Kevin Drum

Friday Cat Blogging - 24 April 2009

| Fri Apr. 24, 2009 9:00 AM EDT

With any luck, I'll be on a plane to Georgia by the time you read this.  I'm attending a conference this weekend with fellow members of the VLWC on — let's see, what does it say here?  Ah, yes: "Attendees will discuss major themes such as the restructuring of the financial industries, the development of regulatory systems, transparency in stimulus contracting, and the impacts of the stimulus on jobs and housing in local communities."  Exciting!

But you didn't think I'd let you all face the weekend without Friday Catblogging, did you?  Of course not.  Today is portrait day, and they're trying to look serious and businesslike.  Did it work?

And hey — as long as I've got a captive audience here, a question: can anyone recommend a cheap and simple keystroke logger for Windows?  I'm tired of losing posts, so I'd like to keep a continuous keystroke logger running so that I have at least a fighting chance of recovering stuff that disappears into the ether.  Any help much appreciated.

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Stress Test Update

| Fri Apr. 24, 2009 12:06 AM EDT

The Treasury plans to release the broad results of its stress tests on Friday.  The New York Times reports:

Analysts are already betting that the stress tests will show that banks need to raise significant amounts of new capital, as profits made in the first three months of the year give way to more losses, tied to credit card, commercial real estate and corporate loans. An assessment by [Keefe, Bruyette & Woods], which calculated its own stress test for the industry, concluded Thursday that United States banks might need as much as an additional $1 trillion in capital.

As part of their exam, regulators have been poring over bank balance sheets to spot financial problems that may not surface for months. Officials are assessing the financial condition of the banks based on their potential losses and earnings over the next two years. That is why some banks that recently announced blockbuster earnings may still need to raise sizable amounts of fresh money.

As the dust settles from the shakeout on Wall Street, the 19 banks subject to stress tests are starting to divide into three groups: the strong that can weather the storm; the weak that will need new, perhaps significant, support; and the ones on the verge, whose fate will be decided by regulators.

I'm still shaking my head trying to figure out how this is going to work out.  If KBW is right — and their estimate certainly seems to be in the right ballpark — and a substantial fraction of that capital turns out to be needed by half a dozen of the biggest banks, where is it going to come from?  The Times report is very antiseptic, but it's a fantasy to think that any bank "on the verge" will be able to raise private capital, and the Treasury's TARP money is nearly exhausted.  So then what?

The next couple of weeks are going to be very interesting.  If this report is even roughly accurate, I really have no idea how Tim Geithner is going to tap dance his way around the N-word much longer.

Contrafactual of the Day

| Thu Apr. 23, 2009 7:58 PM EDT

James Surowiecki sez:

The Great Depression [] wouldn’t have become the Great Depression had the Federal Reserve and the Hoover Administration acted in 1930 the way the Federal Reserve and the Obama Administration are acting today.

Is this true?  Discuss.

Quote of the Day - 4.23.09

| Thu Apr. 23, 2009 4:47 PM EDT

From Barclays analyst Craig Huber in a research note:

"We view the 17.75 percent stake in the Boston Red Sox as having among the very best long-term asset appreciation potential at the company."

Unfortunately, he's talking about the New York Times.  (Via Ryan Avent.)

Risk

| Thu Apr. 23, 2009 2:22 PM EDT

Like pretty much everyone else on planet Earth, I've been thinking about risk a lot lately.  And I suppose I've been thinking pretty much the same thing as everyone else.  The following excerpt, from a speech to a bunch of bond dealers, is a bit jargony, but gets the basic point across.  Take it away, Felix Salmon:

You and I and Alan Greenspan all thought that credit derivatives were wonderful things because they moved credit risk out of the hands of people who didn’t want it, like banks, and into the hands of people who did want it.

In reality, however, the appetite for risk was never nearly as great as we all thought. $10 billion of loans becomes less than $200 million of credit-risk instruments, and everybody else reassures themselves that they’ve managed to reduce their credit risk to zero, even as the people holding that $200 million in synthetic CDO tranches are reassured by their own single-A or triple-B credit ratings that theyaren’t taking a particularly large amount of risk either.

And of course you know what happens next: some bright spark invents the CDO-squared, which seems to reduce the total amount of risk even further. You take the mezzanine debt, the triple-B stuff, and you do all manner of securitization magic to it, and it turns out that you can turn most of that into triple-A paper, too!

