Saturday, October 25, 2008

Clive Crook - A system overwhelmed by innovation

In an interesting article in the Financial Times, Clive Crook mulls over the long-term prospects for the financial system and for regulation of the overall economy.
Sorting out the details of the response will be messy but the principles are now clear and policy is forming around them. First, address illiquidity in the market for mortgage-backed securities. Second, inject public capital on a huge scale, drawing in new private capital at the same time. Third, revive the inter-bank market with temporary guarantees. Fourth, especially in the US, step up efforts to slow mortgage foreclosures, to relieve the distress and stop house prices undershooting.

Monday, October 20, 2008

Financial Risk, Safe Bike Lanes

Here's an interesting mix. Real Time Economics summarizes Fed Governor Kroszner's words encouraging the financial sector to take risk into account. At the same time, Streetsblog summarizes some research that indicates that increasing the availability of safe bike lanes increases the number of people who bike.

Perhaps it isn't so much that bankers don't take into account risk per se, but as a result of the structure of incentives we've built up. Perhaps, to make an analogy, there aren't very many safe bike routes.

We have either highly padded and regulated cars (the commercial banking sector). Many accidents occur not because of lack of regulation but perhaps because of an "excess" it, which encourages drivers to stop paying attention to risk (I have a huge amount of metal surrounding me, I can't feel the wind, I have a nice, cushy seat and a seat belt and air bags, etc.). Lots of car accidents aren't really terrible, but a few are.

The idea of increasing the awareness of risk in bank management by adding indicators and reports is like adding an extra gauge in one's car that indicates the level of risk at which one is driving. I bet most people might pay attention to it the first day or two, and then just go back to the old ways ... because the incentives haven't changed at all. I know driving 20 miles above the speed limit is pretty stupid. But I haven't died yet, and I'm in a hurry.

On the other hand, bikers (and motorbikers) are exposed to huge amounts of risk if they interact with cars. Those who ride end up being highly risk-taking (who'd ride a bike in his right mind?).

What we want is a more innovative financial system that is, at the same time, not a danger to our health. We also want the environmental, health, and aesthetic benefits of biking (and, sure, the added flexibility), without the risk. Indeed, biking is in itself safer (who has ever heard of anyone dying from a bike collision).

Making safe bike lanes available increases the likelihood that people will bike rather than drive because now it's no longer just the highly risk-taking who drive. A "safe bike lane" is one in which the car-bike interaction is minimal. My analogy would point to creating areas of the financial system that in themselves are completely unregulated but which have no interaction with the rest of the financial system and in which collisions aren't very damaging.

The analogous group might be financial institutions that offer checking accounts, savings accounts, and perhaps CDs, but no more on the liability side (nothing fancy, nothing with very much leverage at all, nor very much return -- very solid stuff for people who have very simple needs and little sophistication), and very simple, very plain-vanilla assets that everyone understands easily and that are directly connected to some tangible backing.

These institutions would have to have access to liquidity in case of localized widespread defaults or liquidity needs (perhaps through the discount window and a network of similar financial institutions across the country), perhaps also full FDIC backing, etc., but would not be allowed to interact with the more sophisticated sectors of the financial system.

Perhaps what all this is leading to is a return of Glass-Steagall.

Housing Markets that May be Ready for a Turnaround

According to this article, these cities may be ready for an improved housing market:
  • Philadelphia
  • Raleigh
  • Seattle
  • Des Moines
  • Birmingham
  • Salt Lake City
  • Denver

In October 2005, near the peak of the boom, the median sales price for a U.S. home reached 7.3 times per capita income; by this May it had fallen to 5.7, in line with historical norms. Nationally, the rate of decline in sales is slowing, and in some regions sales numbers have actually perked up. "The indicators are starting to look better," says Adam York, an economic analyst with Wachovia.
Why the disconnect? For starters, the national sales figures that get so much attention -- and remain depressing -- are brought down by boom-and-bust markets like Las Vegas, Miami and Phoenix. David Berson, chief economist with mortgage insurance firm The PMI Group, says that if hard-hit states like California, Arizona, Nevada and Florida are taken out of the statistical mix, the picture is much more promising.

