Saturday, February 28, 2009

Kevin Murphy vs Chuck Norris

Kevin Murphy was the smartest person I met at Chicago -- faculty included of course. So I find this hilarious.

Friday, February 27, 2009

Obama: "I will deceitfully give your money to bankers"

The best site for a pure, Post-Keynesian, 100% fiscal approach to the crises is Mosler Economics. It is very difficult to understand, but I've invested some time there and I think he has excellent insights. Recommended.

The best site I've found so far for a Rational-Expectations, 100% monetary approach to the crises is The Money Illusion. He has not written the required posts yet to really explain what he means, and what a purely monetary approach to the recession would look like, but I look forward to them.

As far as I can tell, traditional monetary policy has the Fed buying short term Treasury securities to drive up their price, and lower interest rates to zero. The Fed can do this up and down the yield curve, and can also buy other securities, (mortgages, bank debt, etc. etc.) to similarly impact interest rates. Basically, the Fed just increases its balance sheet in non-conventional ways, to impact money supply, further reducing real rates, until monetary policy is correct to drive the economic changes desired. I still struggle with how you can reduce real rates when nominal rates are at zero--is there anything to it beyond simply expanding scope?--but hopefully he will post on that soon. Let's run with this distinction between monetary and fiscal policy.

While it is true that the Fed can increase its balance sheets and buy assets, changing interest rates (price), it is also true that the Fed can overpay for assets, and therefore also include a transfer -- which is traditionally the realm of fiscal policy. We are clearly here now, so I don't think the difference between monetary and fiscal is useful at this margin. Much better just to count dollars and see whose accounts are being credited and debited.

One thing that is clear is that the Obama administration believes that there is no political will to further bailout banks. There will be no new TARP, which while useless, was at least honest(ish). Further transfers from savers to banks will happen via stealth and deceit. This excellent post on Interfluidity shows just how much effort the Obama administration is putting into being dishonest.
In an astonishing abuse of the customary language of finance, the "convertible preferred" shares the government intends to purchase, in addition to mandatory conversion after seven years, are convertible to common stock at the option of the the banks, rather than at the option of the taxpayers holding the securities
Geithner makes me long for Paulson, who was more honest. Obama may yet make me long for Bush. More on the Obama administration's deception here.

I would also add that it was public opposition to the Government bailing out the Japanese financial system that has kept them in 25+ years of stagnation. People seem to believe that US equities are poised for takeoff, but the Japanese example suggests that that is by no means certain.

One final thought. As for about a year ago, the US private sector was as indebted as it has ever been. It is rapidly de-leveraging, which is driving the economic recession. If the Obama administration is going to inflate to reduce real debt burdens, it better do it soon when foreigners will take most of the haircut. The longer the delays, and the deeper the deflation goes (and the more the American private sector saves), the more the inflation haircut will come from voters. Japan, which has been in a deflationary spiral for years, must think at least a little about how much savings is held domestically. Most commentators put this down to incompetence by the BoJ, but the Money Illusion suggests that, after 25+ years, it has to be a actual goal.

Thursday, February 26, 2009

Finance is pro-cyclical

Megan talks about why it would be terrible for banks to recapitalize the traditional way -- wipe out equity holders (who are now 100% moral hazard players) and convert debt holders to equity:
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?
We are back to deciding where the losses, that have been realized in the market, will be borne, as the Fed and the Treasury have decided that those who enjoyed the gains cannot possibly bear the losses. The thing is that the losses are already there, we're just talking about whether or not to recognize them, and if they are recognized, shift them around.

Banks are naturally leveraged institutions, and are therefore extremely pro-cyclical. If they found that their loans are suddenly being repaid, or that there are more good credit risks out there than before, they would begin functioning normally again. But the Obama administration has transferred money to banks which keeps them from going under, but does nothing for the quality of those they have made loans to or those they might make loans to -- US households. This saves bank investors, and bank employees, but does nothing for the economy. Instead, Obama is ushering in double digit unemployment as he adds to fiscal drag through higher taxes.

