Felix Salmon

Bloomberg and the FT have almost-identical headlines this morning, saying that Goldman Sachs stands to make $1 billion if CIT declares bankruptcy. Neither of them is long on specifics, and both seem to be based on information from a single anonymous source, which is then promptly denied by Goldman itself. Here’s Bloomberg:

Goldman Sachs Group Inc. is set to earn about $1 billion should CIT Group Inc. enter bankruptcy or otherwise end a $3 billion financing agreement, according to a person familiar with the matter, who declined to be identified because the payout hasn’t been disclosed…

“This would not be a windfall payment,” Goldman Sachs said in a statement today. “The make-whole payment, which was publicly disclosed at the time of the financing, is simply the present value of the spread to be earned over the life of the facility.”

In the lede we’re told that there will be a windfall of $1 billion for Goldman and that it hasn’t been disclosed, and shortly thereafter Goldman says that it won’t be a windfall and that it has been disclosed. What is a poor reader of such material to think? (The FT story is, if anything, even more confusing, since it conflates the deal with side-bets that Goldman has made in the CDS market to manage its CIT credit risk.)

The easy way out is to simply decide, as Peter Cohan does, that Goldman Is Evil:

Goldman has engineered the world so it wins no matter what…

Goldman’s 0.01 percent of the population is on track to average about $772,858 in total compensation this year, thanks to its ability to engineer the U.S. government and the rest of the business world so it wins while 99.99 percent of America loses.

One thing’s for sure: Goldman isn’t good at playing the press. I don’t know who the source for these stories was, but I’d wager it was the same source for both, someone on the CIT side of the debt renegotiation who knows that Goldman is very concerned with optics these days.

The stories come as Simon Johnson weighs in to the Goldman debate along similar lines, asserting that “US banks or bank holding companies would not generally be allowed” to use private-equity arms to invest in an industrial company like Geely Automotive. I don’t know where Simon got this idea, but generally there seems to have been very little resistance indeed to bank holding companies owning private-equity subsidiaries. (There has been much more resistance to the converse situation, where private-equity shops look to buy banks.) If the Geely deal had been with any bank other than Goldman, this blog entry might well have never appeared.

It’s interesting to me that no one is giving Goldman the benefit of the doubt, and that even in the face of flat-out denials both Bloomberg and the FT are happy to run with aggressive headlines. That says to me that no one trusts Goldman’s flacks to be telling the truth, and that the Goldman image problem remains as bad as it’s ever been.

Given the choice between making lots of money and having a good public reputation, Goldman will always choose the former. But the bank always used to have a reasonably large number of defenders in the press; that number seems to be shrinking daily. Even during the depths of the crisis, when extreme measures got taken every day, Goldman’s “Government Sachs” reputation was bad enough to singlehandedly derail the proposed merger with Wachovia. Since then — and especially since Matt Taibbi’s screed appeared — Goldman’s reputation has only deteriorated further.

Goldman has seconded its president’s chief of staff, Samuel Robinson, to the PR department in recent weeks, in what is surely an attempt to reverse this decline. Judging by today’s headlines, he still has his work cut out for him.

Normally, when I admit that I was wrong, I don’t get a lot of responses basically saying “no, you were right the first time round”. But this time, when I admitted I was wrong about bank nationalization, I’ve received a lot of pushback along those lines. Charles’s comment is representative:

Really ? How did you come to that conclusion? As far as I can see, the “saved” banks are retreating on lending to SME and retail, stuffing their balance sheet with safe bonds (mainly govies) and recapitalizing themselves by taking advantage of the steepness of the yield curve. This has enormous opportunity costs for the taxpayer (these long bonds coupons will have to be paid one day…), depresses the “Real” economy, and is as close to “free lunch” for the banks than anything. The government, and the taxpayers, bear the burden of banking sector losses and get nothing in return. A nationalization has the same risks, but enjoys the potential upside.

One key point of my post was that the Obama administration is very good at tempering its initiatives with a clear-eyed view of what is possible and what isn’t. In the case of the decision not to nationalize the banks (which, it’s worth emphasizing, is different from a decision never to nationalize the banks), I think we’re seeing a real appreciation of the breadth of the possible unintended consequences, as well as the practical impossibilities involved in the government trying to run such an enormous banking book with so many different and competing parts.

