The Float

The Warning

Frontline's latest--"The Warning," about Brooksley Born, Alan Greenspan, and the anti-regulatory ideology that helped put us where we are--is required, morally imperative viewing.

One revealing/disturbing highlight: "Greenspan didn't believe that fraud was something that needed to be enforced." No. We aren't making that up.

We recommend that you watch it at your earliest opportunity.

UPDATE: The bit about Greenspan's bizarro reluctance to discourage/discover/punish fraud is a real jaw-dropper. But the most affecting segment of "The Warning" is former SEC Chair Arthur Levitt's acknowledgment that Brooksley Born was good and right. Here are Levitt's words, roughly 48 minutes into the show: 

"I've come to know her as one of the most capable, dedicated, intelligent, and committed public servants I've ever come to know. I wish I knew her better in Washington. I could have done much better. I could have made a difference." 

Those words mean a lot, but the genuine emotion--the pain--underlying Levitt's statement can only be sensed by watching him. It's as if he becomes, in those few seconds, the personification of so much national regret. Amazing stuff.

The Slipperiness of "Macroprudential Regulation"

Back on April 1st, we produced an excerpt from Simon Johnson's excellent Atlantic essay "The Quiet Coup." We called our post "Line of the Year," with reference to Johnson's statement that "anything too big to fail is too big to exist."

Yesterday, at The Baseline Scenario, Johnson extended that line of thinking by wondering out loud whether the Fed--or any other "macroprudential regulator"--can "sniff" bubbles before they threaten the financial system.

"Asset bubbles may not be that hard to identify," [New York Fed President William C.] Dudley argues. Fine, but it would help to know exactly the Fed would do this ex ante-–not using the rear view mirror.

Of course, if the Fed can't get better at spotting bubbles, the implication is that no one can. Which means that "macroprudential regulator" is just a slogan-–a nice piece of what Lenin liked to call "agitprop."

And if macroprudentially regulating is an illusion, what does that imply? There will be bubbles and there will be busts. Next time, however, will there be financial institutions (banks, insurance companies, asset managers, you name it) who are-–or are perceived to be–-too big to fail"?

You cannot stop the tide and you cannot prevent financial crises. But you can limit the cost of those crises if your biggest players are small enough to fail.

We think Johnson's exactly right, not just in sensible-capitalist principle, but in practical terms as well. Government has a fighting chance to get antitrust-style stuff right. But identifying bubbles? And doing something about them at the right moments...neither too soon nor too late? We just don't see it.

Geithner's Toxic Menu

John Hussman weighs in on the latest emergency measures from the federal government (emphasis added in bold):

[F]rom early reports regarding the toxic assets plan, it appears that the Treasury envisions allowing private investors to bid for toxic mortgage securities, but only to put up about 7% of the purchase price, with the TARP matching that amount -- the remainder being "non-recourse" financing from the Fed and FDIC. This essentially implies that the government would grant bidders a put option against 86% of whatever price is bid. This is not only an invitation for rampant moral hazard, as it would allow the financing of largely speculative and inefficiently priced bids with the public bearing the cost of losses, but of much greater concern, it is a likely recipe for the insolvency of the Federal Deposit Insurance Corporation, and represents a major end-run around Congress by unelected bureaucrats.

...

There is no doubt that the Fed also intends for the extra trillion in base money to end up as bank reserves. But think about what this move implies in equilibrium. The largest purchasers of U.S. Treasury bonds at present are foreign central banks. So what the Fed is really doing is printing enough money to crater the exchange value of the U.S. dollar, while leaving foreigners with a trillion dollars of savings that they would otherwise have invested in Treasury bonds, which they will now use, not to buy our lousy, toxic assets, but to acquire our productive assets, and at a steep discount thanks to the currency depreciation. So yes, the extra trillion in dollar bills will ultimately end up as bank reserves (and currency in circulation), but only by encouraging Beijing to go on a shopping spree to acquire a claim on our future production. Ultimately, funding the bailout of lousy assets comes at the cost of debasing our currency and selling our good assets to foreigners.

And for good measure, here's Tom Toles, who's all over this story...

Hussman Gets It

We have nothing to add to this, an excerpt from John Hussman's March 9^th Market Comment (emphasis added in bold):

The misguided policy response from Washington has focused almost exclusively on squandering public money and burdening our children with indebtedness in order to defend the bondholders of mismanaged financial institutions (blame Paulson and Geithner –- I've got a lot of respect for our President, but he's been sold a load of garbage by banking insiders). Meanwhile, I suspect that the little tapes in Bernanke's head playing "we let the banks fail in the Great Depression" and "we let Lehman fail and look what happened" are so loud that he is making no distinction about the form of those failures. Simply letting an institution unravel is quite different from taking receivership, protecting the customers, keeping the institution intact, replacing management, properly taking the losses out of stockholder and bondholder capital, and issuing it back into private ownership at a later date. This is what it would mean for these banks to "fail." Nobody is advocating an uncontrolled unraveling of major financial institutions or permanent nationalization as if we've suddenly become Venezuela.

