James Pethokoukis

Politics and policy from inside Washington

Dubai and the dollar

Nov 27, 2009 18:09 UTC

My pal Felix Salmon makes a good point about the dollar and Dubai. The greenback initially slid on the news. But isn’t the greenback supposed to be a safe haven. Felix opines as follows:

Needless to say, this isn’t exactly a classic risk-aversion reaction: when the markets are really scared, they tend to flee to the safety of the dollar, rather than to the Japanese yen. So my feeling is that this — along with the relatively modest stock-market reaction in New York this morning — counts as a sign that Dubai really isn’t all that bad: it shows that markets are trading the news, rather than panicking.

On the other hand, it’s clearly not good news that a severe-if-not-life-threatening shock such as this one sends the dollar down rather than up. The immense fiscal cost of the financial crisis has hurt the dollar’s standing as the global reserve currency, and if I were at Treasury right now I’d be very concerned about this reaction. Not that there’s much Treasury can do about it.

The politics of the bailout

Nov 23, 2009 19:33 UTC

From the Times:

Dominique Strauss-Kahn told the CBI annual conference of business leaders that another huge call on public finances by the financial services sector would not be tolerated by the “man in the street” and could even threaten democracy.

“Most advanced economies will not accept any more [bailouts]…The political reaction will be very strong, putting some democracies at risk,” he told delegates.

“I do believe that the financial sector needs to contribute both to the costs of the financial crisis and to reduce recourse to public funds in the future,” he said.

Me: In the US, TARP and bailouts are already transforming the political landscape, giving rise to the Tea Party movement and creating anti-Wall Street sentiment on the left and right.

Just how much danger is Tim Geithner in?

Nov 20, 2009 14:29 UTC

When both Paul Krugman and the WSJ editorial page are hammering you, as they are Geithner, either you are doing something really right or really wrong.

First Krugman:

For the A.I.G. rescue was part of a pattern: Throughout the financial crisis key officials — most notably Timothy Geithner, who was president of the New York Fed in 2008 and is now Treasury secretary — have shied away from doing anything that might rattle Wall Street. And the bitter paradox is that this play-it-safe approach has ended up undermining prospects for economic recovery. For the job of fixing the broken economy is far from done — yet finishing the job has become nearly impossible now that the public has lost faith in the government’s efforts, viewing them as little more than handouts to the people who got us into this mess.

Now the WSJ:

In the fall of 2008 the New York Fed drove a baby-soft bargain with AIG’s credit-default-swap counterparties. The Fed’s taxpayer-funded vehicle, Maiden Lane III, bought out the counterparties’ mortgage-backed securities at 100 cents on the dollar, effectively canceling out the CDS contracts. This was miles above what those assets could have fetched in the market at that time, if they could have been sold at all.

The New York Fed president at the time was none other than Timothy Geithner, the current Treasury Secretary, and Mr. Geithner now tells Mr. Barofsky that in deciding to make the counterparties whole, “the financial condition of the counterparties was not a relevant factor.”

This is startling. In April we noted in these columns that Goldman Sachs, a major AIG counterparty, would certainly have suffered from an AIG failure. And in his latest report, Mr. Barofsky comes to the same conclusion. But if Mr. Geithner now says the AIG bailout wasn’t driven by a need to rescue CDS counterparties, then what was the point? Why pay Goldman and even foreign banks like Societe Generale billions of tax dollars to make them whole?

This means a more complete explanation from Mr. Geithner of what really drove his decisions last year, how he now defines systemic risk, and why he wants unlimited power to bail out creditors—before Congress grants the executive branch unlimited resolution authority that could lead to bailouts ad infinitum.

Wall Street pay continues to be the Great Distraction

Oct 27, 2009 17:05 UTC

Again, all this focus on Wall Street pay distracts from more important issues.  Gary Becker summarizes:

I have not seen convincing evidence that either the level or structure of the pay of top financial executives were important causes of this worldwide financial crash. These executives bought large quantities of mortgage-backed securities and other securitized assets because they expected this to increase the average return on their assets without taking on much additional risk through the better risk management offered by derivatives, credit default swaps, and other newer types of securities. They turned out to be badly wrong, but so too were the many financial economists who had no sizable financial stake in these assets, but supported this approach to risk management.

The experience of other financial crashes also does not indicate that either the level or form of compensation of top financial executives were major factors in precipitating these crashes. Thousands of banks failed during the Great Depression, as did hundreds of American savings and loans institutions during the 1980s, without heads of these institutions in either case getting particularly high pay, or pay that was mainly in the form of bonuses and stock options. My impression is that this same conclusion applies to the Mexican bank crisis of the mid 1990s, and the Asian financial crisis at the end of the 1990s.

