Kevin Drum

Maintaining the Banks

| Sun Mar. 8, 2009 8:07 PM EDT
Atrios sez:

I know I'll make this point a billion times before this is all over, but there's a difference between thinking that well run financial intermediaries (which, in theory, competition will create) are necessary for a modern economy and believing that the semi-oligopolistic system of financial intermediaries which have demonstrated beyond all reasonable doubt that they're at best incompetent and most likely some combination of incompetent and incredibly corrupt should be maintained at a cost of hundreds of billions of dollars (optimistically) in taxpayer money.

I don't really get this.  Aside from the nitpicky point that the United States actually has one of the least oligopolistic banking sectors in the developed world, what's being argued here?  That we should let the existing banks fail?  That we should temporarily nationalize them?  Which ones?  And if we do, how should we treat all their creditors and counterparties?  That's the big question (not whether shareholders should get wiped out — of course they should, but they're mostly wiped out already), and it doesn't go away just because we nationalize TitanoBank instead of shoveling cash down its gaping maw in return for preferred shares.  In fact, it makes the question even more salient, since in a post-nationalization world Uncle Sam would be legally on the hook for all those claims.

As for the cost of all this, we might as well suck it up.  We're way beyond the point of thinking we'll get out of this mess without spending a trainload of taxpayer dough one way or another.  This debacle is going to cost us hundreds of billions of dollars no matter what we do.

And when it's over, guess what?  Pretty much all the same people will be in charge.  A few senior executives will be out of jobs, but that's about it.  And the ones who replace them won't be much different.  The fact is that these people did what they did not because they're stupid, but because the system practically begged them to act the way they did.  That's what's broken, and fixing it depends mostly on what kind of new financial regulations we put in place going forward.  I guess we're still in firefighting mode and don't have time to address that right at the moment, but I'd sure like to start hearing more about it sometime soon.  In the long run, figuring out an effective way to regulate leverage, wherever and however it appears, is probably a lot more important than deciding which bureaucratic solution we should use to clean up the corpses currently littering the battlefield.

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Let God Sort 'Em Out

| Sun Mar. 8, 2009 6:38 PM EDT
Richard Shelby (R–AL), the ranking minority member of the Senate Banking Committee, doesn't want to nationalize ailing big banks like Citigroup.  He thinks we should just shut them down, like we do with smaller banks.  Josh Marshall comments:

Something like this is both heartening and insanely distressing at the same time because what exactly does he think people are talking about when people talk about nationalization? They're talking about some form of FDIC-like takeover, though probably one that would take longer and be much more complicated since you simply can't find another bank that is going to buy or most of its assets at some knock-down price over the weekend — certainly not in the present climate. You either clean the bank up (which would require what amounts to a de facto bankruptcy proceeding) and sell it back into private hands or break it up and sell it off in individual pieces — likely some combination of the two.

This is worth unpacking a little bit.  The FDIC is not set up to run distressed banks.  It's set up to either (a) sell them off immediately to another bank or (b) hold onto them just long enough to liquidate everything.  And the FDIC is really, really not set up to run a big money center bank like Citigroup, which is both a normal depository institution plus a fantastic agglomeration of other financial entities, including derivatives underwriting, asset management, private equity portfolios, a staggering variety of trading operations spread all over the world, and one of the world’s biggest insurance companies.  This is not FDIC territory.

Selling off Citigroup is also not an option.  Who's big enough to buy them?  Nobody.  What's more, their stock is currently selling for about buck a share.  There are thousands of rich investors who could buy the whole place, lock stock and barrel, anytime they wanted to.  But no one wants to.  There's a reason, after all, that huge chunks of the stuff on Citi's balance sheet is called toxic waste.

So: the FDIC can't run Citigroup and nobody in their right mind wants to buy them.  On the other hand, with Citi's stock hovering around a dollar, their shareholders have already lost nearly their entire investment.  Allowing Citi to fail would hardly cause them any more damage than they've already suffered.  So why not just let them go under, as Shelby wants?

The answer is that we could do this.  This was the gamble Ben Bernanke and Henry Paulson took last September when they allowed Lehman Brothers to fail — dammit, it's time to enforce some market discipline on these guys! — and their gamble failed spectacularly.  The global financial system nearly collapsed even though Lehman wasn't all that big.

But hey — maybe Lehman taught everyone a lesson.  Maybe all of Citgroup's creditors and counterparties have already priced in the possibility of default.  You never know.  And maybe if Citigroup fails, and they all end up with a bunch of worthless notes, they'll just shrug and go about their business.

Then again, maybe not.  Maybe Citigroup really is too big to fail.  And maybe if they fail, and all their creditors and noteholders and counterparties are stiffed, maybe they'll all fail too.  And then all of their creditors and noteholders and counterparties will also fail.  Etc.  And then it's back to the dark ages for all of us.

