Kevin Drum - September 2009

Wall Street's Latest Trick

| Wed Sep. 30, 2009 10:44 PM PDT

As you probably know by now (you have been paying attention, haven't you?), banks are required to retain a certain amount of capital on their books.  The capital is there to keep them solvent even if their assets lose value, so the amount they're required to have depends on how risky their assets are.  If they have, say, a bunch of crummy C-rated securities on their books, they have to maintain a full load of capital to back them up.  But A-rated securities are less likely to lose value, so for those they only have to maintain 50% of the normal capital levels.  And for AAA securities, they can get by with only 20% or less.  After all, AAA securities are pretty unlikely to lose value.  Right?

This was one of the reasons behind the CDO frenzy of the past few years.  If you slice and dice a bundle of securities so that most of them are AAA-rated, then you can reduce the capital you need to back them up, which frees up that capital for other uses.

But then everything came crashing down, the ratings on those bundles tumbled, and suddenly banks had to pony up more capital to back them up.  What to do?  Answer: slice 'em and dice 'em all over again.  Welcome to the re-remic:

The way it works is that insurers and banks that hold battered securities on their books have Wall Street firms separate the good from the bad. The good mortgages are bundled together and create a security designed to get a higher rating. The weaker securities get low ratings.

....A hypothetical example cited in research by Barclays Capital said that a $100 million asset that required $2 million in capital at a triple-A rating may require $35 million if downgraded to double-B-minus. At triple-C, the capital requirement might rise to 100%, or $100 million.

In a re-remic, three-fourths of the same asset may regain a triple-A rating, requiring just $1.5 million in capital, Barclays said. The remaining one-quarter may require 100% capital, but the total capital requirement would fall to $26.5 million.

...."There is $350 billion to $400 billion in market value of securities with no natural buyer due to their rating," Barclays said in a June report. "The re-remic market provides a way out of this gridlock by creating new AAA securities, which are likely to be viewed as attractively priced."

Shiny new AAA securities!  Hooray!  And there's more!  Ratings for re-remics come from the same ratings agencies that bollixed up the original ratings.  And investment banks pocket fat fees for performing the financial alchemy.  What could possibly go wrong?

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Revisiting Banker Pay

| Wed Sep. 30, 2009 9:24 PM PDT

Is banker compensation one of the root causes of last year's financial meltdown?  The Epicurean Dealmaker says no.  A lot of things changed when investment banks evolved from moderate-size partnerships into gigantic public companies, but pay wasn't one of them:

Large public banks did retain much of the partnership compensation model, which deferred ever more of a banker's pay the higher up he got and the more he made. But [...] deferred pay lost its effectiveness as a distributed risk management tool. As investment banks grew ever larger and more complex, each banker had less and less impact on the overall results and health of his bank, almost no matter how much he made.

....Notwithstanding what legions of indignant and self-righteous commentators contend, the incentive system currently in place operates exactly as most of them propose: a large portion of banker pay is deferred for years and is tightly tied to the overall health and success of the firm. Bankers are not incentivized to print huge risky trades and run away as soon as they collect their bonus at the end of the year. In fact, they are more closely tied to the long-term health of the firm and its stock price than any other stakeholder. They just can't do anything about it. Unfortunately for them and for us, such a system does not seem to have prevented anything.

I basically believe this.  The problem wasn't so much that bankers didn't care about long-term results as it was that they never realized they were taking on so much risk in the first place.  They thought they had safely hedged it all away.  Reining in compensation may still be a good idea, but it's just a backstop.  The real fixes to the system are deeper and more fundamental.

Senate Climate Bill Arrives

| Wed Sep. 30, 2009 6:17 PM PDT

Brad Plumer has a very good brief roundup of the Senate climate bill that Barbara Boxer and John Kerry introduced today in the Senate.  In one sense the details of the bill don't matter too much: it still has to get reconciled with other Senate bills and then go into conference to get reconciled with the Waxman-Markey bill in the House, and pretty much everything is going to be thoroughly sanded down before that process finishes up.  Still, it's interesting to at least see the general direction they're pushing toward: basically a little more ambitious than Waxman-Markey but with a few technical adjustments that wonks should like.  The full post is here.  Kate Sheppard has more here.

