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Saturday, April 04, 2009


cognitive regulatory capture is more than cognitive

combine this via bloomberg...

Lawrence Summers, director of President Barack Obama’s National Economic Council, earned millions working at a hedge fund and speaking to banks such as Citigroup Inc. that later received taxpayer bailout money.

Hedge fund D.E. Shaw & Co. paid Summers more than $5 million in salary and other compensation in the past 16 months, according to a financial disclosure form released by the White House yesterday. Summers served as a managing director at the New York-based firm. Summers, a former Treasury secretary, also earned more than $2.7 million in speaking fees.

... with this via yves smith...

In a further sign of an imperial Presidency in action, the Washington Post describes how the Obama administration is circumventing bailout legislation by channeling fund through various entities, then contending the the end recipients aren't subject to Congressional requirements. Huh?

From the Washington Post:

The Obama administration is engineering its new bailout initiatives in a way that it believes will allow firms benefiting from the programs to avoid restrictions imposed by Congress, including limits on lavish executive pay, according to government officials....

The administration believes it can sidestep the rules because, in many cases, it has decided not to provide federal aid directly to financial companies, the sources said. Instead, the government has set up special entities that act as middlemen, channeling the bailout funds to the firms and, via this two-step process, stripping away the requirement that the restrictions be imposed, according to officials.

and it becomes obvious that serious concerns about graft, opacity and lawlessness in the executive have not changed with administrations. this is very disappointing, not least from the perspective of what this administration is tasked with.

richard koo has previously said in his book that summers is probably the only american economist who actually understood the nature of the japanese problem in the 1990s. that is high praise. in this latest presentation at the CSIS, the first questioner mentioned that summers gave a talk at the brookings institute -- "not the kind of talk you do ... to the american public" -- where summers reiterated exactly the characterization that koo is trying to publicize with regard to balance sheet recessions, making the distinction and understanding the absolute need of fiscal stimulus.

this is the brookings media page for that talk -- give it a listen. as obama administration effort take shape, outlines are becoming clearer. the fed has certainly taken on a lot of balance sheet risk in a quasi-bailout role, and tim geithner's PPIP is dependent on the FDIC (of all institutions) to lever small amounts of treasury and private capital. this is done, as with the above, to circumvent approaches to a congress embrazened with populist rage -- both the fed and FDIC can do these things without congressional approval. but the fed also clearly intends to unwind its efforts at some point -- calculated risk summarized the ongoing public debate on the question, and i frankly find tim duy's take compelling. ben bernanke is clearly fighting a credit crunch, a passing liquidity issue.

bernanke and indeed the entire effort spanning the bush and obama administrations has been ridiculed -- and by me as well -- for being misguided in this sense. but the complex reality of this situation was brought more clearly into focus for me by koo, who noted that -- while japan did indeed face as we now face a very serious long-term balance sheet problem, credit crunches within the fifteen-year crisis were rare and transient events remediable by concerted government fiscal and monetary actions. it now seems to me that that is exactly the kind of battle the fed has been fighting -- one within a broader war which summers basically understands.

in the meantime, summers and geithner have returned to the original logic of hank paulson's TARP -- removing toxic assets from bank balance sheets. but they are explicitly making efforts to transact at the highest possible prices in an effort to minimize realized damage to bank balance sheets. they've furthermore succeeded in pressuring the FASB into softening mark-to-market accounting rules, which will allow banks with large securitization portfolios to at least place those assets in the level 3 basket and hold them using discounted cash flow modeling for better marks than could be obtained in a delevering marketplace. the resulting combined effect will allow most banks to hold impaired assets at much less damaging valuations, while allowing weaker banks in desperate need of raising cash a venue by which they can be delevered with significant public loan subsidy in an effort to minimize the need of explicit public capital subsidy. this should grant banks precious time, during which assets continue to throw off cash flow at yields vastly higher than the banks' near-zero (thanks to the efforts of the fed) cost of funds. the most troubled major bank, citigroup, has also seen its preferred shares -- most owned by the government -- converted to common equity in a first-step debt-to-equity restructuring.

