Tuesday, March 30, 2010

Student loans

The public purpose of banking is to provide credit analysis -- namely, to separate good loans (loans that will be paid back) from bad loans (loans that will not be paid back). Therefore, having private banks issue loans that the Government banks makes no sense. Having the Government make student loans directly is a good move in that sense, although there are other parts of the program that are problematic.

Thursday, March 25, 2010

Social Security will never go bankrupt

The NYTimes leads:
The bursting of the real estate bubble and the ensuing recession have hurt jobs, home prices and now Social Security.

This year, the system will pay out more in benefits than it receives in payroll taxes, an important threshold it was not expected to cross until at least 2016, according to the Congressional Budget Office.
There is nothing important about this threshold. Alan Greenspan, whose star has sunk quite a bit since his days as the Maestro, continues:
“When the level of the trust fund gets to zero, you have to cut benefits,” Alan Greenspan, architect of the plan to rescue the Social Security program the last time it got into trouble, in the early 1980s, said on Wednesday.

That episode was more dire because the fund could have fallen to zero in a matter of months. But partly because of steps taken in those years, and partly because of many years of robust economic growth, the latest projections show the program will not exhaust its funds until about 2037.
This is not correct. When the level of the fund falls to zero, the Treasury, who cuts social security checks, and continue to write checks and the checks will not bounce.

The Government prints money whenever it spends, and is thus never operationally constrained in its spending. Spending too much will, of course, cause inflation, but whether the system pays out more than it takes in, or whether it accumulates a "trust fund" (which is a meaningless concept) or exhausts this "trust fund" has no bearing on anything.

Monday, March 22, 2010

Two Chartalist perspectives of Health Care

The first from David Kelly via Mosler:
The most obvious quantifiable impact of the bill is an increase in taxes for upper income Americans, particularly on investment income. Starting in 2013, the Medicare tax rate on households with income over $250,000 will be increased from 1.45% to 2.35%. In addition, a new 3.8% Medicare tax will be introduced for the same group on investment income....
...it's not like we haven't been here before. On average over the past 40 years the maximum federal tax on capital gains was 24.7% and the maximum tax rate on dividends was 44.6%.

For the Medical Care Industry, this bill will expand demand without much effort to reign in costs. A combination of federal subsidies and mandates will increase the pool of insured, and while there many constraints preventing insurance companies from limiting coverage there are few which limit how much they can charge for it.

However, whatever else is said about this bill there is nothing in it to suggest a reduction in either the quantity or prices of health care services consumed.

* - There is no meaningful malpractice reform.

* - There is no reduction in drug patent lives.

* - There is no compulsion to force insurance companies to compete across state lines.

* - There is no effort to limit health care procedures in the last year of life.

* - There are no meaningful incentives to force the insured to take better care of their own health.

Despite dire predictions, it's not clear that health care reform will really slow economic growth that much. Most of the tax provisions don't kick in until 2013 and the mandates on businesses and individuals don't kick in in a big way until 2016. Between now and then, the economy is quite capable of staging a full cyclical recovery. It may be that businesses will, in the end, be forced to pay more for the health care of their workers – however, overall, American business is quite capable of limiting wage increases to add to benefit costs.
And from Wray:
he most significant outcome of this legislation is the windfall gain for insurance companies—who will be able to tap the wages of the huge pool of nearly 50 million Americans who currently do not purchase health insurance. Since many of these are too poor to afford the premiums, the government will kick in hundreds of billions of dollars to line the pockets of health insurers...You might wonder how Democrats can call this a deficit reduction deal? Elementary, dear Watson. They will slash Medicare spending
I don't believe Medicare spending will be cut, and taxes don't increase much under the bill until about 2013-4, IIRC. I'm not as sanguine as Kelly about the economy though, as private sector debt remains too high, and the EU presents significant downside risks to equity. Net net though, I think this Bill is good for the insurance industry primarily, and OK for the healthcare industry. It is a strange creature, requiring households to pay private companies and give them Government money to do so, but then healthcare is a strange industry.