From the Annals of Great Punditry

| Wed Sep. 30, 2009 4:07 PM PDT

Jim Henley explains counterinsurgency in terms even a U.S. senator can understand:

In a counterinsurgency strategy, America hangs around a foreign country for years and years, occasionally killing people who live there, while pretending it’s for their own good. This takes a lot of people because the military, and the civilian parts of the government that control the military, are very specialized. You need people to do the hanging around, people to do the occasional killing of people that live there, and even more people to do the pretending. As you might imagine, pretending to foreigners that killing them is for their own good is hard! Not just anyone can pull that off with a straight face, and you need a lot of people who can.

This is part of Jim's entry in the Washington Post's "America's Next Great Pundit" contest — a sort of reality-show-in-print where ten promising entrants get chosen and are then kicked off one by one as they compete with each other over the course of three weeks1.  Think Project Runway for the opinionated but poorly dressed.  It's an idea so mind-blowingly dimwitted that it could only have come from the same people who brought us Mouthpiece Theater.

Still, every cloud has its silver lining, and mocking the Posties by writing amusing entries for their contest is one of them.  Get cracking, bloggers.  Jim has set the bar high.  I expect great things.

1To make this gruesome spectacle even worse, the winner gets to write 13 op-ed pieces but isn't even guaranteed that the Post will run them.  In fact, the winner isn't even guaranteed that the columns will be run online.  What the hell kind of contest is this?2

2Though I admit it might have possibilities if the Post made their current writers compete, with the loser getting a final 13 columns before being booted off the op-ed page for good.  I'd certainly pay to watch the championship round, where Richard Cohen and Robert Samuelson battle each other desperately to avoid the title of America's Next Laid Off Journalist.

Chart of the Day

| Wed Sep. 30, 2009 3:08 PM PDT

Longtime political analyst Charlie Cook thinks there's a good chance that Democrats could lose control of Congress in next year's midterm elections.  Independent voters, he says, are "viscerally" worried about the deficit and hyperactive government.

I wonder.  The deficit is a pretty abstract thing, and "hyperactive government" doesn't necessarily mean healthcare and the stimulus bill.  When it comes to voter discontent, I think I'd put my money elsewhere.  First, as the chart below, from the Economic Policy Institute, shows, people are pretty strongly convinced that the finance industry has gotten huge amounts of help from Obama and Congress, while ordinary people have gotten squat.  As Ezra Klein says, "The economic logic behind preserving the financial sector was bulletproof. But the electorate is not composed of economists. And all they know is that the banks got a lot of money, and this is the worst recession in memory."  In other words, "hyperactive" might be a lot more acceptable if all that activity were aimed somewhere other than Wall Street.

Second, there's jobs.  John Judis tells the story here: if you want to be a popular president, you'd better be able to demonstrate some job growth.  End of story.  Obama still has some time on that front, but probably not very much.  If the economy is starting to recover by next spring, he and the Democratic Party will probably be in decent shape when the midterms roll around.  If not, not.

Catblogging News

| Wed Sep. 30, 2009 12:27 PM PDT

Attention cat fans: We recently redesigned our thrice-weekly email newsletter into three separate newsletters.  One of those newsletters is based around yours truly, and you know what that means: catblogging.  Or, I guess, catlettering.

Or something.  In any case, we've decided that once a week is plenty of exposure for Inkblot and Domino, so we're soliciting photos of guest cats to appear in the newsletter.  If you want some temporary stardom for your adorable furball, just email a photo to:

cats@motherjones.com

Include a couple of sentences of description (names, ages, what they're up to, favorite tricks, whatever else you feel like) and we'll select one each week.  Dogs are welcome too!  And if you want to sign up to receive the newsletter, you can do it here.  Sign up for one, two, or all three.

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Quote of the Day

| Wed Sep. 30, 2009 11:07 AM PDT

From an "industry expert" explaining why Sarah Palin is having trouble booking speeches at $100,000 a pop:

The big lecture buyers in the US are paralyzed with fear about booking her, basically because they think she is a blithering idiot.

I don't understand this.  Since when is being a blithering idiot any kind of drawback for a politician on the lecture circuit?