Which is it?  I don't know.  All I can say is: Richard Shelby has way bigger balls than I do.  Call me a wuss if you must, but I'm really not willing to gamble on nuclear meltdown, especially since I think the odds are pretty strongly in favor of Citigroup having the ability to take all the rest of us down with them if they collapse.  Shelby, however, the ranking Republican member of the Senate Banking Committee, guardian of the nation's financial health, is apparently willing to just say "fuck it," roll the dice, and hope against hope for snake eyes.

Of course, this is precisely the kind of imbecilic, high-stakes gambling that got us into this mess in the first place.  Maybe Shelby ought to think twice before deciding that the hair of the dog might get us out.

Quote of the Day - 03.08.09

| Sun Mar. 8, 2009 5:13 PM EDT
From Michael Lewis, writing about the epic implosion of the Icelandic banking bubble:

After three days in Reykjavík, I receive, more or less out of the blue, two phone calls. The first is from a producer of a leading current-events TV show. All of Iceland watches her show, she says, then asks if I’d come on and be interviewed. “About what?” I ask. “We’d like you to explain our financial crisis,” she says. “I’ve only been here three days!” I say. It doesn’t matter, she says, as no one in Iceland understands what’s happened. They’d enjoy hearing someone try to explain it, even if that person didn’t have any idea what he was talking about — which goes to show, I suppose, that not everything in Iceland is different from other places.

If you haven't already, you should read the rest.  Or, at the very least, search down to this passage and then read from there.

Oh, and one other thing: this is not actually a story about financial collape.  It's a story about gender roles.  Consider yourself forewarned.

Movie vs. Maxi Series

| Sun Mar. 8, 2009 1:41 PM EDT
Matt Yglesias saw Watchmen last night and says:

All-in-all, I’m torn between immense admiration for the film and regret that it was done as a movie at all. In retrospect, I kind of wish we’d instead gotten a 12 part HBO maxi-series that was really uncompromising and didn’t leave anything out.

You could think that about a lot of movies, couldn't you? And I have! Which is a little odd since I don't subscribe to HBO and wouldn't get to see any of these maxi-series ideas if they actually got made.

Watchmen, of course, would present a challenge here. At least I think it would. The problem is that the original chapters are pretty self-contained and it really would make sense to keep them that way. So, one episode per chapter. Unfortunately, that would require a fair amount of padding. Most of the chapters just don't have enough substance to take up an hour of screen time.

So a movie it is. I haven't seen it yet, so I have no comment on how it turned out. But I'm looking forward to it even though the reviews so far have been pretty lukewarm. I don't think I'll be buying a Rorschach doll any time soon, though.

Journalistic Malpractice

| Sun Mar. 8, 2009 12:35 PM EDT
The Washington Post has a big front-page story today about a sudden spike in fraudulent FHA loan activity.  Here's the nut:

With the surge in new [FHA] loans, however, comes a new threat. Many borrowers are defaulting as quickly as they take out the loans....Many industry experts attribute the jump in these instant defaults to factors that include the weak economy, lax scrutiny of prospective borrowers and most notably, foul play among unscrupulous lenders looking to make a quick buck.

If a loan "is going into default immediately, it clearly suggests impropriety and fraudulent activity," said Kenneth Donohue, the inspector general of the Department of Housing and Urban Development, which includes the FHA.

....More than 9,200 of the loans insured by the FHA in the past two years have gone into default after no or only one payment, according to the Post analysis. The pace of these instant defaults has tripled in one year. By last fall, more than two dozen FHA home loans on average were defaulting this way every day, seven days a week.

So is fraudulent activity up?  That's hard to say because the Post story goes to considerable lengths to leave out the one obvious stat that would tell us: how many loans is the FHA insuring in the first place?  Here's the answer, according to figures compiled by MortgageDataWeb: there were roughly 500,000 FHA loans originated in 2007 compared to 1.4 million in 2008.

In other words, the number of FHA loans has tripled in one year.  And the number of instant defaults has tripled too.  The amount of fraudulent activity appears to have held pretty steady at about 0.5% of all FHA loans.

Now, there's nothing wrong with running this story anyway.  If FHA loans are up, it makes sense that oversight staff should be up too, and apparently it's not.  That's a problem, so good for the Post for bringing this up.

At the same time, the Post also tries very hard to make it sound like the increase in fraudulent activity is fundamentally due to a sudden onslaught of shifty mortgage brokers and lousy supervision from the government.  But that's almost certainly not really the case, something that would be immediately apparent if the Post included the one figure that practically screams its absence.  In fact, this statistic is such an obvious one to include that it's hard not to believe that it was included in early drafts of this piece and then removed in order to juice up their story.