People talk about Japan's "lost decade", and sometimes "second lost decade", but in fact it is 25 years into stagnation with no end in sight. Japan reached this situation by propping up zombie banks, believing that poorly conceived "infrastructure" projects were "stimulative", and raising taxes. As of this week, Obama has hit the trifecta. Geither makes Paulson look good. Is it conceivable that, four years from now, Obama will make Bush look good? The mind boggles.

Tuesday, February 24, 2009

Quick links

I loved this Dilbert cartoon.

Also, I strongly recommend this excellent post on what the Fed's latest scheme around non-recourse funding to banks really means. Hint: it is similar to what the Fed's been doing for the past 2 years.

Monday, February 23, 2009

Are banks insolvent?

Bronte Capital does a good job of going through the various flavors of "insolvency" and declaring that US banks are not, necessarily insolvent.
* Definition 1: Regulatory Solvency. Does the bank have adequate capital to meet the solvency tests imposed by regulators?
->Not right now. And even if they were, it would not matter as that capital is just a buffer and should be

* Definition 2: Positive net worth under GAAP. Does the bank have positive net worth under GAAP accounting (ie yield to maturity with appropriate provisions when YTM is required or mark to market otherwise)?
-> Probably not, under GAAP. (If you believe YTM).

* Definition 3: Positive economic value of an operating entity. If the bank is allowed to continue to operate it will be able to pay all its debt and replace its capital?
-> Yes, if access to capital was normal.

* Definition 4: Positive liquidation value. If you liquidated it today at current market prices it would have positive value.
-> Nope.

* Definition 5: Liquidity. Does the bank have adequate liquidity to operate on a day to day basis?
-> Depends on Government action.

My own answers are "No", "No", "No", "No", and "No". Look at how capital requirements are set, it's a hoary mix of accounting judgement, and pro-cyclical regulatory requirements:
Tier 1 (core) capital

Tier 1 capital, the more important of the two, consists largely of shareholders' equity. This is the amount paid up to originally purchase the stock (or shares) of the Bank (not the amount those shares are currently trading for on the stock exchange), retained profits and subtracting accumulated losses. In simple terms, if the original stockholders contributed $100 to buy their stock and the Bank has made $10 in profits each year since, paid out no dividends and made no losses, after 10 years the Bank's tier one capital would be $200.
So, after large losses, Tier 1 capital gets eroded, which worsens all the ratios tied to tier 1 capital. Banks need to raise more capital and reign in lending, just when lending is needed and capital is scarce. Let's pass over the question of whether this is sound financial regulation and agree, at least, that it is profoundly pro-cyclical. This pro-cyclical nature means that the US will not exit the economic recession it is in through sound banks, because sound banks do not create sound borrowers. It is the other way around. If the Obama administration had thrown the money they have given to banks at households, helping them save, the economic situation would be much better.

The cry for nationalization has hit the NYTimes, so political reality cannot be far away. It's amusing to hear Geither talk about how the US does not want its finance system to be a branch of the Government. We crossed that bridge a long time ago. My favorite description of the current system is a Potemkin market.

Saturday, February 21, 2009

Obama: I will worsen the recession in the US by decreasing the deficit

If you want to see the end of the Obama administration, it's on the front page of today's NYTimes. Obama does not understand that the Federal deficit funds private savings, and if he refuses to let the Government fund private savings by running a larger deficit, the private sector will try to save by cutting back on spending and investment -- also known as falling into a deeper and deeper recession.
Measured against the size of the economy, that would mean a reduction from a deficit equal to more than 10 percent of gross domestic product — larger than any deficit since World War II — to 3 percent, which is the level that economists generally consider sustainable.
Economists have to clue what they are talking about. The size of the deficit needs to be large enough to fund private saving, without triggering inflation. There is no "sustainable".
In his weekly radio and Internet address on Saturday, Mr. Obama said his first budget was “sober in its assessments, honest in its accounting, and lays out in detail my strategy for investing in what we need, cutting what we don’t, and restoring fiscal discipline.”

