Those Toxic Assets

Valuing mortgage-backed toxic assets is hard.  They've been sliced and diced and synthesized and swapped so thoroughly that by now no one knows quite what's in them or what they're worth.  So Tim Geithner has a plan to jump start the sale of these assets and try to get the market to value them.

Fair enough.  Maybe it will work, maybe it won't.  But Zach Carter wants to know why so much of Geithner's plan isn't aimed at toxic securities at all.  It's aimed at toxic loans, and those aren't nearly so hard to value.  Banks do it all the time.  So what's going on?

A bank that trades heavily in mortgage-backed securities is in trouble if the market for those assets dries up — and it has, and they are — but regular loans are different. So long as a bank intends to sit on them and collect the interest rather than sell them to another company, the government lets that bank use its own secret financial formula to determine the loan values. In short, banks have carte blanche to claim their assets are worth far more than they really are....

Given this long leash, banking executives have naturally inflated the book value of their mortgages. And even as more and more of their customers fail to make payments, bankers have proved reluctant to admit their hubris and take a hit on the balance sheet. Why is that? Well, the government says banks have to keep enough assets on hand to cover their behinds if things go south. So if a bank that has foolishly overextended itself admits it was overvaluing its loan assets all along, it will fall short of this critical regulatory requirement. And when that happens, under the "prompt corrective action" laws enacted after the savings and loan crisis of the 1980s, federal regulators are obliged to invoke the N-word: nationalization.

But Geithner's plan is voluntary, meaning that if the naughty banks don't like the price that hedge fund investors are offering, they can simply turn the deal down. And no bank on the precipice of nationalization is going to voluntarily sell loans to Wall Street for less than it has been claiming they're worth. Doing so would be corporate suicide. Instead, the only way a troubled bank will likely participate is if it receives an absurdly generous price for its dubious assets — a full-fledged bailout, in other words.

Carter's basic thesis here is that while the Geithner plan in general is likely to subsidize the price of toxic assets, thus propping up insolvent banks, this subsidy is at least fairly subtle — and maybe even defensible — in the case of complex mortgage-back securities.  But in the case of ordinary loans, the subsidy is blatant and entirely indefensible.  Its only purpose is to keep banks out of receivership by literally shoveling money into their laps.

My first thought when I read this was skepticism.  The Geithner plan has come under a ton of criticism, but this particular criticism is one I haven't really heard before.  That seems odd, since there are plenty of smart people who'd be happy to jump on this bandwagon if it's really as bad as Carter says.

So here's the deal: hopefully some smart critics of Geithner's plan will read this piece and talk about it.  Is there something missing here?  Or is Geithner's plan worse than even its critics think?

One outcome of the G-20 meeting (as I wrote yesterday) was an agreement to earmark as much as $1 trillion for developing countries, where the economic crisis is having a life-threatening impact. This figure is in line with what the United Nations estimates is needed to “buffer the blows of the global downturn on the most vulnerable.” 

In fact, $1 trillion is the least the rich countries owe to the poor, considering the chaos and suffering our own economic policies and practices have brought upon them. In part, the additional hardships now being experienced by the developing nations result from the recession trickling down in a way that wealth never seems to do. But there’s more to the story than this.

Some of the heightened suffering in the developing world can be traced back to the Clinton and Bush administrations, when a series of legislative and regulatory changes paved the way for rampant speculation on the commodities market. What happened next is explained in a report by the Minneapolis-based Institute for Agriculture and Trade Policy (IATP), the most comprehensive source of information on this subject.

Wall Street went to work and bundled together groups of commodities futures–everything from oil to copper to basic staples like corn, wheat, rice, and soybeans–into commodity index funds, similar to what you find in the mutual fund business. The subsequent explosion of buying and selling by a handful of Wall Street firms (led by Goldman Sachs and AIG) ran the prices of different commodities up and down with little relation to any actual market or to the so-called laws of supply and demand. (James Galbraith describes the process in detail here.) 

Under Stress

Frederick Cannon, an analyst with KBW, says that if unemployment hits 12% Wells Fargo is likely show over $100 billion in losses and will need to raise another $25 billion in capital.  Matt Yglesias comments:

This is why nothing you near from the financial sector about how all’s well should be taken too seriously. It’s true that given very bank-friendly monetary policy it’s easy for banks to run an operating profit. But most of these large banks are zombies — insolvent. They’re only able to run an operating profit because they’re not going out of business and being liquidated. And the reason they’re not being liquidated is government guarantees. It’s as if I had a profitable business selling cookies, except I didn’t actually have any cookies to sell and was just putting government-provided cookies in boxes, then bragging about how profitable my company is and how the government should stop hassling me about paying myself a bonus.

