Economic Darwinism

Barry Ritholtz Hits it Out of the Park

Posted in Action, Bailout, Barry Ritholtz, Obama by Economic Darwinism on June 28, 2009

If President Obama reads one interview this year on the financial crisis, it should be, without a doubt, this interview Barry Ritholtz did for Welling@Weeden:

Fix What’s Broken
Barry Ritholtz Takes Aim at What the Regulatory Proposal Leaves Out

Letter to Obama: Losing Political Capital

Posted in Action, Barry Ritholtz, Bernanke, Geithner, Greenspan, Obama, Paulson, The Big Picture by Economic Darwinism on June 18, 2009

Dear President Obama,

I say this as a supporter and as someone who wishes you success as we face extreme challenges on many fronts. I work among conservative Republicans and actually had to sneak out of the office to watch your inauguration. It was a touching and historic moment I will never forget.

You are on the verge of losing whatever political capital you had coming into office due to your refusal to acknowledge that the people you are relying on for economic policy are the very people who are responsible for getting us into this situation. Greenspan, Bernanke, Paulson, and now Geithner (and Summers) all continue to fail to see the causes of the crisis. As a consquence, current proposed regulatory reform is bound to fail yet again.

At this point, the rapid loss of confidence in both Geithner and Bernanke are weakening your ability to push your agenda in other critical matters. You must do something to remove them both or you will  imperil your potential to accomplish lasting and necessary change.

Please listen to Barry Ritholtz*  and others such as Alan Blinder who actually understand what is happening. In particular, see Ritholtz’ article

Obama Reform Plan Fails to Fix Whats Broken

He enunciates six unacceptable weaknesses in your proposal:

1) No major changes for the ratings agencies!

2) Turn Derivatives into Ordinary Financial Products

3) If they are too big to fail, make them smaller.”

4) The Federal Reserve, Despite its Role in Causing the Crisis, Gets MORE Authority

5) Require leverage to be dialed back to its pre-2004 levels.

6) Restore Glass Steagall

All of which suggests that the status-quo-preserving, sacred-cow-loving, upward-failing duo of Lawrence Summers and Tim Geithner are still in control of economic policy. The more pragmatic David Axelrod and the take-no-prisoners, don’t-give-a-shit-about-Wall-Street Rahm Emmanuel have yet to assert authority over the finance sector.

All these should be considered uncompromising requirements of any regulatory reform. Anything less than these six items will have no positive effect and will likely lead to another crisis before the end of your first term.

You are running out of time.

*Author of Bailout Nation and the phenomenal blog The Big Picture.

A New Financial Foundation: Reaction

Posted in Action by Economic Darwinism on June 15, 2009

Today, we had the pleasure of a long article published in the Washington Post penned by no less than the dynamic duo: Geithner and Summers (listed in that order?).

A New Financial Foundation

Over the past two years, we have faced the most severe financial crisis since the Great Depression. The financial system failed to perform its function as a reducer and distributor of risk. Instead, it magnified risks, precipitating an economic contraction that has hurt families and businesses around the world.

Oh, and by the way, we are both largely responsible for the ill-conceived deregulatory bank-friendly policies that got us into this mess.

We have taken extraordinary measures to help put America on a path to recovery.

Since everyone knows that the way out of a credit crisis is to artificially extend credit at irrationally cheap levels.

This current financial crisis had many causes.

The authors being two big ones.

It had its roots in the global imbalance in saving and consumption, in the widespread use of poorly understood financial instruments, in shortsightedness and excessive leverage at financial institutions. But it was also the product of basic failures in financial supervision and regulation.

But please don’t think we had anything to do with that.

In recent years, the pace of innovation in the financial sector has outstripped the pace of regulatory modernization, leaving entire markets and market participants largely unregulated.

Thanks to us.

First, existing regulation focuses on the safety and soundness of individual institutions but not the stability of the system as a whole.

This is actually a thinly veiled attempt to RELAX regulation. The idea is similar to that adopted by Basel II and new rules allowing margin requirement be set at the portfolio level rather than the individual security level. Diversification helps. So when you group things together, the apparent risk is decreased allowing for additional leverage. Nice try.

The administration’s plan will impose robust reporting requirements on the issuers of asset-backed securities; reduce investors’ and regulators’ reliance on credit-rating agencies; and, perhaps most significant, require the originator, sponsor or broker of a securitization to retain a financial interest in its performance.