if i'm not mistaken, this is the outline of a significant and durable safety net for the banks which can be sustained over an extended period while banks redirect income to slowly retiring non-performing loans while being provided sufficient capital to continue lending in an environment of greatly reduced loan demand. that is exactly what i've come to believe needs to be done, particularly for banks which -- on the example of lehman brothers -- present their clearest and most present danger in a forced restructuring, which in the current environment quite possibly means liquidation and a hammering of senior debt holders, potentially propagating a cascading collapse of banks, pension funds and insurers through the system.

given this state of affairs, i am hard pressed to think of someone who i would rather to have in the driver's seat than lawrence summers.

and that makes the sort of crass opportunism of summers in collecting monster fees in an obviously ingratiating and incestuous relationship with the major banks all the more horrifying. it isn't that summers is merely a victim of cognitive regulatory capture; he's being paid for, and handsomely. what's worse, he's being paid to do more or less the right job in the right way. provided that the government now continues to offer steady fiscal stimulus for the duration of this balance sheet recession, summers' efforts should see the financial system through a very dark hour. should summers be plastered by his political enemies over this brazen example of graft in a time of extreme public flammability on such issues, however, the country might be made under less knowledgeable leadership to lurch onto an altogether more hazardous path with an altogether more damaging and frightening conclusion.

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This is a very significant post. (And I too had noticed the possibility implied in Koo's talk that Summers may be trying to drive down this specific path).

Koo is very clear on the need for fiscal stimulus to consume the increase in savings, but barely touches on the bailout side of things...

What I fail to fully understand from Koo's CSIS talks (and I have not yet read Koo's books or viewed the Summers piece) is why it is necessary to preserve the banking system in its current form in order to meet the critical goals of lending to those [relatively few] who need and justify it, and writing down the system-wide losses slowly. In other words, do these goals (or other goals I'm forgetting) prohibit a rebirth of the banking system in some other healthier form with the government itself writing down the losses on the old toxic assets slowly and the old bank bondholders sharing the losses somehow? Perhaps you have already answered this in stating the importance of the future cash flow in reducing the damage of the writedowns, but I can't help but wish there were some more just configuration that achieved this.

Hopefully the administration's recent push for a financial resolution authority signals an attempt at this (bondholders sharing some losses) even though it is not something I saw Koo mention. You mention not wanting the cascading effects of a repeated Lehman, but could there be a middle ground?

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Let me try to clarify what you mean -- is the crux of the matter that the problem should be kicked down the road long enough so as to keep bondholders whole? Does that mean you disagree with those who claim that banks should be nationalized before being recapitalized -- because, in my opinion, nationalization means giving bondholders a haircut, else I don't see any point in nationalization. Also, does that mean you think zombie banks, a la Japan, are a good thing -- I think David Goldman says as much today.
Does that also mean you think that forbearance on MTM is a good thing because it would kick the problem down the road long enough for banks to earn their way back to health?
Lots of questions, not disagreeing with you, but trying to understand ..

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Great post, even if I don't agree.

If Larry Summers is the *only* economist who "understood" the Japan balance sheet problem, then his theory about the lack of women in the top rank of science achievement needs to modified and applied to the economics profession in the United States. Despite Larry's vivid demonstration that economic studies can lead to the accumulation of vast riches in return for part-time work and one day speech engagements, it must be that economics attracts only second-rate intellects in the United States.

The other possibility is that Richard Koo was exaggerating to be kind to Mr. Summers. Perhaps Koo owed him for an insider stock tip or some such.

Summers is one of the great promoters and enablers of the FIRE-based economy. Now we learn it paid him millions in return. No surprise there.

I prefer to be led by people I trust. People who pay their taxes and don't take millions of dollars from the banks whose fate they hold in their hands.

Great blog by the way.

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Great post: echo the even if I don't agree.

Summers IMNSHO is a moron who should resign. I don't think more debt is the answer. Certainly not more debt from the worlds largest debtor.

Sorry, I think they are down the wrong path.