Without actually signing on to the cookie metaphor here, there's a pretty good chance this is right.  Without the combination of TARP and the extraordinary bundle of loan guarantees and liquidity tsunamis engineered by the Fed over the past couple of years, Wells Fargo might very well be out of business.  It's impossible to say this for sure, of course, just as it's impossible to say if unemployment is going to hit 12%.  But if it weren't for government intervention, it's a good bet that nearly every big bank in the United States would either be insolvent or so close as not to make any difference.  And instead of losing a few points of GDP, we'd be in another Great Depression.

Megan McArdle thinks that, from a libertarian perspective, maybe this is what should have happened.  Ben Bernanke may have saved the economy, but he only did it by intervening against the market, and worse, doing it in ways that the public and its elected representatives never would have supported if they'd had a say:

I think that the political process will hopelessly screw up the management of this crisis....But maybe The People, God bless them, deserve to screw up their economy if they want.

....On the other hand, do they have a right to screw things up for everyone else?  Should a populist 60% be allowed to plunge their neighbors deeper into crisis?  In the case of America, to plunge the whole world deeper into crisis?

The uncomfortable conclusion I'm coming to is that yes, they should.  Ben Bernanke should be hamstrung even though it's likely that this would make everyone worse off.  And people who advocate for ending the independence of the central bank should be willing to accept all that this entails:  inflationary monetary policy (the people love inflation!), bad and unpredictible banking policy, the collapse of the US economy.  I just wish I didn't have to go along for the ride.

Me too!  This may be the best argument I've ever read for not being either a libertarian or a pure small-d democrat.

With Tax Day coming up, and astroturf tea parties being organized around the country, a lot of people have been linking to polls showing that most Americans aren't, in fact, actually unhappy with the amount of income tax they have to pay.  Gallup, for example, reports that 61% of Americans think the amount they're paying this year is fair.  Or there's this one, also from Gallup, that asks directly whether the amount you're paying is too high or not:

Not bad!  49% think their income taxes are just fine or even a bit low.  Except for one thing: this chart shows exactly the opposite of what it seems.  Consider this: about 40-50% of Americans pay no federal income tax at all1.  That's zero dollars.  I think we can safely assume that these are the people who think their taxes are about right.  What this means, then, is that virtually every American who pays any income tax at all thinks they're paying too much.  There are various reasons why this might be so (a sense of unfairness regardless of amount paid, a fuzzy sense of how much they're paying in the first place, simple bloody-mindedness, etc.) but overall it's not exactly a testament to our collective willingness to fund the machinery of state.

1Of course, all of them pay other taxes.  There's more to life than just the income tax.  But this question was strictly about federal income tax, and it demonstrates that nearly everyone with a nonzero 1040 payment thinks they're paying too much.

Berkeley prof and former Labor Secretary Robert Reich echoes Jim Ridgeway. Both are deeply skeptical about claims that the economy will soon be back on its feet. Here's Reich:

But we're not at the beginning of the end. I'm not even sure we're at the end of the beginning. All of these pieces of upbeat news are connected by one fact: the flood of money the Fed has been releasing into the economy. Of course mortgage rates are declining, mortgage orginations are surging, and people and companies are borrowing more. So much money is sloshing around the economy that its price is bound to drop. And cheap money is bound to induce some borrowing. The real question is whether this means an economic turnaround. The answer is it doesn't...

Some of the big banks will claim to be profitable, but don't bank on it. Neither they nor anyone else knows what their assets are really worth. Besides, the big banks are sitting on over $500 billion over taxpayer equity and loans. Who knows how they're calculating profits? Most importantly, there's still a yawning gap between the economy's productive capacity and what it's now producing, and absolutely nothing will turn the economy around until that gap begins to close.

I don't have the economic expertise to know if all of this is right, but if my choice is between Reich and Larry Kudlow, who boosted the market right until it fell off a cliff and is starting to boost it again (by saying we've already hit bottom, recovery is around the corner, etc.), I know who I'm going to trust.

Waste Not, Want Not

Paul Krugman sez:

President Obama hails the fact that stimulus projects are coming in “ahead of schedule and under budget.” Yay — but boo.

Ahead of schedule is good. Under budget — well, ordinarily that’s a good thing. But the point of the stimulus is to increase spending! So if we don’t spend as much as expected, that’s less stimulus.