How much of the decline in bank lending to individuals and small businesses is due to a drop-off in demand, and how much is due to banks’ increasing risk-aversion? It’s hard to say, but the former is clearly important, and having government-owned banks wouldn’t change that. Such lending is normally much more profitable than the big wholesale loans which banks have increasingly been keen on extending of late; that says to me that they’d be perfectly willing to make smaller loans if only there were reasonably high-quality demand out there. I might be wrong, but even if I am, it’s hard to see how government ownership would change things: government simply doesn’t have the ability to micromanage bank lending at that level.

The reason why I wanted to nationalize the banks is that they were suffering from a major liquidity crisis, and they were insolvent on a mark-to-market basis. In that situation, the government essentially has two options, when the banks are too big to fail. It needs to provide liquidity either way; the only question is whether it does so while taking ownership, or whether it leaves the banks to continue in their existing form, in the hope that the markets will recover and they will no longer be mark-to-market insolvent.

The latter is much easier, and is pretty much what happened. It also has the added advantage that you don’t have government ownership driving out private-sector risk capital. As an anonymous Treasury official says in Lizza’s piece, “People had money to put into banks. The nationalization crowd would have had the government putting all that money in.”

It’s true that when the government determines that a certain bank is too big to fail, and then lowers interest rates to the point at which the yield curve becomes steep, the result is a recapitalization of that bank through easy profits. And yes, those profits go to the bank’s private shareholders. You can call that a free lunch. The alternative, for taxpayers, is the possibility of a very expensive lunch indeed. Here’s Lizza again:

Furthermore, Summers said, there was a medium-term risk that nationalized banks would lose value, in the same way that the act of foreclosure decreases the value of a home. Summers pointed to the example of Sweden, which was regularly cited by economists who favored nationalization. But Summers noted that Sweden didn’t nationalize for two and a half years, by which time the situation had become so severe—interest rates had reached a hundred per cent—that there were no other options. In addition, Nordbanken, the largest bank nationalized in Sweden, was already eighty per cent government-owned. Summers concluded by emphasizing that nationalization was a strategy that governments turn to only after it is very clear that nothing else can work.

One of the problems facing Summers and Geithner when they made this decision was how to get the wholesale market in bank debt moving again. (Remember the TED spread?) Given that they couldn’t nationalize thousands of banks at once, and given that nationalization was tantamount to an admission that the banking system was insolvent, non-nationalized banks would have found it pretty much impossible to find funding at any level, and there might well have been a much larger number of bank failures than we’ve seen to date.

The fact is that nationalization is a negative-sum game. Just because banks are making large profits now, doesn’t mean that they would have made just as much under government ownership. And the political noise surrounding just about any decision that any nationalized bank made, especially as regards pay and bonuses, would have made any other kind of reform (healthcare, financial-regulation, you name it) even more difficult than such things have turned out to be sans bank nationalization.

Now that the results of the stress tests have been made public and the debt market has recovered impressively, there’s a strong case to be made that the banking system is no longer insolvent. If we could get here without the incredibly drastic measure of nationalization, that’s a good thing. Yes, we might have lost a bit of potential upside on our hypothetical equity stake in the big banks. And yes, it’s very depressing to see a large chunk of that upside going to the very bankers who helped drive the economy into the current recession in the first place. But let’s not kid ourselves that the nationalization option would have been trivially superior in all respects.

It’s a day for long readings: not only Ryan Lizza in The New Yorker, but also Andrew Ross Sorkin, whose book excerpt in Vanity Fair — all 12,000 words of it — is now online in full.

If the excerpt gives any indication of the quality of the book as a whole, Sorkin has succeeded in writing the book of the crisis, with amazing levels of detail and access. Many books end up having much less detail than the day-to-day journalism in the papers, choosing instead to concentrate on the bigger picture. This one, by contrast, has a lot of detail, and it’s worth reading the Q&A with Sorkin to get an idea of how much reporting went into it.

The VF excerpt covers a period which has been rather overshadowed, in retrospect, by the collapse of Lehman Brothers — the week after that epochal event, when Morgan Stanley came thisclose to failing. At the time, my predictions that Morgan Stanley was going to fail resulted in my getting a serious death threat, so I was interested to read Sorkin’s account of this period to see how close I had been. The answer is very: on Wednesday September 17, Morgan Stanley’s CFO calculated that the bank was going to run out of money by the end of the week, and that was just one of many life-threatening crises for the bank.