Make no mistake. Buying up "troubled assets" will not materially ease this crisis, nor will it even improve the capital position of financial institutions (see You Can't Rescue the Financial System if You Can't Read a Balance Sheet). Homeowners will continue to default because their payment obligations have not been restructured to any meaningful extent. We are simply protecting the bondholders of mismanaged financial institutions, even though that bondholder capital is more than sufficient to cover the losses without harm to customers. Institutions that cannot survive without continual provision of public funds should be taken into receivership, their assets should be restructured to better ensure repayment, their stockholders should be wiped out, bondholders should take a major haircut, customer assets should (and will) be fully protected, and these institutions should be re-issued to the markets when the economy stabilizes.

The course of defending the bondholders of insolvent institutions is not sustainable. Do the math. The collateral behind private market debt is being marked down by easily 20-30%. That debt represents about 3.5 times GDP. That implies collateral losses on the order of 70-100% of GDP, which itself is $14 trillion. This estimate would include not only bank mortgage losses, but also loan losses to insurance companies, pension funds and other institutions that own private debt. Unless Congress is actually willing to commit that amount of public funds to defend the bondholders of mismanaged financials so they can avoid any loss, this crisis simply cannot be addressed through bailouts. Bondholders have to take losses. Debt has to be restructured (and can be restructured in ways that largely preserve the present value of the obligations). There is no other option –- but the markets are going to suffer interminably until our leaders figure that out.

Gary Shilling on a Slow-Growth World

Here's another worthwhile item: a recent newsletter from Gary Shilling, as reproduced and distributed by John Mauldin. Shilling's a long-time deflation worrier who's now (finally/more or less) right. So you might read his deflation discussion in the context of a guy trying to prove just how right he is. Not that there's anything wrong with that!

Regardless, we think much of his analysis of a slow-growth world is right on the mark. It's long, but worth a few minutes when you have the time.

Monday Reading

A handful of new and old items to get the week started...

• We missed this when it first appeared, but it's no less relevant today than it was three weeks ago: "Index Funds Win Again."
• Daniel Gross weighs in on risk appetites. Short version: We gotta have 'em, not in the manic sense of the last several years, but we gotta have 'em. 
• Barry Ritholtz links to last night's 60 Minutes segments on Ben Bernanke, whose occasional expressions of flinty anger were refreshing--and seemed plenty genuine. 
• Interesting stuff from Calculated Risk (also channeling some James Hamilton) on the timing and sequence of recovery from post-war recessions. 
• We've written on "the financialization* of everything" in this space. Today the WSJ's Justin Lahart riffs on what de-financialization* might look like. (*Forgive the funky terms...they're unorthodox, but they just feel right in this context.)

Toles Strikes Again

Gotta love this guy...

 

 

Crisis Reading

A few items relevant to this crazy confluence of credit crisis and bureaucratic politics:

• Geithner Hampered by Staff Deficit as Wall Street Demands Speed (Bloomberg)
• Ailing Banks May Need More Aid to Keep Solvent (New York Times)
• MidSouth Loses Would-Be Borrowers as TARP Fails With Louisianans (Bloomberg)
• Next Challenge on Stimulus: Spending All That Money (Wall Street Journal) 
• Obama walks line between politics, economy (Reuters)

The Big Fix

Nothing terribly original from us today, so we'll point you to the New York Times and David Leonhardt's excellent summary of the economic environment and the policymaking challenges it presents to the Obama administration, Congress, the Fed, and state and local governments. This is heavy, smart, important stuff. Check it out.

Some Parades Need Rain

Back in those sweet, sweet college days, a small group of friends came up with a category of people we weren't terribly fond of.* We called 'em "parade rainers," and their crimes against our sensibilities typically took the form of finding something negative to say about, some set of caveats to offer concerning, some form of doubt or discounting to apply to somebody else's success. It was conduct unbecoming, we thought, and, preferring sun to clouds (in particular given our pacific northwest whereabouts), we didn't like to see negative energy crowding out the positive.

Those basic preferences still apply, but the fact is that not all parades are created equal. Many are richly deserved, serving to encourage and reinforce whatever good behavior combines with good luck to produce good outcomes. But some reflect more good luck than good behavior, and can actually reinforce bad behavior that appears (to almost everyone!) to correlate with good outcomes.

With that as a semi-philosophical backdrop, please read this, Justin Lahart's description of one observer who rained--not obnoxiously, but wisely--on a very big parade thrown for Alan Greenspan in 2005. (A free summary version of Lahart's account is available here.)

The key substantive point in Lahart's piece is that free market absolutism makes no more sense than other forms of dogmatic ideology. That's not to say that markets don't make more sense than other forms of economic organization. We certainly think they do, and we think whatever finishes second in that race finishes a very distant second indeed. But the totalizing ideology of markets, which tends to rise up just as market mechanisms are about to break down, tends to leave some serious--and, what's worse, unnecessary--destruction in its wake.

The ultimate irony here is that those best suited to defend markets are those most attuned to their limits and periodic failures.

~~~~~~~~~~~~~~~~

* Yep. That sentence ends in a preposition. We're over it. Many grammatical rules exist for good reason, and we'll defend those that do until last we type. But the no-preposition-at-the-end-of-a-sentence rule serves no identifiable purpose, does nothing to favor clear communication over muddled, and deserves polite but firm relegation to the dustbin of linguistic history.

Source

Justin Lahart, "Mr. Rajan Was Unpopular (But Prescient) at Greenspan Party," Wall Street Journal, January 2, 2009