“We can’t generate sustained growth without getting our deficits under control,” he added.
Wrong on every count. The awful "stimulus" plan is useless pork and cronyism, with a lousy $400 that actually goes into people's pockets. $400 will not help households save.
Mr. Obama will also call for letting the Bush tax cuts on income, dividends and capital gains lapse after 2010 for individuals who make more than $250,000 a year. As a candidate, Mr. Obama called for immediately repealing those tax cuts; he decided instead to keep them in place through 2010, as scheduled, reflecting the widespread belief that raising taxes further depresses economic activity.
It's not a belief, it's a fact. Taxes uncreate money, and uncreating money depresses economic activity. The economy will be in desperate need of activity in 2010 and 2011.
As difficult as cutting the deficits will be, much of the reduction by the end of his term will simply reflect an end to spending from the two-year stimulus package and — assuming the economy recovers — higher tax revenues and lower expenditures for safety-net programs like unemployment compensation.
This is true, but simply reflects how the only effective fiscal response is being driven by automatic stabilizers such as income taxation, and unemployment benefits. Obama's "stimulus" is totally ineffective, and a transfer to the politically well connected.

The impotence of Obama's "stimulus" is clear when he talks about them:
"Never before in our history has a tax cut taken effect faster or gone to so many hardworking Americans," Obama said Saturday in his weekly radio and Internet address.

The president said his signature two-year "Making Work Pay" tax break will affect 95 percent of working families, and, in six weeks' time, a typical family will start taking home at least $65 more every month.
$65/month is pathetic. I'm surprised he's willing to say the number out loud. It should be more like $1000/mo. $1000/mo is stimulative. $65 is like leaving a 3 cent tip at a restaurant.

And where does this level of fiscal incompetence lead? NYTimes let's us know:When Consumers Cut Back: A Lesson From Japan
“My husband is retiring in five years, and I’m very concerned,” says Ms. Masaki’s mother, Naoko, 52. She says it is no relief that her husband, a public servant, can expect a hefty retirement package; pension payments could fall, and she has two unmarried children to worry about.

“I want him to find another job, and work as long as he’s able,” Mrs. Masaki says. “We must be ready to fend for ourselves.”
The Japanese income tax rate is 40% on its highest earners, and they have a VAT of 5%. Given that the economy has been in deflation now for 25 years and counting, why does the Japanese government collect any tax at all? Mrs Masaki is correct -- she has to be ready to fend for herself because the Government is actively depressing economic activity. Obama is doing exactly the same thing in the US. When he will announce a plan to raise taxes and decrease the deficit in the next few days, and the economy will take another big leg down. Economists will be baffled as to why this display of fiscal "responsibility" makes things worse.

Thursday, February 19, 2009

Deficit spending *enables* private savings

It's worth reiterating Mosler's explanation of how Federal deficit spending enables private savings.

1. The Treasury sells $100B of government bonds.

2. Private sector bank balances go down by $100B to pay for those bonds.

3. Private sector holdings of government bonds go up by $100B.

4. The Treasury now spends the $100B it just raised by issuing debt

5. Private sector bank balances go up by the $100B the Treasury just spent.

So, net net, bank balances are exactly where they were before. The private sector holds $100B new Treasury debt, and the Government has funded $100B of public works (or whatever). The Treasury debt the private sector now holds is savings which pay interest, higher interest, than the bank liabilities (deposits) they held earlier. So private sector savings has gone up by exactly the amount the deficit has increased.

