Kevin Drum - March 2009

Chart of the Day - 2.26.2009

| Thu Mar. 26, 2009 12:32 PM EDT
From Brad Setser, who notes that "much of the expansion of global trade over the last decade...rested on a weak foundation."  In particular, countries like China and Japan and Germany exported too much and countries like the United States and Great Britain consumed too much.  Since this needs to change in the long term, you'd like to see the surplus countries running bigger stimulus programs than the deficit countries, but that's not what's happening:

Big external deficit countries like the US and the UK are going to run fiscal deficits of between 8 and 10% of their GDPs, while the deficit in surplus countries like China and Germany remains between 3 and 4% of their GDPs.

....All in all, fiscal policy clearly is being used to support global growth, as it should be. The fall in exports globally in February leaves no doubt that there is an enormous shortfall of demand, relative to the world’s capacity to produce. But the global decomposition of the stimulus doesn’t suggest that it will do much to support “rebalancing.” The surplus counties generally aren’t leading the stimulus league tables.

Something more for Obama and Geithner to talk about at the upcoming G20 meeting.

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The Geithner Put

| Thu Mar. 26, 2009 11:55 AM EDT
Tim Geithner's toxic waste plan allows investors who want to bid on distressed assets to use Treasury matching funds plus FDIC non-recourse loans to lever up their investments.  The combined leverage is about 12:1, so a hedge fund that wants to buy $100 worth of toxic assets would end up investing about $7 of its own money.  What's more, since the FDIC loan is non-recourse, it means that if the investment goes bad the hedge fund doesn't have to pay back the loan.  It only loses its original $7.

For investors, this is a great deal.  If the investment does well, they make lots of money.  If it tanks, they can only lose $7.  The upshot is that they can afford to bid more than they normally would since their losses are capped.  But how much more?

Estimate 1 comes from Paul Krugman, who suggests they'll overvalue the assets by about 30%. Estimate 2 comes from Nemo, who suggests it could be as high as 68%.  Estimate 3 comes from Rortybomb, who figures something on the order of 20% or so.  Estimate 4 comes from Wagster, who thinks that in real life the assets will be overvalued by less than 10%.

So who's right?  Beats me.  To be honest, I don't even completely understand the four posts I just linked to.  But it's a pretty important question that some financial engineering types should spend some more time on.  If, in the end, the toxic waste gets overvalued by 10% or less, that's not too big a deal.  If it's overvalued by 50%, it's a disaster.  Not only will taxpayers likely lose a lot of money, but no one outside the auction will have any faith in the prices.  And since price discovery is one of the goals of Geithner's plan, lack of faith would be disturbing indeed.

Anyway, I just thought I'd toss this out to stimulate discussion.  I can't really participate since I don't have the financial engineering background to have an opinion, but plenty of other people do.  Let's hear from them.

The World's Dumbest Deliberative Body

| Thu Mar. 26, 2009 10:58 AM EDT
Midway through the second period of our global economic collapse, how's the home team doing?  Conventional wisdom says the Wall Street crowd is whiny and petulant.  President Obama is well-meaning but maybe a little too cautious. Europe is too disorganized and too eager to shift the blame instead of taking action.

And then....there's the Congress of the United States.  Michelle Bachmann, taking a page out of the Bircher playbook circa 1963, wants to make sure the Chinese don't foist a one-world currency on us while we're down.  Don Manzullo is so relentlessly clueless that even the normally imperturbable Ben Bernanke can't pretend to understand him.  And LA Times columnist Michael Hiltzik is watching television:

On C-SPAN I found the perfect thing: The House Financial Services Committee was grilling Treasury Secretary Timothy F. Geithner and Federal Reserve Chairman Ben S. Bernanke about the AIG rescue.

Rep. Jeb Hensarling (R-Texas) grumbled about "socialized medicine," as though he had wandered into the wrong committee room. Rep. Maxine Waters (D-Los Angeles) obsessed about the "small group of Wall Street types who are making decisions," especially Goldman Sachs & Co., which she described in terms James Bond uses to describe SPECTRE.

Their colleagues, meanwhile, emitted what the writer David Foster Wallace might have described as "recombinant strings of dead cliches" about undeserved bonus payments, U.S. taxpayer money paying off foreign banks and the mushrooming of that new American art form, the bailout.

They showed, in sum, that they have no understanding of the roots or remedies for the financial crisis, and — more to the point — no great desire to understand. They left me convinced that if we are to have a productive investigation of the financial meltdown, it must be taken away from posturing lawmakers.

Hiltzik's solution is a fantasy lineup of investigators to shove Congress out of the way and figure out what really happened.  A friend who works on Wall Street ended an email cautiously supportive of Geithner's toxic waste plan with this: "One last thought — could we possibly send Congress into recessuntil this is all over? They are killing us...."  My solution is — what?  I don't have one.  Enjoy the show, folks.