The generous bonuses and stock options received by financial executives may often have been unwarranted, but they are being used as a scapegoat for other more crucial factors. Financial institutions underrated the systemic risks of the more exotic assets, and apparently so too did the Fed and other regulators of financial institutions. In addition, large financial institutions may have recognized that they were “too big to fail”, and that they would be rescued by taxpayer monies if they were on the verge of bankruptcy because they took on excessively risky assets.

COMMENT

I think you’re both missing the point. This whole business of Wall Street pay levels and bonuses &c. has been a convenient shield for Mr. Obama and his radical advisors to move into territory previously off-limits. See David Rosenberg’s analysis of the current situation in the subsequent article. Mr. Obama has moved into corporate management (GM, Chrysler, AIG); has demonized insurance companies preparatory to taking over (read: socializing) the healthcare industry; and attempted to delegitimize FOX news and anyone else who would dare differ with his agenda. (Think Jimmy Carter and his criticism = racism remarks) Keeping the ignorant masses occupied watching some hapless Wall Street executives get crucified might have seemed a winning strategy for Mr. Obama’s radical advisors. American voters may be getting wise to this game.

Posted by gotthardbahn | Report as abusive

Wall Street pay is the Great Distraction of the Great Recession

Oct 22, 2009 11:49 UTC

If I made of list of factors contributing to the recession and financial crisis, Wall Street pay would come in around 6th, after 1) easy monetary policy; 2) TBTF; 3) US housing policy; 4) global savings glut/China labor shock; 5) Wall Street group think.  Yet pay is where so much energy is being directed at this issue thanks to its populist appeal. America hates TARP so Washington needs to make amends by hammering execs at TARP recipients.

Now two other takes. First, Marginal Revolution:

There is no way this will work as advertised.  If the administration actually follows through, most of these executives will quit and get higher paying jobs elsewhere.  Executives not directly affected by the pay cuts will also quit when they see their prospects for future salary gains have been cut.  Chaos will be created at these firms as top people leave in droves.  Will the administration then order people back to work?

Here is Naked Capitalism:

The point is that the collection of these scalps will do nothing to comp levels ex these firms. The companies that also enjoy implicit government guarantees are free to do the “heads I win, tails you lose” game of privatized gains and socialized losses. And Ken Lewis is the poster child of why these measures are completely meaningless. He sacrificed his 2009 pay, but will still collect $125 million when he departs Bank of America.

If the government is going to backstop the industry (and this isn’t an “if” anymore), it needs to limit those firm’s activities to what is socially valuable and regulate them heavily to contain risk taking. As we have said, reining in executive pay (and note there is no will to do that anyhow) is not an effective approach. Those employees who don’t like that are free to decamp and raise money in ways that do not involve the regulated firms in any way, shape, or form, save perhaps counterparty exposures on very safe, highly liquid instruments.

COMMENT

I agree with much, but take issue with the Naked Capitalism blurb. The solution is not to’limit those firm’s activities to what is socially valuable and regulate them heavily to contain risk taking.’ The solution is to eliminate the government policy of too big to fail.

Once that message is sent loud and clear, then the behavior of market participants will adjust accordingly and ‘excessive’ or ‘irresponsible’ risk taking will decline by virtue of the natural dynamics of capitalist discipline. Because the prospect of real failure is powerful incentive for any institution to be more judicious in the risks that it takes — as opposed to today’s environment where ‘failure’ means the government will likely step in to make you whole.

Posted by Bill, Fairfax, VA | Report as abusive

Tryanny of the status quo: homebuyer tax credit edition

Oct 21, 2009 16:22 UTC

A great point made by the Tax Foundation about the National Association of Realtors and its support of the homebuyer tax credit:

When the economy is recovered, is the NAR going to support its elimination? Not a chance. There’s a better chance of Glenn Beck being appointed to Obama’s cabinet than NAR ever advocating for eliminating a tax preference for housing.

Assuming the homebuyer credit is extended to June 30, 2010, come May next year the NAR and NAHB lobbyists will be on Capitol Hill again saying that the economy still hasn’t recovered. And then when it’s extended for another year and the economy is fully recovered, they’ll be saying things like “we can’t afford to go back to where we were 18 months ago with lower home prices.” By then, it will be permanent, and any time discussion of repealing it or scaling it down is brought to the forefront, NAR will cite how home prices are going to fall if it’s repealed. You get what Milton Friedman called a tyranny of the status quo, or an endowment effect of a tax provision.

COMMENT

Although I am one of the taxpayers who would benefit from the $8,000 first homebuyer credit, I also realize that waiting for the right home makes more sense than rushing to grab a house currently on the market to get a credit from the IRS.

