mattlantz

Boom & Bust Cycles

James Fallows article on Nouriel Roubini in the July 2009 issue of The Atlantic makes an important point about boom & bust cycles:

The damage done in these boom-and-bust cycles, Roubini says, is greater than politicians and the media usually acknowledge. Stock-market averages eventually recover, as all buy-and-hold investors now keep telling themselves. (Except in Japan, where the main stock index stood near 39,000 in the late 1980s and is around 9,000 today.) But that doesn’t take into account the damage done to the real economy by the swings up and down. “These asset bubbles are increasingly frequent, increasingly dangerous, increasingly virulent, and increasingly costly,” he said. After the housing bubble of the 1980s came the S&L crisis and the recession of 1991. After the tech bubble of the 1990s came the recession of 2001. “Most likely $10 trillion in household wealth [not just housing value but investments and other assets] has been destroyed in this latest crash. Millions of people have lost their jobs. We will probably add $7 trillion to our public debt. Eventually that debt must be serviced, and that may hamper growth.”

The Big Fix

From Sunday's NY Times magazine, by David Leonhardt:

Olson’s book was short but sprawling, touching on everything from the Great Depression to the caste system in India. His primary case study was Great Britain in the decades after World War II. As an economic and military giant for more than two centuries, it had accumulated one of history’s great collections of interest groups — miners, financial traders and farmers, among others. These interest groups had so shackled Great Britain’s economy by the 1970s that its high unemployment and slow growth came to be known as “British disease.”

Germany and Japan, on the other hand, were forced to rebuild their economies and political systems after the war. Their interest groups were wiped away by the defeat. “In a crisis, there is an opportunity to rearrange things, because the status quo is blown up,” Frank Levy, an M.I.T. economist and an Olson admirer, told me recently. If a country slowly glides down toward irrelevance, he said, the constituency for reform won’t take shape. Olson’s insight was that the defeated countries of World War II didn’t rise in spite of crisis. They rose because of it.

The parallels to the modern-day United States, though not exact, are plain enough. This country’s long period of economic pre-eminence has produced a set of interest groups that, in Olson’s words, “reduce efficiency and aggregate income.” Home builders and real estate agents pushed for housing subsidies, which made many of them rich but made the real estate bubble possible. Doctors, drug makers and other medical companies persuaded the federal government to pay for expensive treatments that have scant evidence of being effective. Those treatments are the primary reason this country spends so much more than any other on medicine. In these cases, and in others, interest groups successfully lobbied for actions that benefited them and hurt the larger economy.

Socialism for the Rich Continues Under Obama Administration

Krugman's column in the NY Times shows that not much has changed in the continuing history of socialism for the rich in the US:

Will there at least be limits on executive compensation, to prevent more of the rip-offs that have enraged the public? President Obama denounced Wall Street bonuses in his latest weekly address — but according to The Washington Post, “the administration is likely to refrain from imposing tougher restrictions on executive compensation at most firms receiving government aid” because “harsh limits could discourage some firms from asking for aid.” This suggests that Mr. Obama’s tough talk is just for show.

Meanwhile, Wall Street’s culture of excess seems to have been barely dented by the crisis. “Say I’m a banker and I created $30 million. I should get a part of that,” one banker told The New York Times. And if you’re a banker and you destroyed $30 billion? Uncle Sam to the rescue!

CDS Articles

The Big Picture has a post that links to an article in the NY Times and to a couple of other posts on the Institutional Risk Analyst site.

This is the issue; how to create a credit market that works with the proper risk management.

I am especially interested in your comments on

1) the issue of what to do with CDS written against the top four money center banks, which are all under de facto public ownership as will become apparent as loss rates eat remaining private common and preferred; and

2) how to bifurcate the functionality of current CDS into a) an exchanged traded, index like product that tracks the spread/volatility of a corporate single name issuer and b) an exchange traded form of bond insurance with minimum 50% collateral vs net exposure (par less current estimated recovery rate, which will vary with spreads).

The End of Wall St

I just wanted to keep a link to this great article by Michael Lewis that appeared in the December issue of Portfolio.