Regulation Redux

| Thu Mar. 26, 2009 1:12 AM EDT
Slowly but surely, the Obama administration is rolling out its vision for reformed financial regulation:

Treasury Secretary Timothy Geithner will call Thursday for changes in how the government oversees risk-taking in financial markets, pushing for tougher rules on how big companies manage their finances as well as tighter controls on some hedge funds and money-market mutual funds.

....The new rules will likely require financial institutions to hold more capital as a buffer against losses and will bolster risk-management standards. All told, the proposals would mean significant expansions of power for the Treasury, Federal Reserve and other regulators.

This is all well and good, though I'm still a little hazy on what underlying principles are guiding all this stuff.  That aside, though, I wonder how much good this will do all by itself.  After all, the problem during the housing bubble wasn't a lack of regulatory authority, it was a lack of regulatory will.  The Fed could have insisted on stiffer mortgage lending standards, but it didn't.  Alan Greenspan could have pushed for higher interest rates to slow down the rate of credit expansion, but he didn't.  Congress and the president could have raised taxes and run budget surpluses, but they didn't. The SEC could have tightened capital adequacy standards for investment banks, but instead it loosened them.

A more sensible set of financial regulations is long overdue.  But the bigger problem is ensuring that regulations actually get used, even when it means slowing down an economic expansion and spoiling everyone's fun midway through the party.  I'm not quite sure how to deal with that — I'm not quite sure it's even possible to deal with that — but it's something we should be addressing if we're even halfway serious about this stuff.

Getting to Yes

| Wed Mar. 25, 2009 8:24 PM EDT
I was browsing through The Corner today and came across David Freddoso lauding the House Republicans' new housing plan.  You will be non-shocked to learn that it consists of a bunch of new tax breaks, including — naturally — elimination of the capital gains tax on investment property.  Yawn.

But wait!  It turns out that the House GOP's plan has inspired some surprising comity between right and left: they both hate it.  Jerry Taylor gives the conservative rationale for opposing the plan:

I know that there is plenty of political capital to be gained by providing handouts to middle-class homeowners and little political capital in removing the same. But a political party that ostensibly stands for free markets and limited government should not be in the business of underwriting or subsidizing private investments in anything unless we can find some plausible market failure in need of correction (and perhaps not even then).

Matt Yglesias provides the lefty view of why this plan sucks:

Preferential subsidies for investment in housing lead people to, on average, consume more housing and less stuff-that-isn’t-housing than they otherwise would. In other words, bigger houses instead of fancier clothes. This, in turn, has a substantial negative impact on the economy. Larger houses cost more to heat and cool, and larger houses lead to longer commutes. We shouldn’t stop people from buying big houses if that’s what they want to do, but it’s quite harmful to be specifically encouraging them to invest their resources in this way quite independently from the financial crisis. Reduce the tax-side subsidies to homeownership and we’d have somewhat faster economic growth, somewhat more public revenue, and a somewhat cleaner environment.

So: get rid of housing subsidies and we'd have both a freer market and bigger government.  It's a win-win!  Except for anyone who actually voted for it, of course.  But at least we get this bonus factoidish wonkery from Taylor:

For what it is worth, Switzerland is the only major country I am aware of that does not implicitly or explicitly subsidize housing in any substantial manner. Home ownership rates are somewhere around 35% as a consequence. But no one thinks of Switzerland as poor or deprived somehow because it does not receive the positive externalities allegedly associated with private home ownership.

I suppose not.  Still, it didn't stop the Swiss from buying our crappy mortgage-backed securities, did it?

The Repeal of Glass-Steagall

| Wed Mar. 25, 2009 3:56 PM EDT
Jason Zengerle points us to this allegedly prescient quote from 1999 in the New York Times:

"I think we will look back in 10 years' time and say we should not have done this but we did because we forgot the lessons of the past, and that that which is true in the 1930's is true in 2010," said Senator Byron L. Dorgan, Democrat of North Dakota. "I wasn't around during the 1930's or the debate over Glass-Steagall. But I was here in the early 1980's when it was decided to allow the expansion of savings and loans. We have now decided in the name of modernization to forget the lessons of the past, of safety and of soundness."

I understand the outcry over passage of the Commodity Futures Modernization Act, which happened a year later in 2000.  Aside from opening the infamous "Enron loophole," it also prevented the regulation of credit default swaps, something that might have come in handy over the past few years.

But despite a strong preconceived distaste for any legislation sponsored by Phil Gramm, I'm still a little mystified over the impact that repeal of Glass-Steagall is supposed to have had on our current financial meltdown.  Standalone investment banks have suffered every bit as much as the big conglomerates — maybe even more — and it's not clear that combining commercial and investment banking under one roof had any effect one way or the other on the housing and credit bubble that drove the collapse.  AIG would have gotten into the CDS business with or without Glass-Steagall, and crappy lending standards were the order of the day at Countrywide and IndyMac just as much as they were at Citigroup and Bank of America.