Post Binge World

Post Binge World

Economic crisis Web site
The financial industry itself is likely to shrink, and that's not a bad thing, either. It has ballooned dramatically in size. Curry points out that "30 percent of S&P 500 profits last year were earned by financial firms, and U.S. consumers were spending $800 billion more than they earned every year. As a result, most of our top math Ph.D.s were being pulled into nonproductive financial engineering instead of biotech research and fuel technology. Capital expenditures went into retail construction instead of critical infrastructure." The crisis will stop the misallocation of human and financial resources and redirect them in more-productive ways. If some of the smart people now on Wall Street end up building better models of energy usage and efficiency, that would be a net gain for the economy.

Friday, October 10, 2008

There Is No Reason to Panic

Casey Mulligan in The New York Times
An Op-Ed piece by Casey Mulligan in the New York Times. He very clearly lays out economic arguments as to why things are just not that bad.
He concludes as follows:
So, if you are not employed by the financial industry (94 percent of you are
not), don’t worry. The current unemployment rate of 6.1 percent is not alarming,
and we should reconsider whether it is worth it to spend $700 billion to bring
it down to 5.9 percent.

Tuesday, October 7, 2008

Excellent discussion of likely Fed policy

By Tim Duy, via the Economist's View
It is impossible to rule out a rate cut, and it seems like a cut should be the baseline case. Indeed, the case for a rate cut should be a slam dunk, expect for a.) rates are already low and b.) we haven’t seen a rate cut yet. ... The Fed may simply have already moved well beyond rate cuts in searching for solutions to the current crisis. And outright asset purchases is looking like that next move.
Paying interest on reserves (banks' deposits at the Fed) puts a floor on the Fed Funds rate. Suppose, as is the case, that the Fed flooded the market with liquidity (through the TAF, temporary auction facilities - which, now that there's an actual schedule, don't look too temporary). The increase in the supply of excess reserves should lower the Fed Funds rate, say from 2% to 1.5% But if the Fed keeps the interest rate to be paid on deposits at the Fed at, say, 2%, then those excess reserves will be borrowed at 1.5% and flow back into the Fed, as deposits, at 2% - this will keep going on until the Fed Funds rate returns to 2%.

So why do this? The problem of the TAF is that it provides liquidity a little too broadly. Not every institution that gets liquidity needs it equally badly. Suppose an institution that doesn't need liquidity gets it: since it didn't need it to pay its liabilities, and since keeping it as excess reserves earns income, the institution will "park" the excess reserves at the Fed, effectively "mopping up" the excess liquidity. Suppose an institution does need liquidity. It will use it to pay its depositors, suppliers, employees, creditors, etc., because its need for liquidity will exceed the interest on the Fed's deposits. So we get a happy situation in which the people that spend the Fed's cheap cash are the people who actually need it.

WSJ: Obama's Lead Widens in New WSJ/NBC Poll

Presenting himself as a man of action, it seems, was not terribly attractive to independents
Independent voters are starting to swing behind Barack Obama and Joe Biden, who continue to benefit from economic turmoil and the public response to their debate performances, according to a new Wall Street Journal/NBC News poll. The survey gives the Democrats a six-point edge over John McCain and Sarah Palin, 49% to 43% with a margin of error of plus or minus 3.8 percentage points. That's up from a slim two-point advantage from the last Journal poll two weeks ago, and parallels other recent national polls.

The new poll is full of good news for the Democratic ticket. Obama increased his advantage over McCain when voters were asked which one they prefer to handle conomic issues, as a growing percentage of voters said that was their top concern heading into the election. More voters said they're "more reassured" by how Obama was responding to the financial crisis than by McCain.

Delenda Crisis Est

From UBS:

+ There are three key conditions for resolving this crisis. First, bank balance sheets must be repaired. The private sector does not have the resources to do this. Governments must inject capital into banks. There is no alternative.

+ A piecemeal approach to recapitalising will not work. We need a system wide solution to a system wide problem. This will enable confidence in the system to be restored. There is no alternative.

+ Central banks must cut rates (Australia cut 100bp today). This will allow borrower balance sheets to be repaired, gradually. It will not boost growth (because there is no lending). It gives money to borrowers. There is no alternative.

+ Policy measures are anti-deflationary. They are not inflationary. There is no inflation threat in the OECD. Swift action is required to bring about stability to the financial system. Policy makers must listen to economists. There is no alternative.

Monday, October 6, 2008

UBS: Recession

From Swiss economists
+ In the wake of ongoing financial turmoil and (so far) an ineffective policy response, UBS economists worldwide have revised down their outlook for 2009. We now see global growth at 2.2% yoy (previously 2.8%). The IMF brands 2.5% yoy a "recession".