All manner of options were looked at, including really messy mergers with Wachovia or Citigroup or JP Morgan. Nothing looked remotely attractive. China’s CIC bank had cash to play with but didn’t seem overly keen to do a deal; Japan’s Mitsubishi was also interested, but culturally pretty much incapable of moving with speed and decisiveness over the course of a sleepless weekend.

And then there was the too-many-cooks problem: because Morgan Stanley was systemically important and its collapse would almost certainly cause Goldman to domino into failure as well, Tim Geithner and Hank Paulson and Ben Bernanke were all breathing down the neck of Morgan Stanley’s CEO, John Mack. None of them had had much sleep either, and they were making rushed and ill-thought-through decisions, like trying to get Goldman to merge with Wachovia or even buy Citigroup. The Goldman-Wachovia deal, pushed by the Fed, almost happened, until it was vetoed by the very people who had encouraged it in the first place.

In Sorkin’s telling, Wachovia CEO Bob Steel has a moment of minor glory shouting at the Fed’s Kevin Warsh over a speakerphone, but it’s John Mack who has the real brass balls, fighting with Paulson himself and telling Geithner to “get fucked” while he’s putting a deal together with Mitsubishi. Mack’s a hero of this story: while everybody else is panicking, Mack is clear-eyed and doing the right thing for his employees and his shareholders. But how close did his gamble come to failing? I asked Sorkin, who replied:

As you’ll see in the book in the chapter that follows the excerpted material, the Mitsubishi deal briefly almost falls apart two weeks later, leaving Mack anxious that the firm was imperiled all over again. Of course, in the end, the deal is completed and disaster averted.

Mack had only bad choices to make: Sell to JP Morgan for $1 a share, which would have meant at least 20k employees would be fired, if not more; sell half the firm to the Chinese for next to nothing, which likely would have meant he would have had to raise capital again because CIC was only prepared to contribute a couple of billion; or pursue the deal with Mitsubishi. Of those choices, he clearly made the right one, but as you said, things could have turned out very differently. One other thing to consider: In the book, I provide a scene inside Morgan Stanley’s board meeting that Sunday afternoon — it was edited from the excerpt for space — but the group was pretty unanimous in its view that it should pursue Mitsubishi, despite someone else in the room suggesting otherwise. (There’s a fun little surprise in that scene, so I won’t spoil it for you.)

I’m looking forward to reading the book, including the board-meeting easter egg. But this excerpt, more than anything else I’ve read in the orgy of one-year-later reminiscing, shows just how close the entire financial world came to collapse. It should be required reading for anybody in Congress who is breathing easily again and thinks that the worst is over and we don’t need to do too much in the way of regulatory reform. These crises can come out of nowhere, and it’s imperative that the next time round, we have institutions capable of dealing with them, instead of having to rely on dumb luck and the occasional deus ex machina from Japan.

Did you know the pata negra iberico pig originated in the US? — Feedbag

Olivia Judson with a good short explanation of what’s happening to Simon Singh in the UK — NYT

A long piece on the new Damien Hirst, by Sarah Thornton — Times

Hope, donated by lobbyists. Frank Rich is on form this week. — NYT

Why housing derivatives will never take off: you can’t delta-hedge them. — Rortybomb

The high dollar price of being gay — NYT

Shouldn’t the “extensive newsroom dialogue” on WaPo Twitter guidelines come before their publication, rather than after? — WaPo

NYT ‘obtains’ 248-pg report on bloody Afghanistan battle- & then doesn’t post it or explain why not — NYT

I had good fun on BNN Friday. The DC studio is definitely nicer than the Nasdaq studios in Times Square. — BNN

Evening Standard to be free paper — BBC

Yikes the Ryan Lizza piece on Larry Summers is long — over 11,500 words. And even then it manages to say absolutely nothing about some key issues, such as the $5.2 million he was paid by DE Shaw to work one day a week in 2008; or the allegations of Summers actively working to marginalize the influence of Paul Volcker; or l’affaire Shleifer. But Lizza does get Summers to admit to mistakes during his tenure at Treasury, at least as regards the subject of derivatives:

In Rubin’s memoir, “In an Uncertain World: Tough Choices from Wall Street to Washington,” he describes the debate that he and Summers had over the issue. “Larry thought I was overly concerned with the risks of derivatives,” Rubin writes. “His argument was characteristic of many students of markets, who argue that derivatives serve an important purpose in allocating risk by letting each person take as much of whatever kind of risk he wants. Larry’s position held together under normal circumstances but seemed to me not to take into account what might happen under extraordinary circumstances.” Summers told me, “If we had known that derivatives markets would mushroom the way they did and that regulators would remain spectators, we would have acted. With hindsight, all of us with involvement in financial policy wish we had done more to forestall problems.”