I’m sorry to be the one to break it to you, but the guys at Goldman are smarter than you. They will find a way around this.

All derivatives contracts will be subject to regulation, all derivatives dealers subject to supervision, and regulators will be empowered to enforce rules against manipulation and abuse.

What is your definition of a “derivative”? Does a credit default swap count?

We will lead the effort to improve regulation and supervision around the world.

Can you hear those Chinese college students laughing again?

Like all financial crises, the current crisis is a crisis of confidence and trust.

As long as the two of you have any say at all in policy matters, I know I will not experience anything remotely like “confident and trust”.

Reassuring the American people that our financial system will be better controlled is critical to our economic recovery.

Can you hear the unemployed graduating American college students laughing this time?

By restoring the public’s trust in our financial system, the administration’s reforms will allow the financial system to play its most important function: transforming the earnings and savings of workers into the loans that help families buy homes and cars, help parents send kids to college, and help entrepreneurs build their businesses. Now is the time to act.

It is too bad that the only solution you are capable of seeing is easy credit. Easy credit is what got us into this mess. Easy credit will not get us out of it. I don’t know what is so complicated about that concept that you cannot get it into your head. This is America. We don’t need and we don’t want your easy credit. If we let the big banks fail, would the availability of credit disappear? No way. Give me a break. That is fear mongering on your part to scare policy makers into excessively banker friendly policies. No. If every big bank failed tomorrow, there would almost immediately spring up 100s or 1000s of small banks in their place. There is great money to be made these days in opening a bank IF you would let competition play its course. Currently, the playing field is unfairly stacked against the small banks. I am tempted to start a bank myself. That is, if I thought you weren’t unfairly propping up economic sink holes.

To get this country back on its feet, we need entrepreneurs not oligarchs.

The history books will not make light of your misguided policies. The sooner you are both out of the picture, the sooner we can get back on the road to recovery.

Alan Blinder: A Voice of Reason for the Fed

Posted in Action, Alan Blinder, Bernanke, Federal Reserve by Economic Darwinism on June 15, 2009

Bernanke’s term as Chairman of the Federal Reserve ends on January 31, 2010. There seems to be a silent understanding that there are two possible outcomes:

  1. Summers slips into the role
  2. Bernanke stays

Both of these outcomes would be dreadful. It is not too early to start making noises now. The one person that stands out in my mind who should be the next Fed Chairman is Alan Blinder. Hands down. Throughout this crisis, he’s been a voice of reason. Bernanke, on the other hand, has been a bumbling disappointment.

I hope we can start a discussion early so that people are well informed ahead of time. These are challenging times and we need someone at the Fed we can feel confident about.

My vote would be to nominate Alan Blinder for Chairman of the Board of Governors of the Federal Reserve. Help make it happen.

Geithner’s Plan: Initial Thoughts

Posted in Action, America, Bailout, Bernanke, Geithner, Greenspan, Obama, Protest by Economic Darwinism on March 23, 2009

Here are my initial thoughts while they are still fresh. From the Wall Street Journal:

No crisis like this has a simple or single cause, but as a nation we borrowed too much and let our financial system take on irresponsible levels of risk. Those decisions have caused enormous suffering, and much of the damage has fallen on ordinary Americans and small-business owners who were careful and responsible. This is fundamentally unfair, and Americans are justifiably angry and frustrated.

So far so good. But why did we borrow too much? Because we could. Why could we? Because the Fed held rates too low on the short end and oil exporting countries and Asian savers (supposedly) kept longer maturity rates anchored. When he says “we borrowed to much”, he must be referring to his predecessors at the Treasury as well as the Fed.

The depth of public anger and the gravity of this crisis require that every policy we take be held to the most serious test: whether it gets our financial system back to the business of providing credit to working families and viable businesses, and helps prevent future crises.

Hold on one second. Working families and viable businesses do have access to credit. Just not at ridiculously unreasonably low yields that do not incorporate risk premia. Anyone who can put 20% down payment on a house should have no problem getting a mortgage even today. Businesses that need a loan may need to pay higher rates that are dependent on what the lender perceives the risk to be. That is how it should be. What he seems to be saying is that we want to give away free credit as if risk premia is a thing of the past. That is precisely what Greenspan and Bernanke have done for the past 20 years and is a primary reason why we are in the situation we are in. I’m worried. I hope it gets better from here.