Russia-Georgia Postmortem

| Wed Sep. 30, 2009 10:51 AM PDT

A long-awaited EU report on the causes of the Russia-Georgia war last year has finally been released.  The New York Times reports the reaction from both Russia and Georgia:

Vladimir Chizhov, Russia’s envoy to the European Union, told reporters in Brussels that the central finding concerned Aug. 7, and that he hoped it would prompt foreign leaders to withdraw their support for Georgia’s president, Mikheil Saakashvili. The report provided “an unequivocal answer to the main question of who started the war, and it says squarely that it was Georgian massive shelling and an artillery attack which marked the beginning of large-scale hostilities.”

In Tbilisi, the Georgian capital, Temuri Yakobashvili, the minister of reintegration, said the report exonerated Georgia because it emphasized the long-term buildup of tensions. “This report will kill the Russians’ spin that it was Georgia who started the war, and it will finish all these notions and speculations about who started the war,” Mr. Yakobashvili said. “The first line of this report states that the war didn’t start on Aug. 7.”

That's my kind of report: one that resolves nothing.  But in fairness, how could it?  Its conclusions were pretty obvious to everyone aside from hardened ideologues long ago: Russia spent years trying to goad Georgia into war, and in August of last year Georgia finally took the bait.  In a situation like that, who you blame is almost entirely a matter of who you feel like blaming.

So there's no knockout blow here.  Still, I give it to Russia on points.  Georgia was hardly innocent in all this, but Russia's goals were pretty clear all along, and they obviously kept escalating tensions until they got the reaction they wanted.  They deserve all the condemnation they got for that.

How Crazy Are We?

| Wed Sep. 30, 2009 9:47 AM PDT

Do baseball players make a greater number of spectacular plays than they did 30 years ago?  Of course not.  It just seems like it because ESPN packages them all up for us every evening on SportsCenter.  These days, we get to see every spectacular play, not just the ones in the games we happen to watch.

David Post calls this the ESPN Effect and wonders if it applies to politics:

All I hear from my left-leaning friends these days is how crazy people on the right are becoming, and all all I hear from my right-leaning friends is how crazy people on the left are becoming, and everyone, on both sides, seems very eager to provide evidence of the utter lunacy of those on the other side.  “Look how crazy they’re becoming over there, on the other side!” is becoming something of a dominant trope, on left and right.  It is true that we’re seeing more crazy people doing crazy things on the other side (whichever side that may be, for you) coming across our eyeballs these days.   But that’s all filtered reality; it bears no more relationship to reality than the Sportscenter highlights bear to the game of baseball.

My very, very strong suspicion is that there has never been a time when there weren’t truly crazy people on all sides of the political spectrum doing their truly crazy things. Maybe 1% or so, or even 0.1% — which is a very large number, when you’re talking about a population of, say, 100 million.  They didn’t get through the filters much in the Old Days, but they do now.  All this talk about how extreme “the debate” is becoming — how, exactly, does anyone get a bead on what “the debate” really is?  In reality?

Is he right?  Are Fox News and Twitter and the blogosphere and talk radio the collective SportsCenter of politics?  Or are people really crazier than they used to be?

Or is it even worse than that?  SportsCenter mostly just records what happens.  (It might also play an active role in producing more spectacular plays because players are eager to make the night's highlight reel, but that's a small effect.)  But in politics it's worse.  Not only might people act crazier in order to get on the news, but seeing all those crazy people might drive the rest of us crazier too.  So maybe at first this was just the ESPN Effect, but over time it became a vicious circle and now there really are more crazy people around.  I sure feel crazier these days.  How about you?

Not Out of the Woods Yet

| Wed Sep. 30, 2009 8:51 AM PDT

Housing prices were up slightly in July, but there's also this:

The number of homes lost to foreclosures rose about 17 percent in the second quarter of this year despite the launch of an extensive government program aimed at helping borrowers save their home, according to government data released Wednesday.

....The report also reflected the risks still posed by hundreds of thousands of risky home loans known as option adjustable-rate mortgages, which reset to significantly higher payments. With these "option ARMs," also known as pick-a-pay loans, a borrower chooses how much to pay each month, often less than the interest due. But the payments on these mortgages eventually rise significantly, putting the borrower at risk of losing the home.

So: rising foreclosures, another wave of ARM resets, the summer home buying season is over, and the $8,000 federal tax credit for first-time home buyers is about to expire.  Buckle your seatbelts.