpose of putting on those hedges is to smooth out their fuel expenses.
It’s also worth noting that Harvard might well not be considered to have an “insurable interest”, if it didn’t hold any Massachusetts bonds — even though buying credit protection on Massachusetts might make sense. Defaults have repercussions far beyond the narrow circle of bondholders, and there are many people who might want to hedge against a certain entity defaulting, even if they don’t directly hold that entity’s debt.
A CDS is simply a deal whereby two counterparties promise to pay each other a certain income stream. The buyer of protection commits to paying a fixed amount of money every six months; the seller of protection commits to paying an uncertain amount of money (to be determined via an auction mechanism) should certain events happen in the future. Yes, insurance policies work in a similar manner. But so do, say, office lottery pools — a bunch of co-workers all commit to paying a small amount every week on the understanding that if something improbable happens in the future, they will share a large but unknown amount of money.
Even if some bright spark determines that CDS are insurance contracts, however, that doesn’t mean that they should properly be regulated by insurance commissioners. After all, even if they are insurance contracts they’re also financial derivatives, and it’s pretty clear that financial-derivative regulators are much more likely to be able to effectively regulate financial derivatives than insurance regulators are. What’s more, the SEC looks as though it’s going to be given explicit responsibility for regulating CDS; as we’ve seen in the banking sector, all hell tends to break loose when multiple regulators share responsibility for regulating the same companies or financial instruments.
To make matters worse, there is no national insurance regulator in the US: insurance is regulated on a state-by-state level. Why should a credit default swap entered into between two Delaware counterparties be regulated by the New York State insurance commissioner? It makes no sense at all
And let’s not forget that the New York State insurance commissioner — the only insurance regulator even remotely capable of regulating credit default swaps — was the regulator responsible for regulating MBIA, Ambac, and all the other monoline insurers who blew up as a result of writing far too many underpriced credit-default swaps. The SEC may or may not be an effective CDS regulator, but New York State has proved itself an ineffective CDS regulator.
In any event, if you want strong and effective regulation, the last person you want to turn to is an insurance commissioner. Insurance companies are the most highly-leveraged financial institutions in the world, if you look at the ratio of their contingent liabilities to their book value. That’s one reason why most insurers end up blowing up: they’re generally massively exposed to tail risk. Consider life insurers, for instance: they dodged one bullet, when AIDS ended up disproportionately hitting the kind of people (gay men, intravenous drug users) who don’t tend to have children and therefore normally don’t have much in the way of life insurance. But if a pandemic does start scything down a lot of rich people with children, expect a lot of life insurers to go bust — just as property insurers would disappear en masse if a hurricane were to hit Miami or New York. In theory, insurers hedge their catastrophe risk in the reinsurance market; in practice, they don’t, or not completely. And reinsurers can go bust, too.
What’s more, insurance companies are pretty much the last outpost of extreme opacity when it comes to the effects of the financial crisis. Most of the time, the way that insurers work is that they pay out in claims slightly more than they bring in, in terms of insurance premiums; their profit comes from investing those premiums before they’re paid out. If the investment returns are negative rather than positive, as they almost certainly were last year, then the total losses can be enormous. And I’ve been hearing rumors for months that there are lots of insurance companies which are failing to come clean on their investment losses, especially with respect to their securities-lending operations. AIG was not the only firm investing repo proceeds in subprime-backed securities and losing a fortune in the process — who were the others?
One of the reasons I’m still very bearish on the markets and the broader economy is because I’m convinced that there are lots of enormous financial institutions which haven’t even started to come to terms with their losses yet. Some of those institutions are European and other non-US banks; others are large insurers and reinsurers. I have no faith in the insurers’ regulators’ ability to reassure me that such losses don’t exist or are manageable. And I certainly have no faith in their ability to regulate the CDS market. So let’s not go there.