Technically, maybe this is right.  But it ignores the political side of things, which in this case is probably more important than a few billion dollars here and there.  Back in the 30s, the WPA struggled endlessly with attacks on "wastefulness," and those attacks were instrumental in keeping spending below the level it otherwise could have been.  Filling up bottles with money and paying people to dig them up may have been a nice metaphor for Keynes, but that's all it was: a metaphor.  In the real world, if we want to maintain public support for stimulus spending, it has to be seen as fair, efficient, and well managed.  Obama is playing this exactly right.

 

Unions and Inequality

The Employee Free Choice Act would make it easier for workers to organize new unions.  This would probably increase unionization in the United States, and unsurprisingly, corporate America is fighting EFCA like a pack of crazed weasels.  But today Lane Kenworthy points out something that's also been in the back of my mind during this whole debate: just how big a deal is EFCA, anyway?  Why the full court press against it?  Right now, private sector union density in the United States is around 8%, and if I had to guess I'd say that EFCA might — might! — increase that to 10% or so.  Maybe even 11%.  Is that really worth going nuclear over?

Kenworthy's own skepticism is mainly based on the chart on the right.  Sure, America has uniquely unfriendly labor laws these days, but outside of Scandinavia, where union membership is required to remain eligible for unemployment benefits, unionization has been dropping like a stone practically everywhere.  So just how much impact do different regulatory regimes have, anyway?

Not too much, probably, and Kenworthy suggests that the bigger issue isn't unionization per se, but laws that extend union wage agreements throughout an entire industry, even to firms that aren't unionized.  This practice is widespread in Europe but practically unknown here.  Kenworthy:

I would like to see EFCA become law. The ability of workers to bargain with management collectively rather than individually is, in my view, an important element of a just society, and these days the playing field is too heavily tilted in management’s favor. But I doubt EFCA will get us very far in reducing income inequality. Extension of union-management wage settlements would likely have a bigger impact, but at the moment that isn’t even part of the discussion.

And not likely to be, either.  We have a long way to go.

The Los Angeles Times

We were chatting about the LA Times during dinner on Sunday, and it turns out that pretty much everyone in my family wonders how much longer we're going to read it.  The conversation got started when I mentioned that I used to link to LAT stories fairly frequently on the blog, but that I find myself doing this very rarely anymore.  I deal almost exclusively with national and international news here, and in the past the Times frequently covered different stories, or had different takes on the same story, that provided a perspective the other national outlets didn't.  Today, not so much.  It's mostly just routine coverage of the standard set of major events.  You can read the whole paper in a few minutes.  And the op-ed page is so consistently dull that I barely even skim it these days.

What's more, our subscription costs $42 per month.  Marian pays the bills around here, so I hadn't seen a LAT bill for ages, and I was surprised the cost had gotten so high.  I've been reading the Times since I was five, but now I'm beginning to wonder how much longer I'm going to bother paying $500 per year for a paper that's such a shadow of its former self.

There's nothing new here, of course.  It's just part of the decline of American newspapers generally.  But suddenly it feels an awful lot more real around here.

Tuesday's Washington Post features a narrative of how Navy SEAL snipers dispatched three Somali pirates to free Richard Philips, their hostage and captain of the Maersk Alabama. In the hours following the operation, pundits hailed it as a master stroke, a surefire way (pun intended) to convince pirates that American vessels are not to be trifled with. Are they right? Certainly not. Yes, hostage-taking is a no-no and must be dealt with aggressively, but in a desperate and anarchic place like Somalia, it's unlikely that the deaths of three low-level criminals are going to do anything at all to alter the big picture--except, of course, to make it bloodier for everyone involved.

Until now, the motivation of Somali pirates has been clear: they want money. But shooting pirates who hitherto had shown little desire to kill their captives so much as ransom them off will likely change their calculations. Already one pirate leader has said that the next time he takes a US-flagged ship, the crew is as good as dead. That doesn't sound like a man cowering in the face of American power.

From conservative Bernard Goldberg, talking to Sean Hannity about the right's obsessive effort to find fault with Barack Obama's handling of the Somali pirate affair:

"I'm sorry, Sean....but we have to stop going out of our way to find fault with every single thing he does.... If something bad happened here, and thank God it didn't, but if something bad happened here, I guarantee you, I'll tell you who would have been leading the crusade against him: you."

Jeez, even Bernard Goldberg sees this?  Wingers take notice.