When the Treasury issues debt, it does not finance the deficit, it just alters the term structure of money that's out there, because you can either have the Government hold one of your dollars in an FDIC insured account, or you can have the Government hold one of your dollars in an equally zero-default treasury security. No difference, just a new term structure. The term structure is important in that bank deposits can sit at the Federal Reserve account and Treasuries cannot, so the Government issues Treasuries to drain reserves, and thus maintain a positive interbank overnight lending market. In a ZIRP situation (which we are currently in) I don't see why the Government needs to issue any Treasuries at all, nor do I see why the Government cannot simply ran an overdraft at the Fed.

Wednesday, February 18, 2009

How lower interest rates hurt aggregate demand

The formula used to be simple, right? If the economy slows down, lower interest rates. That will goose borrowing and spending, and you'll see aggregate demand pick up, and the economy recover.

I don't know enough about previous recessions to judge how true that ever was really, but in this recession, the problem is that consumers want to save more and spend less, and have been given no other option by stimulus nazis ("no stimulus for you!") like the Obama administration and Paul Krugman than to try and save out of aggregate demand, with predictably dire consequences.

In this environment, it's worth mentioning that interest rates of 0 really hurts savers. At this point, ZIRP is taking savings income out of the private sector, and may be doing more harm than good.

Friday, February 13, 2009

All I got was this lousy $400

The Republicans, and seven Democrats, were right to reject the lousy Obama administration stimulus bill today. It will be a total dud, and six months from now you'll see the jobless rate reaching 10%, while stories of rich bankers and Government workers will fill the NYTimes. Maybe even Paul Krugman will declare it a failure.

The stimulus bill is awful because it does not help households save. The US household has gone from an unsustainable level of negative saving to a sustainable level of positive saving, as we all knew it eventually would, and this is only triggering the Apocalypse because academic economists have no idea how money works. If they did, they would be increasing the Federal Deficit to fund this increased demand for private savings, through a payroll tax holiday. Instead they are doing nothing except transferring wealth to bankers and Government workers, and making households cut back on transaction, forcing saving the old fashioned way -- unemployment.

The Finance Buff put it best:
- Making Work Pay: For 2009 and 2010, $400 per person tax credit for AGI under $75,000; phased out to $95,000 (double everything for married filing jointly).
- One-time $250 payment to Social Security and other fixed income recipients.
You got that. $400 for some households. And $250 if you're living on SS. Note, the $400 used to be $500, but it got cut.

These numbers are piddling. They need to be multiplied by about 15 before they'll make a dent in the average household balance sheet.

Happy Birthday, Charles Darwin

While Creationists are always and everywhere (ie. on NPR and the NYTimes) mocked, they do share a common belief with modern Enlightened Progressives. Happy Birthday Charles Darwin!

Thursday, February 12, 2009

Compare and contrast

Warren Mosler on the awful Obama/Geithner plan:
Seems much of the latest proposal is designed to attract private capital by offering investors a sufficiently high level of profit.

This directs income to those with financial capital, who now look to be the main beneficiaries of the new administration.
Compare and contrast with John Hempton
Asset prices are way down – this crash might be the investment opportunity of a lifetime – and I have a smorgasboard of assets to chose from on which I will not lose money over the long term – indeed on which I might make 5% per annum.

I am just thrilled.

So how are those assets really? Underpriced but hardly exciting. To be exciting they have to be insanely underpriced. There are a few insanely underpriced assets out there, but John Paulson (Paulson funds) won’t tell you what they are. And even then they are not that exciting.

No – to be exciting you need to borrow against them. You need to be able to use leverage. Cheap leverage. Lots of leverage. And it can’t be margin loans or the like – because the asset prices are so volatile that your funding might go away.

But – with permanent cheap funding at government rates it should be profitable to buy those assets. Seven to one levered at government rates (which are a couple of percent) the returns will be spectacular.

So if the Geithner plan is to attract say one hundred and fifty billion of private risk capital and allow it permanent and secure access to say a trillion dollars of government money at a government rates then hey – I am in. (I would require the interest rate risk be matched too.)