This is a good find from Rubin’s book — which was written, remember, in 2002, many years before the CDS exposure at AIG Financial Products threatened to bring down the entire global financial architecture. And although it’s now pretty clear that Summers’s deregulatory impulses as Treasury secretary had pretty gruesome consequences, it still reflects well on Summers — a man of no small ego — that he is willing to admit as much.

Lizza also provides a lot of detail on Obama’s decision not to nationalize the banks:

On March 31st, Summers sent the President a page-and-a-half memo outlining the reasoning behind the decision not to nationalize any banks. Obama was on his way to the G-20 meeting in London, and he wanted to be prepared with the best case against it.

The memo was divided into four sections. First, Summers explained that there was no legal authority to take over large bank-holding companies like Bank of America and Citigroup. Next, he pointed out that full nationalization of a financial institution might trigger systemic shocks, as investors retreated from other banks, creating exactly the kind of panic that nationalization was intended to prevent. (As Sperling often argued, “You might come out and say, ‘I’m gonna take over Bank of America and Wells Fargo, but everybody else is safe!’ Maybe they believe you. And maybe they don’t. But if you get this wrong the Dow’s at thirty-five hundred! You’re the worst economic manager in the history of the United States!”)

Furthermore, Summers said, there was a medium-term risk that nationalized banks would lose value, in the same way that the act of foreclosure decreases the value of a home. Summers pointed to the example of Sweden, which was regularly cited by economists who favored nationalization. But Summers noted that Sweden didn’t nationalize for two and a half years, by which time the situation had become so severe—interest rates had reached a hundred per cent—that there were no other options. In addition, Nordbanken, the largest bank nationalized in Sweden, was already eighty per cent government-owned. Summers concluded by emphasizing that nationalization was a strategy that governments turn to only after it is very clear that nothing else can work.

In hindsight, Summers was right and those urging nationalization were wrong. (Which group includes Paul Krugman and Nouriel Roubini, as well as me.) What I’m particularly happy about is that the debate took place, in a lot of detail, within the White House, between people who had no ideological axe to grind and who were intent on working out the objectively right thing to do, given the uncertainty surrounding the banking system and the economy.

I can see why Summers’s memo could not have been leaked at the time — the worst possible outcome would have been to reveal that the nationalization option was being seriously debated at the White House, sending markets into a tailspin which then would have gotten even worse when the government revealed that it wasn’t going to nationalize after all. But in hindsight, Summers seems to have made some very strong arguments.

Lizza’s article concludes with this:

So far, none of the worst fears of those who believed that the stimulus was too small or that nationalization was the only option or that taking over car companies would destroy the fabric of capitalism have materialized. Indeed, several private forecasters have credited the stimulus with blunting the impact of the recession—it probably added around three points to the G.D.P. last quarter—and the banking system has dramatically stabilized since the stress tests were completed.

This doesn’t mean that all these decisions were necessarily exactly right. But in politics, the quality of the implementation is often at least as important as the quality of the original decision. And the way that the Obama administration has spent its $787 billion, or avoided nationalizing the banks, or bailed out the auto industry, has been extremely professional and effective.

Indeed, in homage to the great dsquared, I’ll ask a question: can anybody give me an example of something with the following three characteristics:

1. It is a policy initiative of the current Obama administration
2. It was significant enough in scale that I’d have heard of it (at a pinch, that I should have heard of it)
3. It wasn’t fundamentally extremely well-managed during the execution.

The point here is that policy initiatives are sometimes good and sometimes bad. We all disagree with some of the Obama administration’s decisions, like for instance the tariffs on Chinese tires. But once that decision was made, it was handled very well, and seems to have had very little in the way of negative knock-on consequences. Similarly, after the PPIP was announced with great fanfare, it was allowed to get scaled back to a tiny fraction of its original size and ambition once it became clear that it was neither particularly useful nor particularly popular.