We launched a broad program to stabilize the housing market by encouraging lower mortgage rates and making it easier for millions to refinance and avoid foreclosure.

My gut is beginning to twist. You have got it wrong Mr Geithner. You are not “stabilizing the housing market”, you are using taxpayer money to keep house prices artificially inflated and out of reach of responsible people who chose not to purchase because it was obvious to them house prices were ridiculously high. Now those same people are subsidizing your flawed ideas. Someone please save us from you and your cronies.

By providing confidence that banks will have a sufficient level of capital even if the outlook is worse than expected, more credit will be available to the economy at lower interest rates today — making it less likely that the more negative economy they fear will take place.

Why are lower interest rates the objective? Interest rates can be decomposed roughly into a primary “risk free” rate, a “credit risk” premium, and “inflation” premium. By keeping rates low, which of these are you ignoring? You are already manipulating the “risk free” component through quantitative easing and now you are trying to manipulate the “credit risk” component. That credit risk component is critical for the healthy functioning of the credit markets. Without it, you are just going to create another bubble. You are not even thinking about inflation risk. Sorry if I seem to be losing my patience, but I am.

Just this month, we saw a 30% increase in refinancing of mortgages, which means millions of Americans are taking advantage of the lower rates.

And you are also seeing another spike in borrowers who fail to even make their first mortgage payments. Refinancing mortgages at low rates completely ignores credit and inflation risk (you will learn about that soon enough). Mortgage rates should not be artificially lowered. If anything, you should reduce the principal and face the reality that home prices are unsustainably inflated. Oh wait. You cannot do that because principal reductions would impact the senior tranches of those CDOs your friends on Wall Street own so much of. What was I thinking?

This is good for homeowners, and it’s good for the economy.

That may or may not be, I think not, but those that will benefit with absolute certainty are the big banks and hedge funds. Nice try.

The new joint lending program with the Federal Reserve led to almost $9 billion of new securitizations last week, more than in the last four months combined.

Please someone help us. President Obama. Please. Help us. The last thing the Federal Reserve should be doing is encouraging more securitizations. Securitizations are a massive sink hole of economic health. It enriches the middle man and has the potential to lead to irresponsible lending and credit bubbles. Imagine that. Please consider going back to the good old days of responsible banking, where loans stay with the lender. If you ask one of your advisers whether securitizations are detrimental, they are likely going to say “No. Of course not.” Once they say “No” ask them, “Did you foresee this crisis?” If they say “Yes” and can verify it, then perhaps you should listen to them. Otherwise, take it from me. Securitization is not something the Fed should be encouraging right now.

However, the financial system as a whole is still working against recovery.

Maybe I’m just upset now and automatically disagreeing with everything you say, but I even disagree with this statement. What if it is you that are working against recovery? What if the markets are trying to find a sustainable equilibrium? What if markets are actually correcting themselves and prices should be lower? When you artificially try to keep rates unsustainably low and consequently try to keep prices artificially high, maybe it is you that is working against recovery. Think about that.

Market prices for many assets held by financial institutions — so-called legacy assets — are either uncertain or depressed.

No. No. No. If you want a market price, there is a certain way to get it. Try to sell it. The price you get is the market price. What does it even mean for a market price to be depressed? Based on what? If anyone is depressed, it is me after reading this. President Obama. I beg you. Help us. Get rid of these people.

With these pressures at work on bank balance sheets, credit remains a scarce commodity, and credit that is available carries a high cost for borrowers.

I would say the credit that is available carries an appropriately high cost due to the risk involved with lending in this environment. That is as it should be and trying to change that is unnatural.

The funds established under this program will have three essential design features. First, they will use government resources in the form of capital from the Treasury, and financing from the FDIC and Federal Reserve, to mobilize capital from private investors.

Who do you think you are trying to fool? My goodness! The FDIC is begging for money. Where are they going to get it from? You of course. The Federal Reserve is quickly turning into a sovereign wealth fund. The money is coming from you. And you are us, remember? The capital is coming from taxpayers who had nothing to do with this mess. I’m sure they will be happy to learn about that. Believe me, I will do what I can to inform them.