Because it was all triple-A, no one felt much in the way of need to do any analysis of their own: it’s almost impossible to overstate the power of the laziness of the bond investor. You know this from your own work with municipal issuers: the reason for those monoline wraps is not because the issuers have a lot of credit risk, but because the investors are lazy, and don’t want to do their homework, and reckon they can get out of doing their homework so long as there’s a monoline guarantee. Essentially, they’re outsourcing their own job to the monolines. Which might be reasonable for a small retail investor, but is not a good idea if your job is to invest in fixed-income instruments which carry a higher yield than Treasury bonds.

Of course, we all know how reliable those monoline guarantees turned out to be — and that’s a related story. The monolines, just like the ratings agencies, believed far too much in the power of models.

This kind of thing isn't new.  The basic idea is that you take, say, a BBB-rated bond (decent quality but not great) and get a monoline to insure it, and suddenly you've got a AAA bond.  It's now risk free because even if the bond defaults, the monoline will pay you off.  In theory, this is great: somebody who wants less risk in their portfolio is able to buy insurance from someone who wants more risk in return for a greater potential return.  Everybody gets what they want — party A gets exactly the investment it wants and party B gets exactly the investment it wants — which makes the bond market more efficient and more liquid.

But although this is true theoretically, in the real world it turns out that risk is usually best measured by whoever is closest to it.  In the past, bond buyers were pretty careful about evaluating default risk because they were the ones who'd have to bear it.  Then they started selling off that risk, and the monolines, who were eager for business and comforted by the fact that their models had always worked, were just a little less careful.  Then credit default swaps were invented and popularized, and risk was sold off even further.  And then further.  And when you get three or four steps down the line, nobody is seriously analyzing the underlying securities themselves.  They're just relying on increasingly on abstract models.

So a system that theoretically makes the market more efficient ends up, for all too human reasons, with no one truly evaluating the risk of all the securities underlying the rocket science.  And eventually it comes crashing down.

All of which makes me wonder: is Felix still as bullish about credit default swaps as he has been in the past?  Unlike some credit derivatives, there's no question that CDS serves a useful purpose.  In theory.  But in practice, when their use becomes nearly universal and they start getting packaged two and three vehicles deep, they're deadly even if there's no conscious fraud or abuse going on.  They don't so much allocate risk as simply encourage people to ignore it.  It's just human nature.

As for me, I'm increasingly wondering if insurance of financial assets (as opposed to physical assets, which are a different story) is a good idea, period.  Sure, the upside is that it makes debt markets more efficient, but it's worth asking if we even want these markets to be more efficient in the first place.  What has that gotten us aside from gigantic profits for financial firms?  And if there's no upside to balance a potentially catastrophic downside, why allow it at all?  Maybe, human nature being what it is, there's no substitute for forcing debt buyers to be extremely, personally, conscious of the risk they're assuming when they make an investment.  Maybe, in the end, that's the only thing that can keep a credit bubble from overinflating.

I'm not sure.  Pushback welcome on this score.  But it's certainly worth thinking about the big picture here.

Chart of the Day - 4.23.2009

| Thu Apr. 23, 2009 12:01 PM EDT

Just kill me now.  Via The Monkey Cage.

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Where It Started

| Thu Apr. 23, 2009 11:13 AM EDT

FBI agent Ali Soufan writes in the New York Times about the torture memos:

One of the most striking parts of the memos is the false premises on which they are based. The first, dated August 2002, grants authorization to use harsh interrogation techniques on a high-ranking terrorist, Abu Zubaydah, on the grounds that previous methods hadn’t been working....It is inaccurate, however, to say that Abu Zubaydah had been uncooperative. Along with another F.B.I. agent, and with several C.I.A. officers present, I questioned him from March to June 2002, before the harsh techniques were introduced later in August. Under traditional interrogation methods, he provided us with important actionable intelligence.

....There was no actionable intelligence gained from using enhanced interrogation techniques on Abu Zubaydah that wasn’t, or couldn’t have been, gained from regular tactics. In addition, I saw that using these alternative methods on other terrorists backfired on more than a few occasions — all of which are still classified. The short sightedness behind the use of these techniques ignored the unreliability of the methods, the nature of the threat, the mentality and modus operandi of the terrorists, and due process.

As it happens, I've never made arguments against torture based on whether it works or not.  I'm more in the Shep Smith camp: "We are America.  We. Do. Not. Fucking. Torture."  Still it's worth reminding everyone of exactly what happened with Abu Zubaydah, whose case helped touch off the institutionalization of torture under the Bush administration.  Ron Suskind told the story in The One Percent Doctrine, and Barton Gellman summarizes here:

Abu Zubaydah, his captors discovered, turned out to be mentally ill and nothing like the pivotal figure they supposed him to be....Abu Zubaydah also appeared to know nothing about terrorist operations; rather, he was al-Qaeda's go-to guy for minor logistics....And yet somehow, in a speech delivered two weeks later, President Bush portrayed Abu Zubaydah as "one of the top operatives plotting and planning death and destruction on the United States."