It would be a pretty big gift from the government – as nobody – a good bank or a bad bank – can borrow at the same (extraordinarily low) rate as the US Treasury. But as a plan it might just work. And because 150 billion of real private spondulicks is at risk there are some pretty strong incentives for the private sector manager to get it right.
Change we can believe in!

Wednesday, February 11, 2009

China learns what fiat currency is the hard way

You need to feel at least a little sorry for the Chinese. They build up a powerhouse economy, host a killer Olympics, and frugally save save save. And now they ask that the US won't trash all those dollars that the Chinese worked so hard to accumulate.

Sovereign debt has no default risk, but it does have very real inflation risk. China, like most people, thinks that it is better to export than to import. They are wrong. China also thinks that the Government should run surpluses, but they are wrong there too -- the Government should run "Goldilocks" deficits -- deficits just large enough to satisfy the demand for private savings. China thinks they are in the drivers seat because they "finance" the US deficit. But the US can print all the money it wants, and does not need anybody to finance anything. The US has funded China's demand to save, nothing more.

But look at nonsense headlines like these: "U.S. Jan. budget deficit $84.0 bln vs $17.8 surplus yr-ago". It was the budget surpluses, under Clinton and Rubin, that sapped private savings and brought us to this current crises. A larger deficit is a sign that things are getting better, not worse, as the private sector gets the money it needs to net save and stops reducing aggregate demand. What's being termed a budget "shortfall" is nothing more than the Government funding private savings demand. A balanced budget means no private sector savings -- a total disaster. The Federal budget needs to get much larger, much more quickly, with the savings that increase funds being channeled to households who drive aggregate demand, and not to banks who are pro-cyclical and will not help the economy until the cycle turns.

Savings Nazis like Paul Krugman are making things worse, increasing unemployment and prolonging the cycle. Maybe Krugman will be the Mellon of the 21st Century?

Quick links

First read this from Dealbreaker. Then read this. Hysterical!

Also, a nice post on Krugman vs Barro. At least Barro seems to realize that Krugman is cleaning his clock from the crucible of policy: the NYTimes OpEd page.

Tuesday, February 10, 2009

Sovereigns cannot default

John Campbell was my teacher many lifetimes ago. I recommend his presentation (pdf) on treasury bond risk. He correctly points out that a sovereign, floating a fiat currency, with liabilities denominated in its own currency, cannot default. The sovereign has swapped default risk for inflation risk, and inflation is not default. Sovereign debt has no credit risk, it just has inflation risk, which is why those "triple A" ratings for US Treasuries are as meaningful as triple A ratings were for subprime mortgages. Ratings agencies are no better than they were.

The upshot is that nominal sovereign debt is a good bet against deflation, but a bad bet for stagflation. I'm guessing Campbell recommends TIPs. He was in the late 90s (and it was a bad call then).

I want Henry Paulson back

I had grave misgivings over Geithner, even before he was revealed as a tax fraud. His dismal performance at the NY Fed would have led to decapitation during Ceaser's time. Today's kinder, gentler approach has shown nothing to recommend it so far.

He's been working on this issue now for over a year, and yet we have a "plan" which is either so hopelessly vague as to have no meaning at all, or is simply wrong. The Dow's down 4.6%, but remember, the markets also tanked before the Republicans voted down TARP 1, which they were blamed for, and they then passed, but then Paulson did something else, and the markets tanked some more. I have seen no apology to those who initially rejected TARP 1 for their wisdom and foresight.

"Too big to fail" is only a problem if the Government is unwilling to put the company in receivership, maintain operations, and wipe out shareholders and bond holders. It is not an operational problem, it's a problem of political will. There was no custodial receivership to support Lehman's counterparties when Paulson let that fail, which fueled the turmoil that followed. Sadly, the wrong lesson was learned and now all banks will be propped up indefinitely.