+ The US is seen growing at 0.3%, Japan at 0.7%, the Euro area at 0.3% and the UK at -0.3%. Negative growth is very rare, and it takes a special effort to achieve it. The Fed, BoE and ECB are seen cutting rates significantly. The BoJ remains on hold (as there is less deleveraging in Japan).

+ Asia does not decouple. Weak exports will hit domestic demand as exporters cut back. Fiscal policy can offset but not change the direction (down). The idea that consumers in one of the poorest economies on the planet (China) can substitute for one of the richest (the US) is, of course, absurd.

+ Europe's summit of European leaders produced a half hearted desire for global cooperation. This was then immediately ignored by Germany who unilaterally guaranteed all bank deposits. The UK seems to be considering a Nordic style bank bail out. The approach is clearly fragmented.

Fed announces that it will begin to pay interest on depository institutions required and excess reserve balances

Basically eliminates any limits on the amount of liquidity the Fed can inject
Board announces that it will begin to pay interest on depository institutions required and excess reserve balances.

Saturday, October 4, 2008

What the Bailout Means for You

Less volatility, safe banks, milder recession, yet minimal tax relief
and mildly less scarce consumer credit

Friday, October 3, 2008

Reversal of Fortune: Politics & Power

A long piece by Stiglitz in Vanity Fair: "Describing how ideology,
special-interest pressure, populist politics, and sheer incompetence
have left the U.S. economy on life support, the author puts forth a
clear, commonsense plan to reverse the Bush-era follies and regain
America's economic sanity."

Government's Role in the Mess

Russell Roberts' piece in the WSJ on government's role in the mess.

The Economic Consensus v. Politics

"The consensus among economists is now clear, the best strategy for
dealing with the financial crisis is to recapitalize the banks that need

Employment Declines by 159,000 in September

Main Street and Wall Street intersect.

Wells Fargo to Buy Wachovia

Well, well.
The WSJ reports that Wachovia Corp. agreed to sell itself to Wells Fargo & Co. in a $15.4 billion takeover that will require no government assistance, scrapping a federally backed deal with Citigroup Inc.
I thought that any attempt to fix the financial system needed tons of Government cash.
The final TARP ought to be so distasteful to financial institutions that if one of them is in trouble, they will prefer to be rescued first by some private group ... which, really, at the end of the day, doesn't seem to be a problem.
Over the next few days, a regular Hedge-Fund Hurricane will get formed. So the Fed and the FDIC should seek to limit the damage caused by the shadow financial system to the shadow financial system and prevent it from spreading to regular banks. The latter seem to be able to take care of themselves, thank you.

The Democrats and the Crisis

Dominic Lawson says that Democrat fingerprints are all over the financial crisis.

Krugman on the Economic Abyss

This is a good summary of his position.

Thursday, October 2, 2008

Net worth certificates, from the FDIC

Interesting idea via Marginal Revolution

Don't Blame the CRA or the GSEs

Big Picture makes lots of good points, but only partial. Showing that CRA and GSEs were not responsible for everything doesn't prove they weren't responsible for something.

The TARP can make things worse

Alphaville notes that the banking system is in trouble because people prefer to hold Treasuries rather than commercial paper and bank deposits. So how does issuing a lot more Treasuries help?

No Wonder They're Clueless

Most Lawmakers Don’t Have Economic Education
As Congress works on one of the most important pieces of economic legislation in a generation, a Washington research group has pointed out that more than 8 in 10 members of Congress don't have a formal educational background in the business, economics, or finance fields.
"It's interesting that those who are responsible for solving the biggest economic crisis in generations don't have the educational background to know the difference between commercial paper and copy machine paper."

Senate Approves Financial-Rescue Bill

The Senate voted to approve the financial-rescue bill, sending the modified measure back to the House, where its outlook remains uncertain.
And if there was ever a bill more larded with pork to make it palatable (the culinary metaphor doesn't really work, does it?), this is it. That said, the increase in the deposit-insurance limit to $250,000 and the additional funding for the FDIC are both good ideas.

Wednesday, October 1, 2008

Foreclosure Alley

Completely shocking video, via Calculated Risk. What a neighborhood-in-foreclosure looks like.

