Closing the window, opening the corridor I strongly recommend reading both the post, and the comment thread regarding the Fed's recent request to begin offering (and taking) interest on bank reserves.

Last week, the Fed decided to ask Congress for the right to pay interest on bank reserves. (Hat tip Barry Ritholtz, see also William Polley, Mark Thoma, Brad DeLong) This is a very big deal.

Don't be misled into thinking that the Fed's proposal is just some arcane, technocratic change. The Federal Reserve is asking taxpayers for a big pile of signed, blank checks. That's far too much power to put in the hands of a quasipublic organization with little democratic accountability. This authority should not be granted without some strong strings attached.

I don't share Steve Waldman's optimism that democratic accountability will help the situation at all. We are talking about a highly technical area in the field of financial regulation, which is probably as arcane as it gets from a policy perspective, and. I cannot fathom how inviting The Mob to the table will help anything.

That said, the ongoing financial crises is making some informal rules formal, and that can only be good (even if, or especially if, the informal rules were bad ones).

1) The Fed will extend essentially FDIC insurance to all deposit holders, not just those keeping their money in commercial banks. The TSLF makes that explicit.

2) The Fed will shift financial losses to tax payers by swapping good collateral for bad collateral. This is more formal than saying they will not shift losses to tax payers by swapping good collateral for bad collateral, and then doing it anyway, but it is not as formal as simply writing out a check to Bear Stearns bond holders, JP Morgan, Lehman Brothers, Goldman Sachs. So I see this as an improvement, but it still has a way to go.

3) The US has the latitude to do what it wants monetarily because of "vendor financing" (great analogy) from PBOC and GCC. Both countries have taken significant amount of their citizen's wealth and given it to Americans. This may actually be the right thing to do since employment is more important than amenities (gotta keep them off the streets!)

4) Risk management in finance is pointless. They key variable ends up being political risk (how big will my bailout be?) Consider this: financials are trading at where they were back in 2000, just coming out of the Internet bubble with 8 record years of profitability in front of them.

5) The Internet bubble gave us Google, Amazon, eBay, Yahoo!, and a whole host of new services and technologies that create real value. What new service or technology that's created real value has come out of the housing bubble, or associated financial bubble of the past 8 years? Does this matter? The US economy seems to need a leading sector -- what will the next one be?

6) The US government will subsidize mortgages, no matter what. $900K homes in California are now underwritten by taxpayers.

7) I expect to see Fannie Mae and Freddie Mac nationalized before all of this is over -- there is an informal arrangement that should certainly be formalized post-haste.
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Tax incidence The WSJ op-ed says that the housing crises is over, and prices will stop dropping. Why is that?

[I]f one buys a house with a mortgage, the most important factor in deciding what to pay for the house is how much of one's income is required to be able to make the mortgage payments on the house. Today the rate on a 30-year, fixed-rate mortgage is 5.7%. Back in 1981, the rate hit 18.5%. Comparing today's house prices to the 1970s or 1980s, when mortgage rates were stratospheric, is misguided and misleading.

I'm not sure if this is actually true (would you pay more for a stock of Amazon.com if your broker gave you a great deal on your margin account?) but it certainly is how people have behaved. All of the cheaper financing that financial "innovation" created for house prices went directly into the price of those assets, so buyers were no better off before, and all the benefit was captured by previous owners. Similarly, when you hear about new government plans to help the first time homebuyer, all they will do is transfer more money to current homeowners, since the benefit will directly be factored into a new (higher) price. See this in action in my favorite graph below:



The other part that's kinda neat is how expected future appreciation makes current cash flow considerations unimportant. In the Real Bay Area, where I live, you cannot make up the price of a house in rent, buying a house and renting it out is a cash flow negative exercise, but price appreciate has more than made up for that. What happens when price appreciation stops, or goes negative? (Note: that has not happened in the Real Bay Area yet) No one knows, the graph only goes to 3% annual appreciation.


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Better regulation As the US housing bubble deflates, there is an outstanding question of what different regulatory environment would have 1) kept the housing bubble from appearing, but 2) supported "good" financial innovation. Two points on this.



Firstly, the chart above shows how borrowing power increased from 3x leverage to 9x at the peak of the bubble in 06. You can see how a combination of low interest rates, lower down payments, interest only loans all played their part in fueling the boom.

Secondly, I recommend this piece on VoxEU. Key points:

1) Better disclosure does not help to prevent financial crises. They were called "subprime"!
2) Prudential controls never work either, certainly not at a system level
3) Risk management does not work, as it ignores "off model" events which end up being the problems.

Instead, he recommends:

1) Capital controls should be counter-cyclical. So as the risk premium falls, the capital charge should rise
2) Forget about "bank" vs "non-bank". Look at maturity mismatch and leverage. The more an organization has of both, the more it should be regulated. A zero leverage, maturity matched lending institution, for example, would probably need zero leverage. Hmmmm.
3) Banks should pay an insurance premium so taxpayers do not get fleeced too much when they bail banks out.

I think this last suggestion is unworkable as we've seen what a good job social security and medicare premiums have done keep future tax increases down. Any premium collected will be, instantly, spent.
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Traffic in Dubai As horrific as this story is, I also find it quite believable. It seems the morning was foggy
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Funny Warren Buffet has entered the monoline market. Best line:

Connecticut Attorney General Richard Blumenthal said in an interview yesterday that he is investigating possible conflicts of interest since Buffett's company owns almost 20 percent of Moody's Corp., parent of the credit ratings service.

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My experience with Notes Joel complains about how architecture astronauts, like Lotus Notes' Ray Ozzie, is now building the same useless technical toy at Microsoft.

Lotus, of course, began its life with 1-2-3, and then became the sales and marketing arm for Notes, that was developed by Iris. The Iris group kept some of their old offices and signage and continued to work on the convolution that is Notes. I worked there for a summer, and still have no idea why it's anything other than a crappy version of Outlook (not a high bar).

The technical culture at Lotus was exactly like what Joel describes -- people fiddling around with toys and no thought to actually solving real problems. Any solution began as a small, useful idea, and then had layers and layers of architecture wrapped around it until it became a Network Operating System, or whatever. It's not surprising that Ray tried to build the same thing at Groove (which I tried and failed to us) and will try, one more time, at MSFT.
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