Saturday, March 20, 2010

Eric Buell

For those of you into motorcycles, here's a series of great interviews with Erik Buell, who used to make the only bikes on the planet worth thinking about.

Wednesday, March 17, 2010

What's a repo?

Marketplace has a nice video on how Repo 105. Unfortunately, they completely miss the role repos play in the banking system. It actually took me a while to figure this out and I understand the banking system very well, so this may be confusing other people as well.

All banks with reserve accounts at the Fed have reserve requirements. These reserve accounts are primarily used for payment settlement, but are also used in a convoluted way to set the Federal Funds Rate. At the close of business, some banks find themselves short their reserve requirements, and other banks find themselves long their reserve requirements, and so those that are short borrow from those that are long via repos. This overnight, interbank lending market uses repos as the vehicle for its overnight interbank loans.

Note that the repo market is not some shady thing, it is how the Fed has decided to enable payment settlement and set the FFR. If all banks closed long reserves, the Fed would intervene in the market until some were short, and force those banks to repo with other banks.

This mechanism means that quality of collateral and counterparty risk enter into a market for payment settlements and the FFR, which is a terrible design. Instead, the Fed's discount window should be the mechanism for payment settlements, and it could set the FFR to zero and be done with it.

James Hamilton is sympathetic to why the Fed should have regulatory authority, despite it's failure to do so.
Insofar as the Fed is expected to fulfill its function as a lender of last resort through the discount window, surely it needs detailed knowledge of the borrower's financial situation. And actionable information on the financial system's health and stability is just as surely essential for knowing when and how fast to change interest rates.
If you understand how the banking system works, however, you would have the Fed lend uncollateralized (thus solving the issue of liquidity risk) and rely on the FDIC to assess capitalization, and hence, solvency. The Fed should not be judging solvency because it is the ultimate liquidity provider to the payment settlement system.

Repo 105 part deux

Looks like I'm not on the only one struck by how the Lehman Examiner's report elides how the bank was insolvent. And I'm not talking about coming in under regulated capital ratios, I'm talking about a (massively) negative equity number.
Two unanswered questions stand out. The first is that even with the extensive Jenner & Block report, we still do not have even a rough sense of how big the shortfall in Lehman’s equity was at the time of its collapse. We know it was hiding $50 billion of liabilities at the end of its fiscal second quarter through its Repo 105 program, but that only tells us the size of one of the cover-up mechanisms. The Lehman report indicates that William Dudley at the New York Fed thought Lehman might require a $60 billion bailout entity, with Lehman providing $5 billion of equity, which says the authorities pegged the unreported shortfall at $55 billion.

The focus of the report was on how Lehman was shut out of the overnight interbank lending market, and did not go to the discount window. It never explicitly states that the reason it was shut out of the repo market was because it had negative equity, and there was real counter party risk to extending what (by design) should be a riskless loan.

Tuesday, March 16, 2010

Repo 105

I scanned a the opening few chapters on Lehman's Repo 105 and I must say, the report, while excellent in its detail, seems to be to conservative on the state of Lehman just prior to its demise. For example:
Lehman maintained approximately $700 billion of assets, and corresponding liabilities, on capital of approximately $25 billion.8 But the assets were predominantly long‐term, while the liabilities were largely short‐term.9 Lehman funded itself through the short‐term repo markets and had to borrow tens or hundreds of billions of dollars in those markets each day from counterparties to be able to open for business.10 Confidence was critical. The moment that repo counterparties were to lose confidence in Lehman and decline to roll over its daily funding, Lehman would be unable to fund itself and continue to operate.
This sets up the problem as one of liquidity, where Lehman's main problem was that other banks lost confidence in it. Certainly, this is the view of Geithner and the Obama administration. But Lehman made a huge number of loans that would not get paid back, loans they kept on their books. I don't know what the capital requirements are for whatever status of bank Lehman Bros was, but Lehman was booking income losses of $3B a quarter, and if it was honest about writing down its CRE and RE assets, it would probably blow through its remaining $22B in capital. So you have an entity with negative equity -- is its main problem that counter-parties will not lend to it?