Paulson, for all his flaws (which were legion) was less of a soft touch that Geithner. He at least tried to wipe out equity and debt holders, even though he did not do it well. Geithner is simply shoveling money to Wall Street. A terrible pick by Obama.

Friday, February 06, 2009

Peak Oil, Peak Credit, and Peak Obama

I shorted oil when it hit $120. "Peak Oil" never made any sense to me, and while one day the world will move onto other energy sources it will not be because we have no oil left.

"Peak Credit" is also a phenomenon I fundamentally do not believe in. I don't see why we will not, one day, return to the levels of leverage last seen in 2003, 2004, 2005, although when that time will come I do not know. Certainly, as we know that bank lending is not constrained by reserve requirements, it is only constrained by people's willingness to borrow, and that willingness has evaporated, we're talking about a change in sentiment and those are impossible to predict.

When that change in sentiment comes, and Animal Spirits become optimistic once more, we'll see aggregate demand pick up and the credit economy will stop contracting. People say that there is insufficient "trust" and that is what is bringing the Animal Spirits low. I disagree. The problem is that people overlevered, and now they wish to save.

I did not see this before, but the paucity of MV=pY is now clear to me.

p does not fall, not because people are irrational and wages are sticky, it does not fall because debts are nominally denominated and do not rise with inflation, or fall with deflation. As people save, the real debt burden will rise even as household savings rate increase.

Unfortunately, Obama is doing nothing to hasten this change in spirit by doing nothing to help people save and maintain aggregate demand. The Obama/Krugman/NYTimes side of policy wants to pay Government workers to build unnecessary bridges in 2010 or 2011. A stimulus that helps people save is, paradoxically, rejected as being "unstimulative". The Stimulus Nazis, like the Soup Nazi, will get their wish. Moreover, the Obama administration is suffering from exactly the forms of incompetence I was told it would from insiders. In better times it would not matter.

Across the aisle things are no better. The Grand Opposition is uninterested in stimulating at all, whether it be 2009 or 2011. Clearly those in charge of fiscal policy do not understand how Federal Deficits enable private savings.

Things are looking very poor for the Democrats in 2012, and while it is ludicrous to look so far ahead, the underlying macro trends point to a long fall for St. Obama.

Wednesday, February 04, 2009

Another intro to Post Keynesianism

A very good introduction to post-Keynesianism from Australia. I particularly liked the series of graphs at the bottom.

Monday, February 02, 2009

Blogging at its best

It's easy to find ad homiums and flame wars online. It's much harder to find reasoned debate, and rarest of all, real learning.

I once again recommend this excellent post on Interfluidity, and most importantly, the comment thread. JKH is a treasure. Key learnings for me:

1. Creating a balance sheet for a combined Treasury/Central Bank entity is very hard. The equity entry is weird -- it seems it must be negative -- and the cash entry is also strange -- it seems it must be infinitely positive.

2. People believe that a Government can print money, and also that a Government can be insolvent. To me, this is like saying a room can be both dark and lit at the same time. So long as a Government's obligations are denominated in a currency it can print, and so long as that currency is both non-convertible and floating fx, the Government can *always* meet its obligations. It has traded default risk for inflation risk.

3. Classical macroeconomists have a strong, emotional belief that a Government must issue debt, and cannot have an overdraft at its central bank, else it will inflate. The traditional reason for this was that the Government had to issue debt to drain excess reserves from the Fed, and thus support a bid (+'ve FFR). Now that the Government pays interest on reserves, that reason is gone and yet macroeconomists still fear monetizing debt. Dudes, we're already there.

4. While we've been on a fiat money system for a long time, people still believe that we're on some kind of extended gold standard. Witness the scrabbling by Nobel winning economists over what is very rudimentary operational points on the economy and money supply. The only reason Eugene Fama saying that savings create loans is worse than Paul Krugman saying stimulus is ineffective because people save it is that Paul *already* has his Nobel and Eugene just blogged his away. Serve that man a chaser to go with his pitcher of FAIL.