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Hate the sin, love the sinner? While you may agree with the policy prescriptions of Summers, you need to admit that they would be much more trustworthy if he wasn't getting obscenely rich for his efforts. I would be more inclined to trust those in positions of power if they weren't being paid gobs of money simply for being in positions of power--I mean, let's not kid ourselves, that's why Summers gets paid so much for his speaking engagements, not because his listeners think he has the words of salvation. To suggest that he is not conflicted by the large sums of money and flattery of his benefactors is a bit naive; to propose that he is the "only" economist who saw this coming is a bit of fluffery from Mr. Koo--who more and more seems to be talking his book.

Speaking of Mr. Koo's presentation, I noticed in the one slide (Exhibit 14)that Japan's taxes only provide roughly 50% of the government's budget. If I understand that correctly, the Japanese government is creating roughly 50 trillion yen each year. Their GDP is about $4.5 trillion, so their deficit is about 10-12% of GDP, if I read this correctly, and has been for the last ten years, give or take. That this level of currency creation has not destroyed the yen is simply astounding.

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The more I mull this over the more I'm seeing do as I say not as I do. Forgot the minute point but Black really brings some good things to light, both with Japan and with how we got here.

Take care

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the importance of the future cash flow in reducing the damage of the writedowns ... I can't help but wish there were some more just configuration that achieved this

i think yes and yes, hbl. i'm far from a moral authroity, but it seems to me that the best reason not to want the top of the capital structure to fail is a consideration of all the lowly individuals who will suffer from forces far beyond their ken. that may not make this sort of muddle-through workout just in the fiery sense, but may make it the best that could be hoped for.

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is the crux of the matter that the problem should be kicked down the road long enough so as to keep bondholders whole? Does that mean you disagree with those who claim that banks should be nationalized before being recapitalized -- because, in my opinion, nationalization means giving bondholders a haircut, else I don't see any point in nationalization.

this is a sincere change of heart for me, rb, as you probably know -- my senses of righteous indignation and vengenance-seeking have been well and fully triggered -- but this does increasingly look the path for the money center banks. lots of banks whose debt is not widely held can and will be pushed under -- the damage is limited, and it helpfully reduces the cost to the government. but in the case of banks like C, BAC, JPM, WFC -- i suspect the low-cost, low-impact solution is to pull them through.

this of course does not save their managements and traders, who must now be heavily restricted in their activities as a prelude to being jailed while bank's core lending operations are helped to regain their primacy in these banks' cultures.

Also, does that mean you think zombie banks, a la Japan, are a good thing -- I think David Goldman says as much today.
Does that also mean you think that forbearance on MTM is a good thing because it would kick the problem down the road long enough for banks to earn their way back to health?

w/r/t zombie banks, i can't use the word "good". but i can agree with goldman that it's probably the best outcome on offer.

on MTM, i think the primary lesson is that commercial banks should hold whole loans at cost and not securities -- perhaps this country has to rediscover glass-steagall. we would best set about making banks very boring again.

but in the meantime, yes, i increasingly think forbearance on the one hand and on the other active government support of aggregate demand to prevent a collapse in cash flows can see things through the intermediate term short of disaster.

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thank you, oregon.

I prefer to be led by people I trust.

so would i. unfortunately i haven't yet seen anyone i would trust elected to office at any level beyond my township.

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I don't think more debt is the answer. Certainly not more debt from the worlds largest debtor.

i should be quick to say that i don't think it is either, davos. frankly, i don't think more debt is an option in this environment -- the marketplace will ensure that.

but i also think we have to distinguish between no-more-debt and no-more-government-debt -- the former is an inevitability in my view, whereas the latter is quite probably a clarion to the four horsemen. conflating the two (not that you are, but many in the public discourse do) is something of a canard.

we do collectively have to acknowledge the reality that the deathly pile of suffocating debt isn't some future prospect to be avoided -- it already exists. that it is largely on private sector balance sheets does not make it less dangerous. this i think the more informed parties are well out ahead of the general public on, to judge from fox news, et al.

the second part, though -- that this private debt can be carefully refinanced onto the government balance sheet with massive beneficial (relative to the alternative) ramifications for discounted cash flows, with private debt paydowns corresponding to public debt expansion -- is not broadly understood at all even among the illuminated.

this i think summers probably does understand. whether he or anyone can actually turn the trick, though, overcoming the obstacles in the administration and his own party, not to mention the opposition republicans... that's another question.