Dueling Economists: Experts Voice Support for Bailout Bill

Last week, a large group of prominent economists sent a letter to lawmakers opposing the Treasury’s plan to purchase troubled assets. Today, a separate group of economists have come out in support of the plan. Full text of the letter is here.

Elections should be about Big Ideas

This great piece by Alvaro Vargas Llosa argues that
All elections should be about one thing: the extent of government power. After all, the power of government is what a presidential candidate seeks. And all elections, until such time as a cultural consensus is reached one way or the other, should have at least one major candidate arguing in defense of civil society against too much state power and one major candidate making the opposite argument. Whether they end up doing what they promise is a different matter.
and that McCain and Obama simply don't want to play their parts.

George Will on Palin

John McCain's opponent is by far the least experienced person to receive a presidential nomination in the 75 years since the federal government became a comprehensively intrusive regulatory state and modern weaponry annihilated the protection the nation derived from time and distance. Which is why McCain's case for his candidacy could, until last Friday, be distilled into two words: Experience matters. [And yet] The man who would be the oldest to embark on a first presidential term has chosen as his possible successor a person of negligible experience.

Then again, he says, President James Buchanan had the best resume and possibly the worst record. You also need, Will says, character and "a braided mental rope of constitutional sense and political common sense."

And then, Palin seems to be the only one who gives the Madisonian answer to what limits government power ("the federal government's powers are limited because they are enumerated").

In 1912, McCain's Arizona became the 48th state. In 1959, Palin's Alaska became the 49th. Western conservatism has the libertarian cast of a region still steeped in an individualism natural to frontier spaciousness. But American conservatism depends on what it calls "fusion," the collaboration of libertarians and social conservatives concerned that liberty unleavened by restraints creates a licentious culture. Palin supposedly is fusion in one person.

For Republicans: 1932 or 1964?

Unfortunately, he has a point.
If McCain loses the election, each of the three main conservative factions will have a case to make about the others' failure. The war the neocon dreamers cooked up turned out to be a disaster, one in which virtually every Republican was implicated. Future Democrats will only need to say, "Oh yeah? Well you thought the Iraq War was a good idea!" in order to put Republicans on their heels. The Palin pick will no doubt be seen as one of the worst in memory, more embarrassing than even Quayle, offering a rebuke to every social conservative who embraced her with such lip-quivering joy. And the economic disaster that came right before the 2008 election convinced nearly the entire country that deregulation failed, the free market can't be left to its own devices, and government must be the guarantor of economic security.

In other words, all the pillars that have held up conservatism for so long are crumbling. When the dust settles, it will be difficult to know just what it means to be a conservative. Is a conservative who doesn't proclaim the perfection of the free market and the evil of government still a conservative? What about a conservative who thinks his comrades ought to quit yapping about gay marriage and get into the 21st century? What about a conservative who wants to accede to the public's desire for a less bellicose foreign policy?

One of the right's greatest strengths in the last few decades was that they knew precisely what the answers to these questions were (no, no, and no, in case you're wondering). But if they go down to defeat five weeks from now, they won't be so sure. And nothing is less appealing to the public than a political movement that doesn't know what it believes.

No Depression

In spite of yet another big bank failure (or, to the students of economic history, because of the manner of the non-bank failure of Wachovia, as it was bought out by another big bank with FDIC and Fed support), the Intelligent Investor questions the probability of a 2008 (-2009?) Depression.

Bankruptcy better than bailouts?

Perhaps so!
Martin Wolf's excellent recap
Bailout Would Impose Needless Economic Damage, says Daniel Mitchell
The House Republican were right to give us a heart attack, says National Review
Let the suckers go down!, says Jeffrey Miron

However, see this beautifully nuanced analogy at MacroBlog
And just to remind ourselves that the danger of inaction is a return of the anti-market forces of the 30s, read the American Prospect.

Senate set to vote tonight on new bailout bill: Yahoo! Finance

More FDIC insurance, tax breaks for businesses and middle-class
families, etc. Apparently constituents are beginning to warm up to the idea of the rescue.

Roosevelt talk on unstable economy oddly prescient: Yahoo! Finance

For a Roosevelt non-fan like me, the worst consequence of Hoover's inaction is that it created the perception that we needed Roosevelt. Let's not repeat the mistake.

Regulation and Unintended Consequences

Marking to market is a good idea, but beware of the unintended consequences of good ideas.

This article makes the same point, and many others (about Fannie and Freddie, about the repeal of Glass-Steagall), very well.