These funds will be open to investors of all types, such as pension funds, so that a broad range of Americans can participate.

That is wonderful. You are going to raid pension funds now. If you are a retiring baby boomer, all I can say is too bad for you. Sorry mom! I hope pension funds learned their lesson to stay away from structured products. If you do not understand something, do not invest in it. Pension funds, for your own sake and for those who depend on you, please do not participate in this monster.

Third, private-sector purchasers will establish the value of the loans and securities purchased under the program, which will protect the government from overpaying for these assets.

Curioser and curioser. What rabbit hole are you living in? How can you say that with a straight face? Of course the government is going to end up overpaying for these assets. Hopeless.

The new Public-Private Investment Program will initially provide financing for $500 billion with the potential to expand up to $1 trillion over time, which is a substantial share of real-estate related assets originated before the recession that are now clogging our financial system. Over time, by providing a market for these assets that does not now exist, this program will help improve asset values, increase lending capacity by banks, and reduce uncertainty about the scale of losses on bank balance sheets.

By creating a market that does not exist now, you are playing Market God and unnaturally selecting those who will survive and those who do not. Maybe there is a good reason the market does not exist now. Maybe the market should not exist. The market sets asset values, not you. Let the market continue to dictate prices. If the markets says the asset values are lower than you think they should be, so be it. Who do you think you are?

The ability to sell assets to this fund will make it easier for banks to raise private capital, which will accelerate their ability to replace the capital investments provided by the Treasury.

It will also allow banks to throw hail Mary passes with taxpayer dollars.

The Public-Private Investment Program is better for the taxpayer than having the government alone directly purchase the assets from banks that are still operating and assume a larger share of the losses.

Are those the only two options? Whatever happened to Pre-Privatization or Receivership or whatever you want to call it? This entire farce is insulting.

Simply hoping for banks to work these assets off over time risks prolonging the crisis in a repeat of the Japanese experience.

Has anyone actually proposed “hoping banks … work these assets off over time”? I would have some nice words for such a person. Don’t you see that your proposal will have the same result as the Japanese experience? You are artificially propping up insolvent institutions with special funds. The outcome will be the same. Let them perish and level the playing field so that healthier species can replace them.

Moving forward, we as a nation must work together to strike the right balance between our need to promote the public trust and using taxpayer money prudently to strengthen the financial system, while also ensuring the trust of those market participants who we need to do their part to get credit flowing to working families and businesses — large and small — across this nation.

I believe he is sincere here. I believe that Tim Geithner may not actually be sinister, but hell is full of people with good intentions. This proposal is a colossal mistake and should be rejected. If President Obama will not see it, then I hope the fury taking root across this country will force Congress to do something to stop this debacle.

We have already seen that where our government has provided support and financing, credit is more available at lower costs.

What makes you think this should be the motivation? Credit at unsustainably low costs was the cause of this mess. I fail to see how it will get us out of it.

Our nation deserves better choices than, on one hand, accepting the catastrophic damage caused by a failure like Lehman Brothers

Do you really believe this? I mean, really? I suppose you do, which is scary. Scary!  There was no catastrophic damage caused by Lehman Brother’s failure. If anything good has happened to date, it is that Lehman and Bear Stearns failed. The damage was there already done. The disease (of excess credit) was already coursing through the veins of the entire financial system. The death of one organ did not cause the damage. The death of one organ was a symptom of the disease. Purging these decaying organs was necessary to prevent gangrene from setting in. What you are suggesting is analogous to an embalming. Konnichiwa zombi ginkou!

In conclusion…

I am extremely disappointed.

The common theme and the common error throughout Geithner’s proposal is that credit is too expensive, rates are too high, and asset values are too depressed. The reality is that asset values are what they are. If no one wants an asset, its price goes down until it becomes attractive enough to reconsider. Throwing billions of dollars at unattractive assets with the purpose of artificially inflating their price is completely irresponsible and wasteful on a grand scale.

America, you need to care about this. You are surely facing your own problems like we all are and I understand the last thing you want to think about is some yahoos in Washington D.C., but these guys are hurting you. They are hurting your children and more than likely they are hurting your grandchildren. Both born and unborn. Take notice and if you are as upset about this as I am, then do something. Let your representatives know how unhappy you are. At this point, I think they are the only ones who can put a road block down before this train leaves the station.