On a broad note, I suppose you can argue that repeal of Glass-Steagall encouraged the growth of ever more too-big-to-fail financial institutions, and there might be something to that.  On the other hand, I don't think Travelers Insurance has contributed anything to Citi's troubles, so it's not clear that crude size is really the culprit here.  There are big banks all over the world, not just here in the post-Glass-Steagall United States.

Maybe someone would like to take a crack at making the case for the malign role played by repeal of Glass-Steagall.  Even better, how about the case for reinstating it?  I'd certainly be interested in hearing it.

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Just How Bad Will It Get?

| Wed Mar. 25, 2009 1:30 PM EDT
Via Brad DeLong, Menzie Chinn compares the CBO's February and March projections of economic disaster and notes that they've become considerably more disastrous in only a month:

Notice that the no-stimulus counterfactual output gap and unemployment rates are noticeably worse now than only a month ago (see this post). For 2010, the February counterfactual was -6.3% of GDP, now around -10%; the February counterfactual for 2010 was 8.7% unemployment, now it's nearly 11% (I'm eyeballing the current counterfactuals off of Figures 2-1 and 2-2)....My guess is that that "massive" stimulus is going to look a lot less "massive" given the severity and duration of this recession.

A month ago CBO estimated that unemployment would hit 8.7% in the absence of a stimulus package.  Now they think it would have been around 10.5%.  With the stimulus, they think it will top out at a little over 9%.

Healthcare Reform, Insurance Industry Style

| Wed Mar. 25, 2009 12:52 PM EDT
Over at the Wonk Room, Igor Volsky notes that AHIP, a healthcare insurance trade group, has finally announced its position on healthcare reform:

Specifically, by enacting an effective, enforceable requirement that all Americans assume responsibility to obtain and maintain health insurance, we believe that we could guarantee issue coverage with no pre-existing condition exclusions and phase out the practice of varying premiums based on health status in the individual market. While we support transitioning to a reformed system in which health-status-based rating is no longer used, rating flexibility based on age, geography, family size, and benefit design is needed to maintain affordability.

Volsky is pretty unimpressed, but I guess I feel slightly more generous toward this proposal than he does.  If AHIP is serious, this represents a philosophical concession that's worth having.  Unfortunately, the devil is in the details.

AHIP says that in return for making insurance mandatory, the industry is willing to guarantee coverage to everyone, regardless of health status.  But check out that last sentence, which is a loophole big enough to drive an EMT ambulance through.

I'll grant them family size as a reasonable criteria for premium flexibility.  Obviously a big family should be charged more than a single person.  But age?  Health issues rise rapidly with advancing years, so it would be fairly easy to avoid the worst risks by simply making premiums rise dramatically after age 50.  Geography?  Everyone knows that poor people tend to have the worst health, and obviously they cluster in low-income areas.  Benefit design?  Every health insurance company understands where the costs are in the system.  If plans with decent coverage of expensive chronic conditions like diabetes are priced out of reach, then nobody will buy them even if, technically, the premium isn't based on health status.

Now, some of this is simply fodder for regulation.  Maybe you can set minimum standards for plan benefits, or limits on how fast premiums can increase with age. But as Volsky points out, AHIP's position today isn't really very different from its position in 1992, which it abandoned at the first sign of political opportunity.  Liberals, including me, have a fond hope that the political scene is different today than it was in 1992, which might keep AHIP from bolting, but recent events suggest that Republicans are pretty likely to adopt the same "Just Say No" strategy this year that they did during the Clinton administration.  It's possible that the political scene hasn't changed as much as we think.

Bottom line: AHIP's statement is better than no statement.  It's progress of a sort, especially if they're serious about it and willing to accept reasonable regulations on how it gets implemented.  We'll see.

Suckitude Update

| Wed Mar. 25, 2009 11:50 AM EDT
Man, does it suck working on a 1024x768 screen with a 1360x768 monitor.  It's like staring at a Dali painting all day long.  I've got a new Acer on its way, though, and I even paid a boatload extra for 2-day delivery.  Now I'm wishing I'd paid a yachtload more for overnight.  Sigh.

Quote of the Day - 3.25.09

| Wed Mar. 25, 2009 11:36 AM EDT
From Bank of America CEO Ken Lewis, on the $45 billion in taxpayer capital that they accepted last year:

"As soon as we think the markets normalize, we would very seriously like to pay it all back."

Granted, Lewis left himself the escape hatch of waiting until "markets normalize" to pay back this capital, but even so this statement means one of three things: (1) he's lying, (2) he's crazy, or (3) BofA really is in fairly decent shape.  I report, you decide.