That’s when Eisman finally got it. Here he’d been making these side bets with Goldman Sachs and Deutsche Bank on the fate of the BBB tranche without fully understanding why those firms were so eager to make the bets. Now he saw. There weren’t enough Americans with shitty credit taking out loans to satisfy investors’ appetite for the end product. The firms used Eisman’s bet to synthesize more of them. Here, then, was the difference between fantasy finance and fantasy football: When a fantasy player drafts Peyton Manning, he doesn’t create a second Peyton Manning to inflate the league’s stats. But when Eisman bought a credit-default swap, he enabled Deutsche Bank to create another bond identical in every respect but one to the original. The only difference was that there was no actual homebuyer or borrower. The only assets backing the bonds were the side bets Eisman and others made with firms like Goldman Sachs. Eisman, in effect, was paying to Goldman the interest on a subprime mortgage. In fact, there was no mortgage at all. "They weren’t satisfied getting lots of unqualified borrowers to borrow money to buy a house they couldn’t afford," Eisman says. "They were creating them out of whole cloth. One hundred times over! That’s why the losses are so much greater than the loans. But that’s when I realized they needed us to keep the machine running. I was like, This is allowed?"

401(k)'s a Bust

I've always had a problem with 401(k) plans being the only option available to workers and don't feel qualified myself to manage my money for retirement (that said, I don't trust anyone else to manage it either).  And I'm in a better position than most from an education standpoint to manage my retirement account.   

The Wall Street Journal had a very good article on 401(k) plans in today's paper (sorry, pay site).  This was the most interesting part of the article:

Boston College's retirement-research center recently ran scenarios that assumed workers had contributed 6% of pay to a plan for 40 years, had invested in a target-date fund, had never touched their savings until retiring and had annuitized the assets at retirement. The chunk of preretirement income these savers could replace in retirement varied dramatically depending on when they retired. Those retiring in 1948 could replace just 19%; those retiring in 1999, 51%; and 2008 retirees, 28%.

This is the biggest issue I have with 401(k) plans; they don't provide a guaranteed stream of income.  There is too much left to chance.  That's the basic problem with the idea of an "Ownership Society", there is no pooling of risk.  The result is that there are winners and losers, and the costs are higher overall.

Depression

Why can't people understand this? (from Kevin Drum at Mother Jones)

It's sort of stunning to step back from the daily minutiae once in a while and realize just how bad this economic crisis is. As near as I can tell, the underlying shock really is as intense as the one that kicked off the Great Depression, and the only thing preventing soup lines these days is that we've learned a helluva lot since the 1930s. Retirees all continue to have purchasing power and healthcare thanks to Social Security and Medicare. The unemployed are receiving unemployment insurance. Deposit insurance is preventing bank runs. The Fed has lowered interest rates to zero and is prepared to intervene massively to prop up the money supply. Barack Obama is readying a massive federal spending stimulus package. The Treasury is pumping capital into the banking system to prevent a complete collapse of the credit markets. Aside from tinkering around the edges, most countries have agreed (so far!) not to ratchet up protectionist tariffs and trade barriers. We aren't hobbled by reliance on the gold standard.

Take that stuff away today and unemployment might already be in double digits and still heading up. Put this stuff in place in 1929 and we probably never would have had the original Depression (or World War II). So thanks, FDR! Thanks, modern mixed economy! Thanks, countercyclical policy measures! I sure hope it's enough.

Someone Else Finally Said It

I've been saying for awhile that reporting earnings quarterly causes managers to think about the short term WAY too much.  Someone else finally said it in print, NY Times Op-Ed by Michael Lewis and David Einhorn:

A lot has been said and written, for instance, about the corrupting effects on Wall Street of gigantic bonuses. What happened inside the major Wall Street firms, though, was more deeply unsettling than greedy people lusting for big checks: leaders of public corporations, especially financial corporations, are as good as required to lead for the short term.

Wingnuts Get It Wrong Again, Why Am I Not Surprised?

The Big Picture sets the record straight on the meme that the Community Reinvestment Act (CRA) is at the bottom of the credit crisis:

The root legislative cause of the credit crisis was excessive deregulation. From exempting derivatives from regulation (2000 Commodities Futures Modernization Act) to failing to adequately oversee ratings agencies that slapped a triple AAA on junk paper, the pendulum swung too far away from reasonable oversight. By taking the refs off of the field and erroneously expecting market participants could self-regulate, the powers that be in DC gave the players on Wall Street enough rope to hang themselves with -- which they promptly did.

Reality-Based GDP

From the Big Picture blog: