TARPs and MREs

Seeing as how the big news tomorrow will be the financial stimulus, I wanted to re-post this blog post from Robert Reich (Secretary of Labor under Clinton, all around economics guy, and adviser [I believe un-official] to Obama).

I'm going to intersperse my sardonic comments. To sum it all up, I think Reich gives some clear, albeit obvious guidelines on what should happen to any further money, so that it does not end up like the TARP. He is phrasing his comments in terms of the second half of the TARP funds, but I think it should apply to anything applied financial-wise.

(snip)

What Should Be Done With The Next $350 Billion of Taxpayer Bailout Money: Criteria for TARP II

It's difficult to make the case that the first $350 billion bailout of Wall Street -- so-called "TARP I" -- fulfilled its goals, unless one argues that the Street would have imploded without it, which is pretty much what Hank Paulson is saying these days. And since it's impossible to prove a counter-factual, especially when the Treasury was never clear about TARP I's goals to begin with, Paulson may have a point. But the easier and probably more correct argument is that American taxpayers wasted $350 billion. [seems to me that someone was arguing that this would happen back in the fall!] No one knows exactly where it went -- at least two recent reports reveal that the Treasury had no idea [he's talking about the "capital purchase program" as listed in the chart in my earlier post, which 'only' lost 18%]-- but we do know the money did not go to small businesses, struggling homeowners, students, or anyone else needing credit, which was the major public justification for the bailout. In all likelihood, on the basis of the skimpy evidence we now have, the money went instead to bank shareholders in the form of dividends; to bank executives, traders, and directors as compensation (directors of major Wall Street banks continued to pull down an average of $350K each in 2008 merely for sitting in on a handful of board meetings at which they obviously didn't oversee very much); to some holders of bank debt; and to platoons of lawyers, accountants, and other financiers who have advised the banks about other places to park the rest of the money in the meantime.

Congress is now about to give the next Treasury secretary an additional $350 billion, [or $800B, or make a bad bank, or whatever] as the second tranche of the bailout. One hopes that the new administration will use it better. Some suggested guidelines:

1. Do not use any of the money to buy stock in -- that is, to "recapitalize" -- the banks. This is a sinkhole of cosmic proportion. Citigroup, to take but one example, has so far received $45 billion of taxpayer cash since early October (along with some $250 billion in taxpayer-supported guarantees from the Fed for junky assets on Citi's balance sheets), and is in far worse financial shape than it was three months ago. Perhaps, someday over the rainbow, these shares in Citi along with Citi's lousy assets will be worth more than taxpayers paid for them. But we're not in Wonderland yet and probably never will be. Giving Citi or any other big bank more taxpayer money is analogous to giving it to Bernard Madoff. It's a giant Ponzi scheme. The money will disappear. [yes! this is what I, and those other economists I posted about are saying! BUYING STOCK IN A FAILING COMPANY HELPS NOBODY]

2. Do not use the money to buy the banks' "troubled" assets. This might have made sense a year ago when the proportion of such assets -- which include mortage-backed securities as well as loans to private-equity partnerships that pissed them away -- was relatively small. But these days a huge and growing proportion of bank assets are "troubled." (It's also a huge waste of taxpayer dollars for the Fed to exchange them for Treasury bills.)

3. Prohibit any bank that gets TARP II funds from issuing dividends, purchasing other companies, or paying off creditors.

4. Bar any bank that gets TARP II funds from paying its executives, traders, or directors more than 10 percent of what they received in 2007.

5. Require that any bank getting TARP II funds be reimbursed by its executives, traders, and directors 50 percent of whatever amounts they were compensated in 2005, 2006, 2007, and 2008. This compensation was, after all, based on false premises and fraudulant assertions, and on balance sheets that hid the true extent of these banks' risks and liabilities.

6. Insist that at least 90 percent of the TARP II money be used for new bank loans. If the banks cannot find suitable borrowers, they should return the money. [I think #3, 4, 5, and 6 should go without saying, if they get anything at all]

You may judge these conditions harsh. I think them prudent. They may force a number of big banks to go into chapter 11 bankruptcy, which would not be the end of the world but perhaps the beginning. [it is absolutely ridiculous that people seem to think we should have a banking crisis in which everyone gets to stay in business after they caused one of the largest asset bubbles in history] At least then we'd find out what was on their balance sheets, because they'd have no choice but to sell off some of their junk, even at fire-sale prices (believe me, if the price is low enough, there are investors around the world who will buy them); they'd have to negotiate with their creditors and pay some of them off; many of their CEOs would be fired and directors replaced, which they should have been already; and most of their shareholders would be wiped out, which is unfortunate for them but, hey, they took the risk. In other words, these provisions would force the banks to clean up their balance sheets. This is the only way to get them to start lending again. [or, maybe "somebody" should "take control" of these banks to force these things to happen.]

Meanwhile, Congress should attach to TARP II -- or to the upcoming stimulus bill -- a small change in the bankruptcy law allowing homeowners to renegotiate their mortgages on their primary residences (as owners of second homes and commercial real estate can already do). The practical effect will be to give homeowners more bargaining leverage with their mortgage banks, and save at least 800,000 homes from foreclosure. Yes, in theory, holders of mortgage-backed securities will take a hit but as a practical matter they've already taken a hit because the securities (and the securities in which they're wrapped) are already deemed to be junk. At the least, this change will put a bit of a damper on the rising number of foreclosures. A home that's occupied by a family paying something on their mortgage is far better than a home that's empty, on which no one is paying anything.

(snip)

The only problem is that this week Reich has taken a step back from the sterness of this post. Perhaps with the stimulus bill looming, or for some other reason (note in this one where he mentions that Obama's officials are nodding their heads at the bad bank), he is trying to be more diplomatic and picking his battles.

But one thing is perfectly clear: TARP was a lesson in exactly what not to do. The money vanished, and shit is still broken. No more buying assets, no more buying stock, no more cushioning balance sheets so that investors can get the hell out. It's time to shut the doors, and open the books. Somebody needs to take control, and it sure as hell isn't these bozos.

Trust me--time is running out here. The stimulus isn't going to come in time, not before things get bad. I believe the ticker symbol you are looking for is MRE.

Another Day Another Subsidy

Economy and Nationalization, quickly:

The reporting of the Congressional Budget Office on the "subsidy cost" of the TARP is been widely reported, but I pulled this and the accompanying quote off of FT Alphaville because of the lovely juxtaposition.

Remember how the TARP funds were supposed to be an investment for taxpayers? Well, the CBO has reported, despite general unwillingness to provide any sort of specific information about the TARP, exactly how well this investment has played.


"Amount" is how much the assets cost when the US bought them. The "subsidy" amount is the difference between how much the assets were bought for, and how much they are worth now. In other words, this is the amount of money that was just given away. The subsidy rate is the percent rate that we would be looking at if this was actually some sort of investment, and not a cash give away.

American Taxpayers made -26% over about one quarter. That's $64 Billion just thrown into the void.

And, the funny part is (because there is a funny part, right?) that even after doing this, all these banks are still failing.

And then, there is this gem, from Felix Salmon at Portfolio.com:

"I look forward to Treasury telling us, before it spends any more TARP funds, what kind of subsidy rate it considers acceptable. There’s a total of $453 billion in TARP funds not spent in 2008; if those too have a subsidy rate of 26%, that’s equivalent to government expenditure of another $118 billion. To put that number in perspective, the market capitalization of Citigroup and Bank of America combined is just $55 billion. Isn’t it about time we just nationalized them?"

Yes, why don't we?

Again, thanks again to FT Alphaville, one of the sites that has provided a large amount of my economics education, and from which I just lifted this post wholesale, only adding a bit of attitude.

On the... uh, "Moral-ish Problem".

If, I was (bear with me here), some sort of an intellectual, as it were, the point of this post might be taken to be a classic example of Adam Rothsteinism.

Luckily (for who?) I'm not, so I can post this argument for nationalization of the economy by simultaneously bashing moralistic humanism without feeling like I'm beating the dead horse of that one book that I'm known for writing.

I didn't write any such book, nor do I have any 'line', nor any students. I just have this sardonic blog, and a lot of vitriol against liberal capitalism.

To the point: a common thread of concern among liberal (that is, American political liberals, not libertarian-leaning) economists in the wake of the... you know, problems, is evaluating the "moral corruption" that allowed these events to occur.

The argument, if one can call it that, goes something like this:

"Were the flaws in the system the result of markets corrupting our morals? I think we relied too much on markets to regulate behavior, i.e. as a means of enforcing morality on agents operating within market systems, and we paid too little attention to the need for oversight. But the flaws in the system that created the bad incentives were not, for the most part, the result of moral shortcomings, they resulted from human shortcomings, unintentional mistakes in the design of the system that come from our "psychological limits"."

In other words, it's not so much an argument as a rhetorical question with an afterthought concerning a need for "oversight". (Please note: this is not a slight against Mark Thoma, the author of these words, so much as it is against the line of thinking. His blog and comments on the economy are profoundly enlightening for a student wading through the issues of macro-economics. I say this because he does seem to be very knowledgeable and keen on the issues; my point of contention is with a symptomatic point of argument that seem pervasive in all of humanist thought, from the best minds to the worst.)

The problem, as I see it, is that in dealing with humanity, there is irrefutable desire to attribute morality as the last bastion of any system involving... well, involving humans. We have the system proper, we have checks and balances, we have peer review, we have oversight; but at long last, the metahuman element which drives all of these mechanisms, and which will no doubt save our souls, is good old morality. Because humans don't do wrong knowingly.

Without, of course, remembering that a market is a forum precisely designed for one party to extract value from another party. So any market party wouldn't dare use systems of checks and balances to put one over on another, wouldn't manipulate oversight to benefit themselves, and wouldn't even drop to the level of swearing on the bible to uphold morality, only to sell this promise to the highest bidder? All because "humans like to do what's right?"

Hand over the keys, humanity. You've had enough. When confronted with folks breaking these very rules which we believe are intrinsic to being, our only response is to say, "Whoa, let's tighten the rules a bit." Yeah, and I've only had, like, four beers.

I am not proposing to take the humans out of the system (computers, while perhaps being ultimately correct, often don't come to much better conclusions than we do). I am proposing to take a reliance on morality out of the system.

By linking the market systems to monopolistic control circuits, we don't have to rely on humanity "knowing what's best". What is a monopolistic control circuit? Nationalization. You'd never think to hear me arguing for bureaucracy (or at least I wouldn't think to), but that is exactly what we need. Thermostats are surprisingly efficient, simple physical mechanisms. Why shouldn't flows of capital be under similar control? Of course, it would not be centralized--we know what happens if one person ends up controlling the heat for the whole house, or if that one circuit breaks. A strategic, networked system of flow control is precisely what would work. Like, for example, the Federal Reserve system. Or, any of the regulated market bourses like the NYSE or CME. These work amazingly well, compared to what it was like before they existed. Why not extend this principle to GAAP (generally accepted accounting procedures) or personal investment?

Secrecy is where morality has a chance to leak. It's where bubbles are allowed to form. The reliance on morality that allows for any sort of secrecy is where people are allowed to become insanely rich; it is the realm of confidence. If you have confidence in morality, even if this is directed into oversight, then you are just setting yourself up to have that confidence abused. Morality is the ability to think that someone will do right by you simply because; because they are just like you, another human just out there trying to make some money on the market. Any con man will tell you that getting the victim to feel akin to you is the way to make it work. Put the numbers on the table, don't trust that they're in someone's pocket.

Now, don't go spreading this around, because this information is special, only for you. We don't want everyone getting in on this 'critique of morality' thing, just me and you. We can make a fortune on it--trust me.

Rationalizing Nationalizing

A little bit more exploration of the economy (call it alliterative easing):

So the Fed has admitted that quantitative easing is part of the plan. For those who are only learning what this means for the first time during this living-history lesson (like myself), it means increasing the monetary supply to grease the economy, doing what would ordinarily cause inflation in better times. Japan did this famously in the 90s, with little success, so the plan here is to do it better and quicker to make it work.

What they are doing is pumping money into the economy by buying up assets, increasing their balance sheet with cash drawn from, for lack of a better term, nowhere. More cash = more spending, which might ordinarily drive up prices, but now they are just hoping to increase revenue flows.

Unfortunately, it doesn't seem to be working yet. The banks from which the assets are being bought are just depositing the cash back into the Fed Reserve, which does serve to deleverage them from bad assets, but doesn't help the economy. The credit impasse seems to be sticking, because the banks aren't lending the money back out. Meanwhile, Treasuries are being sold like hot cakes, with the 3-month bill return being almost zero. Bad things that could happen include: the treasury market crashing and the dollar crashing, deflation, and more companies failing as a result of credit problems, which would only increase the amount of assets that the Fed would still need to take out of the market to keep it where it is.

But the main issue, as I see it, is that this shows that the Fed is not pushing for nationalization, as I had argued a couple of times previously. Or, at least they say that their not, because to say so could cause a HUGE panic among investors, who fear the phrase as much as they love "open market".

But, the fact that the quantitative easing is not working only pushes the case for nationalization, and not just from my teleological standpoint. Firstly, and most obviously: if the banks aren't doing what they need to be doing on their own, somebody (or some legislation) will eventually have to force them to do so. Secondly: if there is a currency crash, the country will have to take such drastic steps not only to prevent our economy from going down the tubes, but from all the dollar-backed currencies from going down the tubes. This is a lot more pressure than just the irrational red-baiting fears of "investors". Economists, eventually, always look at the facts. Thirdly: if Treasuries stop selling, something else must prop up the dollar. Now, I admit I'm not an economist, so I don't have a reference list of other options that aren't nationalization (my teleology laid bare). However, if the "open-market" policies of the Fed aren't having an effect, like for example, if treasuries aren't being bought and the value of the dollar is decreasing, controlling the supply of the bills on the open market could be used to control the price: like a repo to oneself. This would be more efficient than the open-market buying of assets, or of other repos. It could be carefully modeled and controlled.

And fourthly, aside from monetary policy: there is the matter of industry. This is the important one, because nationalizing the banks is all well and good, but if the industry is not coordinated as well, you might as well not even bother. The key to national control of infrastructure and economy, in my opinion, is coordination, direction, and execution. These are the benefits that a nationalized economy could have (stress the "could") that a free-market economy will never have.

Which brings us to that trying threesome, the American auto industry. They were sent back to Detroit in shame yesterday, because they could not convince Congress that they had a good plan. This is good, because it means that they will not just be handed cash, and also because it means the next time they will get the help they need. I hope it comes in the form of partial nationalization. I think that Congress realizes that they cannot convert themselves into profitable industries, let alone "automakers for the next century" without a drastic plan that will cost a lot of money to begin with. Operating cash is going down the drain. They need investment, and with investment comes direction, coordination, and execution (hopefully). And because the UAW will necessarily be included in any saving legislation, this could be a good beginning for nationalizing movements in American industry in concert with workers groups, and not just industrial leaders.

At least, I hope so. Or, the Fed and Congress could just keep pushing cash into the economy, hoping for a break in the liquidity trap, which may happen after long enough. Or it could all go down the tubes, and then, of course, the zombies.

The zombies do have a plan for the economy. Not nationalization, but cannibalization! (In America, first you get the assets, then you get rotting, then you get the flesh!)

Let's All Be Banks!

Update to yesterday's post:

It appears that Philadelphia, Phoenix, and Atlanta have written to Sec. Paulson, requesting funds from TARP to support pension plans, and other things.

If these cities are allowed to "convert into banks", then we are proceeding down the course of the nationalization I mapped out. First banks and insurers, large financial entities, are incorporated into the "single balance sheet", then industry (GM), then municipalities. Market and Industrial Zone-Entities (MIZE, consider it coined!). Leaders of the entities are allowed to retain control, but all monetary liquidity, assets, and debt are flowed through the Fed system.

Of course, they won't let those cities become banks. Instead, they just say, "nope, just wipe out the pensions, but keep building highways." Fair enough, I guess. This isn't the Soviet Union, after all!

But more to the point, it doesn't matter that they won't get TARP funds. The Fed is becoming the single market, whether they like it or not. But, can they handle that role....

Don't Worry About the Government

I'm watching my favorite show again: The House Committee of Oversight and Government Reform. Some day I will write them a theme song and intro-clip.

Today was Hedge Fund Day: lots of testimony.

I was enjoying Professor Andrew Lo's (MIT Financial Engineering Laboratory Director) testimony. He drew the distinction between risk and systemic risk.

Risk is easily understandable; one invests, and one may, via capitalization, achieve positive returns or one may lose. Systemic risk is the sort of risk that is currently driving the government's reaction to this evolving economic situation. It is generally understood as risk that would create a collapse of the system. This is the basis of the "too big to fail" phenomenon, that is spurring gigantic bailouts of individual companies. Clearly this is a problem, because the scale of the risk, the inherent denominator of capitalistic investment, is now being plied to the strength of the system as a whole. In other words, if a capitalist entity fails, capitalism fails. Others would put this as, if a market entity becomes market, then if that entity fails the market goes with it. I would say they are the same thing (in this case, systems of debt/capital commodification).

Above are some network diagrams of the correlations among hedge fund indexes. Sweet, huh?