Are the financial markets in denial about how soon the recovery will come and how impressive it will be? Mohamed El-Erian, for one, thinks so, and he points to the unemployment rate as a key reason why things are not going to get noticeably better any time soon:
The unemployment rate will increasingly disrupt an economy that, hitherto, has been influenced mainly by large-scale dislocations in the financial system.
In just 16 months, the US unemployment rate has doubled from 4.8 per cent to 9.5 per cent, a remarkable surge by virtually any modern-day metric. It is also likely that the 9.5 per cent rate understates the extent to which labour market conditions are deteriorating…
Notwithstanding its recent surge, the unemployment rate is likely to rise even further, reaching 10 per cent by the end of this year and potentially going beyond that. Indeed, the rate may not peak until 2010, in the 10.5-11 per cent range; and it will likely stay there for a while…
This possibility of a very high and persistent unemployment rate is not, as yet, part of the mainstream deliberations. Instead, the persistent domination of a “mean reversion” mindset leads to excessive optimism regarding how quickly the rate will max out, and how fast it converges back to the 5 per cent level for the Nairu (non-accelerating inflation rate of unemployment).
The US faces a material probability of both a higher Nairu (in the 7 per cent range) and, relative to recent history, a much slower convergence of the actual unemployment rate to this new level…
The combination of stubbornly high unemployment and growing government debt will not play well.
I completely agree with all of this. The markets seem to be having difficulty adjusting from a happy world where the key unemployment number is the first derivative, to the current unhappy world where the key unemployment number is the sheer deadweight number of unemployed Americans, who aren’t spending and who are going to be a major drag on economic growth for the foreseeable future.
As for the possibility of a higher Nairu, we’re so far away from there right now that for the time being such discussions are probably academic. But clearly the higher that Nairu gets, the higher the tail risk of a stagflationary spiral — and the less that policymakers can do to get us out of one. Governments managed to avert the most disastrous consequences of the financial crisis. But they might be powerless in the face of the current global economic crisis.
Well that’s annoying. I just wrote a very long blog entry about Brad Setser’s wonderful multimedia extravaganza over at CFR.org — click here and then click on “Chapter III: Motion Charts”. And then when I tried to post it, it disappeared entirely. So here’s the short version: all four of the wonderful Gapminder-style charts (household balance sheets, financial failures, global imbalances, and economic power shifts) are great, but my favorite is the financial failures one, which shows banks’ capital, assets, and market capitalization over time.
Check out where that financial-failures chart ends: with five European banks all having assets of more than $2.5 trillion, and none of them looking particularly well capitalized. No US bank is that dangerous, partly because no US bank is that big — and US banks are dangerous enough. All five of those European banks are too big to rescue, and none of them is particularly well regulated. How do we fix this problem? I have no idea. But I do know that it’s a huge problem, and that no one is even beginning to address it.
Update: Thanks to Alea for reminding me that European IFRS accounting standards result in significantly larger numbers for total assets than US GAAP standards. But still, the fact is those European banks are big.
In the world of urban planning, there are few things hairier than transportation hypotheticals. When NYC pedestrianized Broadway in Times Square and Herald Square in May, the transportation commissioner said that traffic speeds would go up — but now it seems that we won’t know until December at the earliest whether that’s actually true.
At the same time, however, a smart model of what exactly would happen if you changed this or charged for that is a prerequisite for making any kind of informed improvements to a snarled-up central business district. And so, ladies and gentlemen, let me introduce you to Charles Komanoff‘s absolutely astonishing Balanced Tranportation Analyzer — a 3.5 MB Excel spreadsheet which is the product of many years of research and analysis into the question of New York City traffic.
This thing is so big and so complicated that even with all of the detailed explanations in it, it’s hard to understand — you really need Komanoff himself to walk you through it. But he recently did just that for me, and so I can point you to the “Delays” sheet, for instance, where Komanoff attempts to quantify the externalities imposed by any given car in NYC traffic.
Being a cyclist, I’m acutely aware of the issue of externalities — it generally costs you nothing to blindly step off the sidewalk and into the bike lane, or to open your taxi door without looking behind you, but it can affect me greatly. Komanoff’s a cyclist too, but he’s concentrating in this spreadsheet mainly on vehicular traffic. After crunching the numbers, he calculates that on a weekday, the average car driven into Manhattan south of 60th Street causes a total of 3.26 hours of delays to everybody else. (At weekends, the equivalent number is just over 2 hours.) No one car is likely to suffer excess delays of more than a few seconds, of course, but if you add up all those seconds for the thousands of affected cars and trucks, it comes to a significant amount of time.
Many of those hours are very valuable things, especially when you consider big trucks, staffed with two or three professionals, just idling in traffic. Komanoff calculates (check out the “Value of Time” tab) that the average vehicle has 1.97 people in it, and that the average value of an hour of saved vehicle time south of 60th Street in Manhattan on a weekday is $48.89. Which means, basically, that driving a car into Manhattan on a weekday causes about $160 of negative externalities to everybody else.
Of course there are lots of variables here; for one thing, the externalities associated with driving your car into Manhattan go up with the total amount of traffic in the CBD. If you think there’s 5% less traffic in New York now than there was a year or two ago, for instance, the cost imposed goes down by 14%, from 3.26 hours to 2.79 hours. Or, to put it another way, if you could somehow implement a policy which resulted in 10% fewer vehicles driving into Manhattan, any given vehicle would impose “only” 2.38 hours of externalities — an improvement of about $43 over the base case.
Komanoff, of course, isn’t just analyzing the present, he also has a plan for the future. First of which, necessarily, involves congestion pricing. To drive into Manhattan south of 60th Street, you pay a toll: on weekdays, the toll is $3 at night, then rises to $6 for most of the day, and for peak periods (6am to 10am, and 2pm to 8pm) goes up to $9. At weekends, there’s a similar but smaller toll, at $1/$3/$5 prices.
Then there’s the subway fare: that too changes according to the time of day. At night subways are free; sometimes they’re 50 cents, and most of the time they’re $1. At ultra-peak hours (between 8am and 9am, and between 5pm and 6pm) a subway fare rises to $2, dropping to $1.50 the following hour.
One of the most interesting parts of Komanoff’s plan is the bus fare: always $0, all the time. That speeds up buses considerably, since it basically eliminates long lines at the fare box as people hunt for their MetroCard. In turn that makes buses more attractive, and a lot of people, attracted by the free fare and faster speeds, will start taking the bus rather than driving or taking a taxi or a subway. In-city commuter rail, on Metro-North and the LIRR, also goes free.
Medallion taxis do not pay the congestion charge, but there is a 33% taxi-fare surcharge. One tenth of that (around 3%) goes to the taxi drivers and owners; the rest (30%) goes to the MTA; the taxi surcharge alone raises enough money to make in-city commuter rail free.
Add it all up, and it’s pretty much revenue-neutral, says Komanoff: the biggest line items are that you lose $1.46 billion in transit fares, while gaining $1.31 billion in congestion charges. But total time savings are the biggie: implement this plan and New Yorkers get over $2.5 billion of time back which would otherwise be spent wasted in traffic. Vehicle speeds in general rise about 20%, and as much as 25% between 9am and 10am.
All in all (see the “Cost-Benefit” tab), Komanoff sees $5.3 billion in gains and just $2 billion in losses. Sounds good to me. What’s more, it’s politically more acceptable than the last attempt to introduce congestion pricing into NYC, where the brunt was disproportionately borne by Brooklyn. This plan puts much more of the cost of the plan onto Manhattanites, largely thanks to that taxi surcharge. Here are Komanoff’s charts (from the “Incidence” tab):
Komanoff’s still working on this spreadsheet, but the main message is pretty clear — that smart congestion charging would be great news for New York, and probably for most other dense cities as well. If you’re feeling really ambitious, you can even try playing around with the numbers yourself. Enjoy!