Still, extending the date 6 months would be helpful to those of us who have been making offers on short sales or bidding on foreclosures. My real estate agent has been aggressively pushing me to purchase a home in Saint Lucie County where prices are falling every month. According to the latest articles I’ve read, economists are predicting regions like South Florida will continue to see foreclosures rise and home prices drop. So if I save another $10,000 by waiting 6 months, I can’t rationalize closing by Nov 30 to beat the current deadline. As the old expression goes, Six of one, Half Dozen of the other.

Posted by Nancy | Report as abusive

Winning the fight for the financial crisis narrative

Oct 21, 2009 13:58 UTC

In an FT piece, Daniel Yergin lists the many competing explanations for the financial crisis: 1) too much leverage; 2) rapid financial innovation; 3) wrongheaded or incomplete regulation; 4) government home ownership policies; 5) high US indebtedness; 6) too much greediness, not enough fear; 7) bubblicious easy credit; 8) hubris from years of global growth; 9) global securitization as a transmitter of crisis; 10) the oil spike; 11) intrinsic evil of capitalism.

Me: The media already has its narrative: markets failed. Now it’s time for government to reassert its authority. That is the political dimension. But there is obviously a policy dimension as a well. And we are seeing the “market failed” explanation play out in Washington where Wall Street is under attack and the housing bubble is being reflated.

Paul Volcker: Obama’s forgotten man

Oct 21, 2009 13:42 UTC

The most devastating part of the NYTimes piece on Paul Volcker’s lack of influence on WH economic policy comes into the very last sentence of the piece:

So Mr. Volcker scoffs at the reports that he is losing clout. “I did not have influence to start with,” he said.

Me: I can’t believe Volcker is also too thrilled with what’s been happening lately with King Dollar. Yet the focus of the story is how the WH is ignoring Volcker’s advice to separate banking from investing and trading, a de facto restoration of the 1933 Glass-Steagall Act.

Mr. Volcker’s proposal would roll back the nation’s commercial banks to an earlier era, when they were restricted to commercial banking and prohibited from engaging in risky Wall Street activities. … The only viable solution, in the Volcker view, is to break up the giants. JPMorgan Chase would have to give up the trading operations acquired from Bear Stearns. Bank of America and Merrill Lynch would go back to being separate companies. Goldman Sachs could no longer be a bank holding company. It’s a tall order, and to achieve it Congress would have to enact a modern-day version of the 1933 Glass-Steagall Act, which mandated separation.

Glass-Steagall was watered down over the years and finally revoked in 1999. In the Volcker resurrection, commercial banks would take deposits, manage the nation’s payments system, make standard loans and even trade securities for their customers — just not for themselves. The government, in return, would rescue banks that fail. On the other side of the wall, investment houses would be free to buy and sell securities for their own accounts, borrowing to leverage these trades and thus multiplying the profits, and the risks.

Being separated from banks, the investment houses would no longer have access to federally insured deposits to finance this trading. If one failed, the government would supervise an orderly liquidation. None would be too big to fail — a designation that could arise for a handful of institutions under the administration’s proposal.

Banking expert Bert Ely sees things differently:

Had Glass-Steagall never been enacted, had it been repealed much earlier than 1999 …  the Big Five investment banking firms … might not have become as focused as they did on buying, securitizing, and trading subprime, Alt-A, and option-ARM mortgages. While the large commercial banking companies also engaged in mortgage securitization and originating nonprime mortgages, they did not get as deeply involved in those activities as did the investment banks. Arguably, then, had the separate, distinct investment-banking industry been melded into mainstream commercial banking years ago, today’s mortgage and financial crisis would not be as severe as it is, or may not have occurred at all.

COMMENT

Goolsbee, Summers, et al need to listen to the chairman and his experience. Investment banking & commercial banking are separate functions which cannot be managed well by a single CEO and board.

Posted by bob mayo | Report as abusive

Is Geithner Wall Street’s man in Washington?

Oct 8, 2009 16:21 UTC

Yes, the treasury secretary talks to bankers, says the Associated Press:

The calendars, obtained by the AP under the Freedom of Information Act, offer a behind-the-scenes glimpse at the continued influence of three companies — Citigroup Inc., JPMorgan Chase & Co. and Goldman Sachs Group Inc. — whose executives can reach the nation’s most powerful economic official on the phone, sometimes several times a day.

But as my pal John Carney of Clusterstock points out, he’s isn’t talking to everybody:

But these generalized claims miss something important: not all banks are equal in the eyes of Treasury Secretary Tim Geithner. Today the AP revealed that Geithner doesn’t give equal access to all of the banks, or even all of the largest banks. Likewise, being one of the biggest, most well-connected investment banks doesn’t get you close to Geithner. Instead, it’s a small select group of financial firms that have Geithner’s ear, at least judging by a review of his phone records.

Who is Geithner chatting with on the phone.?