I don’t know how much credit can be given to Summers for this one; I personally would be inclined to give most of the credit to Obama himself. But Summers has clearly settled into a very important role in this administration, and I can see how his ingrained contrarianism and skepticism might be very good at keeping everybody else that much more intellectually honest and well-prepared.

Update: Dean Baker is unimpressed.

Update 2: The consensus of the commenters seems to be that Afghanistan and pushing healthcare reform through Congress both meet my criteria. I also like Carol Shannon’s nomination of Cash-for-Clunkers.

Tom Lindmark says I should give Ken Lewis a break:

Felix Salmon made a good point in a post yesterday when he said that running a mega bank was not something that any individual was capable of doing…

While Felix thinks that bank CEO’s cannot positively influence the outcome of their institutions, he seems perfectly willing to assert that they can destroy the bank. This makes no sense logically but it does typify the sort of disparagement that has been dealt out to Lewis and others.

I do think that the importance of CEOs is often overrated, but of course Ken Lewis is and was entirely capable of destroying shareholder value. One of the ways he did that was by growing Nationsbank, by acquisition, into a bank which is now too big to manage or effectively run. Another way he did that was by buying Countrywide and Merrill Lynch.

Conversely, there are ways for bank CEOs to protect shareholder value. In an interest-rate environment like the one we have right now, banks will be steadily and highly profitable on a week-to-week basis. The job of senior management is to keep an eye on the risk book, and make sure that no one is taking outsize risks which can’t be managed. Goldman Sachs and JP Morgan are both very good at this. Ken Lewis was always very bad at that aspect of the job: when things started heading south in the housing market, he decided the best thing to do was to redouble his housing bets by buying Countrywide.

Lindmark suggests that the disparagement of Lewis is snobbish NYC elitism:

Lewis’s real problem was never about his ability to run a bank but rather about his looks, demeanor, background and geographic location. He isn’t Jamie Dimon smooth and he looks like a man either in a permanent state of confusion or one about to rip out a subordinates throat. He never made any bones about his middle class background nor about his strong desire to succeed and running a bank based in Charlotte automatically knocks you down a lot of pegs in the viewpoint of the New York crowd.

Jamie Dimon bought Bear Stearns and got a sweetheart deal from the government to make it work. Ken Lewis bought Merrill Lynch and went back after the fact to get their backing. Little is said of Dimon’s deal while Lewis is vilified for everything connected with the Merrill acquisition.

This is ridiculous. People hate Lewis because he’s middle class? Er, no. Because he’s ambitious? (And Dimon isn’t?) Because he’s based in Charlotte? Come on. They hated on Stan O’Neal and Dick Fuld and Jimmy Cayne and Chuck Prince just as much, and they were based in New York.

As for Ken Lewis getting more grief for buying Merrill than Dimon has got for buying Bear, well, yes. Lewis overpaid massively for his failing investment bank, while Dimon got the Federal Reserve to subsidize his purchase to the tune of $29 billion. Both CEOs are ambitious, but only one let his ambition get the better of him. And he’s the one who just resigned.

Spending a couple of high-intensity days in Washington, as I’ve just done, is enough to send anybody dreaming of booze. And so it’s quite lovely to read Dr Vino’s missive from the latest Executive Wine Seminar, which featured not only 15 spectacular 2005 Bordeaux wines, but also Robert Parker, tasting them blind.

Parker has rated all these wines, of course. But would his blind ranking bear much if any relation to his official ranking? And how many of the wines could he successfully identify? The answers, I wasn’t at all surprised to hear, were “no”, and “zero”.

To take just one example, Parker identified wine #8, the mainly-Merlot L’Eglise Clinet from Pomerol, as being the mainly-Cabernet Cos d’Estournel from Saint-Estèphe.

Writes Dr Vino, charitably:

A final issue is about points and the nature of blind tasting, a capricious undertaking if there ever were one. Although Parker did not rate the wines yesterday, his top wine of the evening (Le Gay) was the lowest rated in the lineup from his most recent published reviews… For all the precision that a point score implies, it is not dynamic, changing with the wines as they change in the bottle nor does it capture performance from one tasting to the next.

So should we do away with blind tasting altogether? Tom Matthews, the executive editor of Wine Spectator, wrote this on my blog:

Blind tasting is not easy, but that does not mean it’s not useful. With all due respect to Bob Millman, it’s not that tasting blind is “judging from ignorance”; it’s that ignorant judges do poorly in blind tastings.