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davos -- thanks for the bill moyers/william black link. good stuff.

as a result of the crisis, i think we're finding all manner of regulation in the united states was ill-considered. much of the blame directed at deregulation or nonenforcement is absolutely justifiable, in my view. this would not have been possible without the aid and abetment of both political parties.

but it also cuts both ways. mark-to-market, to take one example, is an accelerant in crisis. to my mind this means banks should not own securities, rather than that they should be relieved of their responsibility to account properly. but few of us still imagine markets produce "correct" prices -- take the example of the "predictive power" of futures curves. prices are a function of many variables, including liquidity, that have little to do with the ancient conception of price. now that we are in this situation and banks are stuffed with securities, it is really smart to mark them down?

it might be, frankly -- if cash flows are allowed to collapse, current marks will prove prescient or even optimistic, and having forced the banks to take them early will have helped. but that's the critical qualifier: if cash flows are allowed to collapse.

similarly with the PCA, a well-intentioned regulation intended to limit taxpayer losses by getting out ahead of the problem. but we have to concede that, in the context of a minor problem like the S&L boondoggle, there were no systemic ramifications from rapidly shutting up a bunch of crooked mom-&-pop slush fund fronts in texas. that's just not so in this mess -- a strict enforcement of PCA would result in the failure of much of the financial architecture and touch off exactly that liquidation spiral which one would hope to prevent.

i understand black's point on legality, but if i might frame it within the war on wisdom -- the best part of wisdom is knowing when to judiciously ignore the rules. this, i think, is one of those times.

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What do you think of Adam Posen's claim that it wasn't until the Takenaka-Koizumi reforms in 2002 where banks were forced to write down assets before being recapitalized that a Japanese recovery began? I might be wrong, but it sounds to me like a take-losses-early prescription. Given that the Japanese stock market staged a recovery coincident with the U.S. one, I'm however also suspicious that the players underestimate effects of global forces on domestic economies.

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And here is the NY Times' coverage of the same.

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Hey, nice chain reaction through the blogosphere! CreditWritedowns picked up your coverage of Koo's second CSIS presentation, then Paul Kedrosky, and now Paul Krugman!

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I don't think anyone associated with Clinton understood the issues facing the end of the national development state in Japan. They saw the closer integration of that economy into the global one as (1) something that could be only managed by America and (2) something that must be managed to help America (because otherwise it would hurt America, a false dilemma). Summers is a piece of shit who surely ought to be made to eat it.

I challenge you to demonstrate that Summers understood the Japan problem in the 1990s or that he is the best man for any job. I wouldn't hire him to sweep floors.

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As for the thoughts about Koizumi in the replies. Sorry. Wrong. For one thing, he is the genius who managed to privatize the surest bank in the world, the government-owned Japan Post. They probably hired some people from CitiGroup to show them how it's done now.

As for the banks that were supposed to be run along American ideas and show the Japanese banks how it is done, Shinsei and Aozora (with Dan Quayle as Chairman of the Board no less!) are in the biggest trouble with losses all over the place--actually most of them going to how Cerberus has dodgily used the banks to make loans to itself to do things like buy Chrysler and GMAC.

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admittedly, cej, i am forced to rely on the recommendations of others -- but if koo thinks he did it is highly likely that he did. one can separate the use of economic and trade policy as an instrument of imperial foreign policy -- a consistent tenet of all american presidencies for well more than a century -- from the identification of problem frameworks within the imperial sphere where japan has resided since 1945. what's more, the white house reaction to the current crisis, to the extent that it can be completely discerned, does seem to hew to the lessons of japan (providing, of course, for the problematic political reality of both congress and the people). i doubt anyone but summers can really be credited for that, as he has secured most of the levers of power.

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re aozora & shinsei -- i can't recall just where, but i read a good piece on the perils of private equity ownership of banks and the resultant minefield of conflicts of interest, citing these two as the picture of such disaster.

a great deal about late-boom-stage american hypercapitalism has been unveiled in the last two years.

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