  • Goldman Sachs
  • JP Morgan Chase
  • Citigroup

Most obviously left off the list are Bank of America, Wells Fargo and Morgan Stanley.

Me: To me, the interesting question is to what extent Geithner shares Wall Street’s world view, and how that has influenced policy. He certainly is sensitive to the systemic nature of these institutions and their role in the financial system, which is why he was a voice against nationalization or debt-for-equity ideas. As Megan McArdle put it earlier this year:

It’s easy to blithely say “Why don’t they just make the bondholders take a haircut?”  Harder when you think about who those bondholders are:  insurers.  pension funds.  the bond component of your 401(k).  Financial debt makes up something like a third of the bond market, and the largest holders are pensions and insurers.

The insurers are the biggest problem, because they’re just so heavily regulated.  They’re not allowed to hold risky assets.  Convert their bonds to equity and they will be forced to dump that equity at prices that will trend towards zero.  Many insurers will see their capital impaired below the regulatory limits, requiring a government bailout.

Pension funds are the next biggest problem.  They’re already in big trouble because of stock market declines.  The bonds are the “safe” portion of their portfolio, the stuff that’s supposed ot be akin to ready cash.  Convert their bonds to equity–or worse, default–and suddenly they’re illiquid and even further underwater.

Nor is the 401(k) problem small.  Bond funds are typically held most heavily by the people closest to retirement; they’re for income, not capital gains.  What is your mother going to do when a third of her mutual fund income gets converted to equity that produces no cash and can’t be sold because the insurers have all had to dump their shares on the market at once?  Or simply disappears into the land of bankruptcy lawsuits?

I think what Geithner et. al. fear is that nationalizing or reorganization will put the government on the hook for massive and immediate losses in both the banking system, and the “safe” entities that lent it money

:

COMMENT

Concerning the Restructuring of the Global Financial/Economic System and Recent Discussion of Nationalizing “Banking” Interests

With regards to “nationalizing” Banks and other “investor owned” Institutions, we must be realistic concerning the inter-national composition of the investing institutions, corporations, and individuals.

Writing from a libertarian socialist point of view, I think it is necessary to clarify the objectives of any comprehensive program to re-dedicate private resources to a quasi-public mission and to consolidate equity and assets for the purposes of sharing the former and writing off the economically paralytic inflationary cost aspects of the latter.

In lieu of an economic system based on credit and equity trading, whose motivation is the underwriting of speculative ventures, we need to transform our fundamentally inflationary financial/economic system to one that is based on equity sharing and meeting the needs of people in the form of community betterment.

Such a financial system would be the right hand, the resource allocation facilitating function and services of an ambidextrous ecological, democratic, economic “plan and implement” economy that would respect and favor the sovereignty of villages/neighborhoods, educate-foster-facilitate-inculcate inter-community and inter-regional equality, unity and cooperation based on the basic principles of inclusion, equity, humanity, mutualism, altruism, quality of life (in lieu of standard of living), environmental/public health and wellness, sustainability, and peace.

Such a system would seek to establish a more just balance between competitive advantage and comparative advantage with the concerns of those indigenous to a community being paramount.

Such an economic system would recognize the necessity to embrace and implement conservation ethics for shorter term programs and projects of ecological economic redevelopment dedicated to survival pursuits and skills and its concomitant ubiquitous environmental improvement activities, and to the longer term programs and policies related to the legacy of the human race and its dominion (i.e. the recognition and respect of the resource limits imposed by a finite planet).

I call such a proposal an equity union and believe it to be a prudent and practical alternative to the extant economic/financial system. I believe such an economic rearrangement based on the fundamental mission of world unity and cooperation is the best hope for the purpose of entering an unprecedented era of peace and human progress and success.

Mike Morin
Eugene, OR, USA
wiserunion@earthlink.net
(541) 343-3808

John Taylor on the Lehman anniversary

Oct 1, 2009 18:15 UTC

From his blog:

Two weekends ago the big news was the one-year anniversary of the Lehman Brothers bankruptcy and the ensuing panic. But when you look at the data, the real one-year anniversary of the panic is closer to now.

In the four weeks from Friday September 12, 2008, just before the Lehman bankruptcy, through Friday October 10, the S&P 500 fell by a huge 28 percent. But the decline was relatively modest (3 percent) in the first two weeks of that period, from September 12 to September 26, a year ago today. It is not unusual to see that size of change in a one or two week period. The real panic (the remaining 25 percent of that 28 percent decline in the S&P 500) occurred later, from September 26 to October 10. If you look at interest rate spreads or stock prices in other countries you see the same timing. Such facts have led me and others to be skeptical about the commonplace claim that it was simply the decision not to intervene and bail out Lehman’s creditors that triggered the panic. Rather I focus on the chaotic rollout of the TARP which began later and continued through October 13 when its ultimate use was finally defined.

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