Lehman did not turn to the Fed discount window, probably because it did not have collateral at the time, and maybe because they wanted to avoid the shame that comes with that. This to me illustrates how poorly the discount window, and interbank loan market, is designed.

Monday, March 08, 2010

A Waste of a Good Crises

Like the Bourbons, the Main Strem Media -- and many bloggers -- both remember nothing and forget nothing. The New Yorker's John Cassidy demonstrates this in his haigography on Obama's Geithner:
And yet—whisper it softly—there is good news about the financial system and the roundly loathed bank bailout, the seven-hundred-billion-dollar relief package that Congress approved in October, 2008. During the past ten months, U.S. banks have raised more than a hundred and forty billion dollars from investors and increased the reserves they hold to cover unforeseen losses. While many small banks are still in peril, their larger brethren, such as Bank of America, Wells Fargo, and Goldman Sachs, are more strongly capitalized than many of their international competitors, and they have repaid virtually all the money they received from taxpayers.
Huh? Anything given billions of dollars will be billions of dollars richer, but that does not count as "success" or "health". A healthy financial system is one that does not pay itself billions while destroying trillions, a healthy financial system is one which pays itself millions while creating billions. And "success" is achieving such a system. In every way, the financial system of 2010 is worse than the one we had in 2007. It has more moral hazard, more concentration, more political entanglements, more unwritten gaurantees, and even more incentive to loot than before. While Cassidy stands in awe of the geniuses at Goldman Sachs, I will humbly submit that I could make that much money too if the Treasury gave me billions and then promised to underwrite any losses I might incur. So could my cat.

If you want to look at what's put a floor under employment, look at a Government sector that now hires about 25%-30% of all workers, plus a slew of automatic stabalizers, and a fiat (non-gold standard) currency, none of which existed in the 1930s. You will note that Obama's Geithner had nothing to do with any of these. Just as the failure of the financial system seems to be an orphan ("economists are still trying to understand what caused the financial meltdown") the "recovery" has a proud father ("Shhh. The Geithner plan is working").

Simon Johnson points out some of the fallacies in this line of thinking quite well.

Other parts of the econ-blog sphere though grow tired of the wreck that is the financial system and now want to make the money they missed by not buying into the S&P last march. Or, depending on their political leanings, they come up with corkers like this:
...we cannot fix the financial sector without addressing the problems and contradictions [of inequality] which we depend upon financiers to paper over. This never was just a financial crisis. It was, and is, an economic and political crisis, and we are only a very short way down the path towards resolving it.
SRW's a nice guy, but we do not need to build a New Jerusalem before we can focus the financial system on its public purpose: making loans that get paid back. It's a shame to see Steve degrade from a smart thinker about finance to just another cog in the all-consuming kto, kogo industry.

Friday, March 05, 2010

More options if you understand the monetary system

Rolfe Winkler lays out a good, if often unspoken, reason for why the Obama has supported his predatory financial system instead of fixed it.
Throughout there was much indignation as to why such sensible reforms haven’t been enacted. Wall Street’s lobby machine got most of the blame, the rest went to “the people” for their perceived lack of outrage. But of course people are mad, and though the lobby machine is strong, it’s not the real obstacle to reform.

We are.

We don’t really want it. More to the point, people care more about their jobs than they do about reform.

What the reforms in paragraph 4 all have in common is that they reduce the availability of debt finance. That’s smart because our chief economic problem is that we’ve too much of the stuff.

But said another way, the reforms reduce credit. Like a lot. And that means deep and prolonged recession. Crucially, it means higher unemployment.
The private sector is over levered, and the solution to this is for the Government to pay in additional equity by running higher deficits. If it tries to limit paying in this equity you'll get what we have -- high unemployment and an overleveraged financial system.

SRW once said that the financial system had a MAD strategy, and this is part of that I'm sure. But the Government has the ability to disarm the financial system by levering up, so it can be levered down.

Monday, March 01, 2010

Love this interview

I love this Harry Markopolos interview.