....Which brings us back to the unbalanced Abu Zubaydah. "I said he was important," Bush reportedly told Tenet at one of their daily meetings. "You're not going to let me lose face on this, are you?" "No sir, Mr. President," Tenet replied. Bush "was fixated on how to get Zubaydah to tell us the truth," Suskind writes, and he asked one briefer, "Do some of these harsh methods really work?" Interrogators did their best to find out, Suskind reports. They strapped Abu Zubaydah to a water-board, which reproduces the agony of drowning. They threatened him with certain death. They withheld medication. They bombarded him with deafening noise and harsh lights, depriving him of sleep. Under that duress, he began to speak of plots of every variety — against shopping malls, banks, supermarkets, water systems, nuclear plants, apartment buildings, the Brooklyn Bridge, the Statue of Liberty. With each new tale, "thousands of uniformed men and women raced in a panic to each...target." And so, Suskind writes, "the United States would torture a mentally disturbed man and then leap, screaming, at every word he uttered."

And so it began.

A War Against Harman?

| Thu Apr. 23, 2009 10:29 AM EDT

When the Jane Harman story first broke, I thought the most interesting question might very well be, Who leaked it?  The more I read about it, the more I'm beginning to think I was right.  Here's the latest from CQ:

Intelligence officials, angry that former Attorney General Alberto Gonzales had blocked an FBI investigation into Democratic Rep. Jane Harman's interactions with a suspected Israeli agent, tipped off Nancy Pelosi, the House Democratic leader, that Harman had been picked up on a court-ordered National Security Agency wiretap targeting the agent.

In doing so, the officials flouted an order by Gonzales not to inform Pelosi, three former national security officials said.

....A well-placed source said an official from the CIA had gone around Gonzales to inform Pelosi about Harman being picked up on the wiretap...."She knew. We made sure she knew," said one of the former officials, chuckling.

It's not at all clear that Harman did anything wrong here.  (Though it's not clear that she didn't either.)  What is clear is that the CIA is engaged in some pretty serious message sending against people they don't like.  My guess: I don't know how Harman is going to weather all this, but I don't think it's going to turn out well for the CIA.  They may have gone a couple of steps too far this time.

Down the Rabbit Hole

| Thu Apr. 23, 2009 10:15 AM EDT

From Matt Yglesias:

Dave Weigel notes that Senator Jon Cornyn (R-TX), in charge of helping GOP Senate candidates, is being surprisingly friendly with former Rep. Pat Toomey who’s mounting a challenge-from-the-right to Senator Arlen Specter (R-PA). Dave notes that “it becomes much, much harder to hold the seat if Specter loses.”

Matt goes on to say that this is pretty similar to what happened in the Virginia senate race last year and wonders why the GOP is essentially committing suicide.  It's a good question, and despite the general wankery involved it makes it almost irresistable to try to psychoanalyze the current Republican soul.  It's all just too weird otherwise.  Having gone crackers during the Bush years, and getting convincingly drubbed at the polls for it in 2006 and 2008, the almost unanimous reaction among conservatives has been to double down: focus even more on tax cuts to the exclusion of everything else; focus more on pure obstructionism; focus more on defending torture and insisting that it works great; focus more on gun nuttery even though Obama plainly has no intention of doing anything dramatic about guns; focus more on the absolute craziest pundits.  It's as if they're convinced, so deep in their souls, that America couldn't have really turned against them, that they can't even conceive of any strategy other than amping up the lunacy even further.

I dunno.  It's all crazy.  I can't even begin to understand it.

Negotiating With Pirates

| Thu Apr. 23, 2009 12:27 AM EDT

Treasury's last offer to Chrysler's bondholders was 15% of the total value of their debt.  The bondholders sneered.  They wanted 65%.  Today, Treasury upped their offer:

The Treasury now proposes that the banks and other lenders accept as payment 22% of the $6.9 billion they are owed plus a 5% equity stake in Chrysler, said several people familiar with the matter.

....The new government offer leaves the U.S. and Chrysler lenders at least $3 billion apart with one week left before an April 30 Treasury deadline to determine the auto maker's fate. The two sides are also far apart in how big an ownership stake the lenders would get in a restructured Chrysler.

Who will blink?  I'll predict that they end up at, oh, 30% and a 20% equity stake.  Put your guess in comments.  Whoever comes closest get an autographed 8x10 of Lee Iacocca.