Looking at things as a network is always a good schematic, in my opinion. Nothing is an island, and that certainly goes for financial systems. And, if we are discussing systemic risk, then certainly interconnections and correlations between risk is very important, as Professor Lo argues.

In fact, let's hear it from Professor Lo (from his written testimony before the committee):

"By looking at the financial system as a single portfolio, several useful measures of systemic risk can be derived by applying the standard tools of modern portfolio analysis."

WHAT??? verrrrrripppperrrrererrrrrrrrrrrrrrrrrr.... (the sound of the pdf being rewound)

"By looking at THE FINANCIAL SYSTEM AS A SINGLE PORTFOLIO, several useful... etc."

Now, let's cut to a single, modern portfolio, one doing very well right now.

The graph is shamelessly stolen from the excellent blog, Calculated Risk, which you should definitely read if you are interested in any of this sort of crap.

The portfolio, as you see, is that of the Federal Reserve. The president of the Dallas Fed predicted it will go to $3 trillion in assets by the end of the year. That is 20% of the GDP.

Let's recap. Because of systemic risk, the Fed is buying assets and lending out money like never before. The best way to analyze risk in the current markets is to view the market as a single system. And now the Fed is quickly, at an incredible rate, becoming the lynch pin of that single system, both in terms of the networks of where the debt flows are coming from (they have gone from being the lender of last resort to the biggest and only lender).

Get it yet? To fix the problem of an incredibly complex and massive system of value, it is best solidified into one system, for the continued maintenance of that value.

NATIONAL - IZ - ATION

Now: this isn't nationalization in the models of nationalization as it has occurred elsewhere in history. We are on entirely new ground here. This means two things, as I currently see it.

One: we will not have the economy "seized". Instead, companies will continue to try and save what assets they have by running to the Fed's door to keep their companies from going under, until eventually, the Fed controls so much of the country's economy (i.e. not only will the government determine monetary policy, they will control debt policy) and we will see a reverse panic. Everyone will take their money to the bank to keep it safe and valuable. To keep businesses operating, the government will have to spend, and, eventually direct large parts of the economy and its markets via its "owned" companies to keep the country going. Regulation will morph into direction/ownership, not by authority, but by de facto conditions.

Two: because this is a unique situation, it will become a positive feedback loop. Companies will not see it coming until it is too late, and they will be forced to go to the Fed like everyone else. This is the nature of the panic. But it will also be make it an unplanned nationalization, because it will be rolling, and not planned from the beginning. This means that many things could go wrong.

The question that I'm thinking about in my head is, what would the country look like with a nationalized economy? It would not be "state-owned", that's for sure. Not in this country, go back to Cuba! But it would be drastically different. If one considers American capitalism before the great depression to the SEC and Fed controlled economy afterward, we see an incredible difference in the philosophy of the market. No doubt there will be a major shift after this "second great depression", and nationalization is what it may look like.

Clearly companies will not be dissolved into worker combines. However, I can see carefully calibrated "free markets" of related industries that work within current anti-trust laws in managed competitions like those for federal contracts. This could mean strange things for free trade; I think it might drastically reduce the number of companies in particular industries, however, unless the economy, at the same time as it unifies into a "single portfolio", is managed into zones of much smaller size that will reduce the size of corporations and their national influence. Anti-trust could be taken along regional boundaries.

Bureaucracy would increase, with all these regionalized regulatory zones and entities. I think that this regulation would be the link that would be the national arm of the economy, and also divide it into regions and industries. Call them market divisions, if you wish. Fed banks, in addition to maintaining the reserves of cash, would also maintain those of debt, selling regionalized treasuries and industry securities, the way that it does government securities now.

The biggest question is what would happen to the individual worker. I would hope that an increase of union influence, combined with a larger number of member workers and an overhaul of their bargaining power would allow the workers to enter these new market zones as equals in the productive relationship, but I have a feeling we will end up the forgotten partner, and the better functioning of the macroeconomy will encourage its controllers to take more surplus value from the workers on the micro level.

Now, I'm going wildly out on a limb here, talking about things of which I have only a limited, amateur understanding. But, there will clearly be more regulation by the time we're through, and if this regulation is clever, it will act with a better understanding of systemic risk, which, perhaps, is what the folks in the Fed think they are doing now by buying tons of pieces of businesses. There's no doubt that we are moving towards nationalization right now, more than ever before. The only question is how far it will go, and by the fact that it does not seem to be having much more effect in the economy other than acting as a giant asset magnet.

we will see...