Millman is the person who runs the Executive Wine Seminar tastings, and he’s much less constructive on the subject of blind tastings than Matthews, and it’s not hard to see why: after all, it does rather seem as though Matthews is saying that Parker is an ignorant judge.

Parker isn’t an ignorant judge, of course. And I daresay he actually did well in this tasting, in terms of judging the wines purely as he was drinking them. He just did badly in terms of identifying what they were, or giving them this time around the same ranking that they got the last time he ranked them. Wine is not a fungible commodity, where one bottle is always the same as the next — quite the opposite. But the fact that wine changes, from bottle to bottle and from month to month, rather defeats the purpose of magazines such as Wine Spectator.

I asked Matthews what he considered a “good judge” to be, and whether there were any downsides to tasting blind. He wrote back:

On judges: Yes, in my opinion, judgment is a quality that lies along a spectrum. “Ignorant” judges lack the context to make useful distinctions; “good” judges have enough experience and understanding to apply appropriate criteria to the wine in the glass. All judges begin in ignorance. If they work hard — taste widely, concentrate intently, read and travel and interview the experts — they may become good. At Wine Spectator, it’s less a matter of “choosing” judges than training them. Before an editor qualifies as a wine critic, he or she undergoes a long and intensive period of apprenticeship with us. The “empirical data” we look for is their consistency of judgment, breadth of understanding and sensitivity to the qualities of the wines they are tasting (faults, structure, flavor descriptors, etc.) Once they do qualify, they are given responsibilty for specific wine types, and as they prove their consistency and expertise, they take on larger tasting beats.

On “downsides”: The challenge in evaluating wine is eliminating externalities that can bias judgment (such as price and reputation) without eliminating so much context that judgment is impossible (since good wine is supposed to reflect its vintage, terroir, etc). Carefully-calibrated single-blind tasting is the methodology that long experience has convinced us is the best and fairest approach. But enjoying wine is a different matter, and in that situation, blind tasting can rob us of information that can supply both pleasure and edification. At dinner parties, I like to serve a wine blind, to get an “unbiased” reaction, then unveil it, so we can learn both from our reactions, and from the wine.

In a world where Robert Parker fails to perform on the criterion of “consistency of judgment”, even in the context of a “carefully-calibrated single-blind tasting”, this does ring a little hollow. Parker didn’t invent the guess-this-wine game that many tastings become, but he is partly responsible for the idea that people who are good at that game are necessarily the people best qualified to judge wine. It’s definitely fun to see him hoist on his own petard once in a while.

Via Paul comes this montage of highlights from the people who brought you the Everything is OK series. What makes it especially fabulous for me is the fact that a  large chunk of it takes place right outside Reuters HQ in Canary Wharf. Obviously, you shouldn’t watch it. Do your job instead. Or go shopping. One or the other.

Jake is on fire with employment charts this morning in the wake of the atrocious payrolls report. This one in particular is new to me, and extremely sobering:

Even at the worst points of the worst recessions of the 1970s and 1980s, never has the number of hours worked per US person been lower than it is now. And this isn’t happy productive people taking time off because they don’t need to work as hard any more: this is unhappy unemployed people who desperately want and need to earn money but can’t.

What we’re seeing in this graph is, I think, the violent implosion of a large swathe of the working classes. Many of those jobs — the ones which, in the boom, were in or connected to the housing or auto industries in particular — will never come back; if they’re replaced at all it will be with lower-wage, lower-skill service-industry jobs. That bodes very ill for the US economy as a whole, and reinforces my notion that the best-case scenario right now, economically speaking, is essentially a square-root-shaped recession where we rebound from the lows but then fail to grow over the medium or long term.

That said, previous plunges in this graph have been followed by relatively sharp rebounds, so maybe we’ll see the same thing happen again. I just can’t work out what the driver of all that new employment will be.

David Leonhardt interviewed Alan Greenspan at the Atlantic event in Washington this morning, and it was quite shocking how little Greenspan seems to have learned from the crisis. Yes, he has decided that banks need more capital: “You cannot function with a financial system with capital as low as it was,” he said, adding that “in retrospect, Basel II was clearly suboptimal. You can’t have capital at 10% or less, because human nature changes too quickly.”

But on other matters — especially when it came to systemically-important things which didn’t fail in this particular crisis, Greenspan was alarmingly sanguine.

When Leonhardt brought up the subject of derivatives, Greenspan was at pains to differentiate interest-rate and foreign-exchange derviatives, on the one hand, from credit default swaps, on the other. He explained, quite rightly, that the percentage of the notional amount which players stand to lose is much higher in the CDS market that it is in say the rates market, but he never mentioned that notional amounts outstanding in the rates market are orders of magnitude greater than the CDS market ever was.

The degree to which Greenspan claimed not to be worried about the vast bulk of the derivatives business was highly alarming:

Nobody hears about problems in interest-rate or fx derivatives. We’ve had the most extraordinary stress test, and they came up clean. I’m saddened by the fact that the problems in CDS have been generalized to all financial derivatives.

For one thing, we do hear about problems in interest-rate derivatives: a man appearing at the conference later this afternoon, Larry Summers, contrived to lose $1 billion of Harvard’s money in just that market. Given the extreme measures which have been taken by the world’s central banks, and given the fact that global capital imbalances remain enormous, there’s clearly a lot of tail risk in the interest-rate and fx markets. If volatility there spikes in some unprecedented way — which is entirely possible — then no one knows who could end up becoming spectacularly unstuck in those markets.

Greenspan defended the CDS market, too, in familiar terms:

We have to make adjustments in the way that market is working, but fundamentally the concept of CDS is a very desirable one. You are distributing risk to those who are more interested in holding it or more capable of holding it, and that’s desirable.

Haven’t we learned that this isn’t true? Haven’t we learned that the people who end up holding the risk, once the banks have done their derivatives-based, structured-product thing, are precisely people who are not interested in holding it but who don’t realize what risk they’re holding? After all, those buyers will always be much more attractive, to risk sellers, than the kind of risk-hungry hedge funds who demand high returns for taking on that risk. The derivatives market turns out to have been one the best mechanisms ever designed for hiding risk, and I don’t see that as desirable in the least.

Greenspan, in other words, seems to have learned almost nothing from the crisis. When Northern Rock failed, he said, “the UK authorities were the best set of regulators in the world” — er no, they weren’t, as a glance at the leverage ratios at UK banks would tell anybody. So when Greenspan talks about inflation not being a problem until 2012, as he did at the end of his session, it’s not obvious why anybody should listen to him. He simply isn’t reliable or useful any more.

Cablevision’s Jim Dolan Successfully Sues Blogger (Teri Buhl) Into Submission — Gawker

A partial defense of Zero Hedge from Justin Fox (!) — Time

Born anxious — NYT

The New York Post wins at headlines — VF

Guess the Ken Lewis beard — FTAV

The proximate cause of Bill Winters’s ouster: a reputation-risk fight with co-head Steve Black? — WSJ

Steve Wynn on USA vs China — LoSC

Data on innumerate artsy journalists — WCI

One of the odder riddles of the financial markets is how they can be so highly competitive and so highly profitable at the same time. The financial innovation debate seems to be helping us find an answer, as clearly articulated by Karl Smith:

It’s not that firms refuse to compete by providing consumers the best products – its that they cannot compete in this way because consumers will naturally gravitate towards products which are bad for them.

That is, if you are offering a product that is just the same as the standard vanilla product but has some hidden tail risk then you can necessarily offer it a lower price.

Why don’t firms compete on offering products with hidden tail risk, and see prices driven down that way? Because there are extremely high barriers to entry when it comes to starting up a firm offering sophisticated financial products. Also, the unspoken rule among investment bankers that you try never to compete on price has somehow become an article of their faith among their clients, too, who tend not to trust investment bankers who try to compete on price. Hence the fact that Bill Hambrecht’s eminently sensible IPO method has signally failed to catch on, while the old fashioned give-the-bank-7% method remains standard.

More to the point, as Arnold Kling says, “a lot of the trick of investment banking is to figure out a way to transfer risks to taxpayers”. If you compete with other bankers, you drive down the profitability of your industry, and ultimately your own paycheck. Bankers tend to be hyper-aware of how much their competitors are paying, and they don’t like doing anything which is likely to bring that number down.

On the other hand, if the money you’re making is coming not from your competitors but rather from taxpayers — if they’re essentially insuring the excess downside on your bets for a premium of $0 — then the sky’s the limit in terms of how much money not only you can make, but all your other competitors potential employers can make as well. What’s not to love? The only people who are liable to object are regulators, and they often have half an eye on getting a lucrative financial-sector job as well.

Ryan Avent explains, contra Matt Yglesias, why hosting the Olympic games makes sense from a behavioral-economics perspective:

Infrastructure benefits begin appearing years down the road and last for decades beyond that, while many of the costs — the political headaches, the need to put together financing, the disruption of construction, and so on — are relatively immediate. Winning the Olympics ties an immediate benefit to the immediate costs.

More to the point, it sets a deadline. Infrastructure projects invariably end up plagued by endless delays: just ask anybody who currently commutes on the Second Avenue subway line in New York. And deadlines are often the only way that anything ever gets finished: just ask any journalist. If you win the Olympics, you know that for all the construction headaches you’ll have to endure before they open, at least you’ll have some decent infrastructure thereafter. If you don’t win the Olympics, then even if you’re enlightened enough to invest in infrastructure, you can have no faith in its arrival.

Rio de Janeiro has desperate need for a good subway system. If it wins the Olympics, it will probably have just such a system by 2016. If it doesn’t win the Olympics, there will still be a lot of infrastructure investment in the city. But without a deadline, I don’t think anybody has any faith in getting that subway system any time soon.

TED has some great insights on banker pay, including this one:

Deferred pay lost its effectiveness as a distributed risk management tool. As investment banks grew ever larger and more complex, each banker had less and less impact on the overall results and health of his bank, almost no matter how much he made.

This is the problem of restaurant checks. If there’s only one or two people dining, it’s relatively easy to keep the cost per person down. Even when the group rises to four or six, when everybody knows that everybody else is paying attention to what they’re ordering, things can remain within the realm of reason. But get a huge group of people together, all ordering individually, and things get out of control. Bringing down the cost of your own consumption has no visible effect on the amount that you’ll be asked to pay at the end, and so everybody pigs out.

The lesson, of course, is that investment banks need to shrink. If they do that, they can go back to being partnerships, rather than public corporations with growth-hungry shareholders. As TED puts it:

Because most of these outsiders were big, diversified institutional investors, they had an even more aggressive risk posture than the investment bankers themselves. They pushed the bank CEOs and Boards for ever more growth and return on equity, and the senior executives, being investment bankers who worship at the altar of revenue anyway, complied.

I’m with TED all the way up to his conclusion, where he seems to say that since reducing investment bankers’ pay wouldn’t be sufficient to solve incentive problems, it can’t be necessary. Maybe the existing structures work in small partnerships, and I’m happy to leave pay in small partnerships unregulated. But in large trading houses with 12-figure balance sheets, the incentive structure is clearly broken, and needs to be fixed. And since the banks won’t do it on their own, it’s down to the regulators to impose some kind of discipline. (After all, they represent the people who will bail the banks out should their bets go bad.)

Ideally, the regulators’ discipline will be harsh enough that investment bankers will leave to set up their own small-enough-to-fail shops, and the systemically-dangerous investment-banking behemoths will slowly go the way of the dinosaurs. And of course it will have to be reasonably well coordinated internationally, since investment banks are now global creatures. But I don’t think there will be any pushback from the Europeans on this front.

The WSJ has a good primer on re-remics today, explaining the regulatory arbitrage at the heart of such deals. Just like capital requirements can drop simply by reclassifying loans as bonds, they can also drop if you play around with bonds and turn them into economically-identical other bonds, which carry different credit ratings. Yes, one would have thought that we’d put an end to such shenanigans by now. And no, we haven’t.

The whole re-remic phenomenon is made even more suspicious, of course, by the fact that bankers, lawyers, and ratings agencies are all charging substantial fees for the work involved. Insofar as they’re creating any value at all, which is doubtful, they’re doing so by creating brand-new structured products with triple-A credit ratings: they’re ratifying the very demand for nominally risk-free assets which lay at the heart of the credit bubble to begin with.

If these things were really attracting new demand, that would be one thing — and indeed Treasury might try to revamp PPIP so as to create liquid triple-A-rated tranches of groups of formerly-distressed assets. But there’s very little evidence that re-remics are being traded: they’re still sitting on the same balance sheets where they’ve been stuck for the past year. They’re just considered a bit less risky, now that some of their AAAs have been regained. How silly.