That's journalistic malpractice.  Unless the Post reporters who wrote this piece are incompetent, leaving out this basic information was a deliberate effort to hype their reporting and mislead their readers.  That's no way to run a newspaper.

Counterparty Risk

| Sat Mar. 7, 2009 7:30 PM EST
What's going on with AIG?  Just in the past few days the entire country has suddenly become outraged by the fact that much of the federal bailout money going to AIG is being used to pay off its creditors. Creditors, in this case, being people who bought insurance via credit default swaps and are now owed payment either for mortgage-backed securities that have gone bad or for increased collateral requirements caused by AIG's downgrade from AAA.  And some of these creditors are other banks!  And some of them are even foreign banks!!!

But look.  Last year "counterparty risk" was practically crowned the phrase of the year.  You couldn't swing a dead copy of the Wall Street Journal without coming across it.  It's the reason we're bailing out all these guys in the first place: if a big bank goes bust and stiffs all its creditors, then there's a chance that they'll go bust too, and before long you have a cascading series of failures that's brought down the entire world.  We tried letting Lehman Brothers — a relatively small bank in the grand scheme of things — go under, and all hell broke loose.  That's why the Fed stepped in a few days later to save AIG.

So why is everyone suddenly acting as if we just discovered yesterday that bailout money is being used to pay off AIG's counterparties?  And that this is some kind of scandal?  Help me out here.  I'm genuinely confused about why, after six months, this has suddenly become the populist outrage du jour.

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Nonprofit Journalism

| Sat Mar. 7, 2009 2:26 PM EST
Newspapers have been dropping like flies recently, and because of that a lot of chatter in reporting circles these days revolves around the possibility that serious journalism in the future will mostly be done by nonprofits, funded by foundations and grants. Today the New York Times writes about a San Francisco-based magazine that's followed that model for over 30 years:

Mother Jones has become a real-life laboratory for whether nonprofit journalism — a topic of the moment in mainstream news media circles — can withstand a deep recession.

....Back in the fall, when the economic downturn intensified, and the plight of print publications became more dire, Mother Jones suffered, despite its position of not being in it for the money. Advertising plummeted, down 23 percent in 2008, and some of the big donations the magazine depends on didn’t come through.

Actually, things are better than that makes it sound.  Advertising is a pretty small chunk of our revenue, and overall fundraising has stayed pretty strong, all things considered:

[Jay] Harris, the magazine’s publisher, said the company met its fund-raising targets last year, although before the economic turmoil in the fall the magazine thought it would exceed goals.

But small-time donations and subscriptions have held steady at Mother Jones, to the surprise of its editors, who figured that the downturn would have taken more of a toll and that the election of Barack Obama would have a negative effect on raising money for liberal causes.

About half of the magazine’s yearly revenue is from major grants and donations. The magazine often seeks donations for specific projects, as it did in recent years to staff its Washington bureau at a time when many news organizations had been scaling back there. The bureau opened in late 2007 with eight people.

The Times failed to note MoJo's groundbreaking hiring of new blogging staff last year, but aside from that it's a decent piece about one possible future for investigative journalism.  Namely, us.  Check it out.

(And you should subscribe!  Only 15 bucks for the first year.  Just click here.)

Florists of Conscience

| Sat Mar. 7, 2009 1:19 PM EST
Via Andrew Sullivan, a Catholic conference on Friday came up with an anti-gay position that seems like something Saturday Night Live might have made up:

[Connecticut's] law does not require Catholic priests — or any other clergy member — to preside over same-sex weddings.

However, the church is seeking additional exemptions. For instance, it wants to ensure that a florist opposed to gay marriage on religious grounds not be forced to sell flowers to a same-sex couple.

I don't think a Catholic nurse should be required to assist at an abortion.  I don't think a Catholic charity should be required to provide benefits to same-sex couples.  But now they're suggesting, essentially, that anyone, anywhere, in any business, should be allowed to withhold their services from gay couples?  Give me a break.

Friday Cat Blogging - 6 March 2009

| Fri Mar. 6, 2009 3:51 PM EST
Inkblot is back up exploring the new fence today.  Something has caught his eye in our neighbor's yard, but it's not clear what.  A leaf?  A stray molecule?  Something from another dimension?  Domino, meanwhile, is rolling around in the lovely, lovely sunshine and mugging for the camera.  And why not?  What better way is there to spend one's day?

How to Make Cap-and-Trade Into a Bad Joke

| Fri Mar. 6, 2009 2:38 PM EST
Via Gristmill, I see that Sen. Jeff Bingaman (D–NM), chairman of the Energy and Natural Resources committee, has decided to preemptively surrender on global warming:

Bingaman said any Congressionally developed system capping and trading emissions probably will include carbon allowances given to polluters like cement factories and coal-burning power plants, along with permits that are sold.

Auctioning 100 percent of the permits would essentially make polluters pay quickly for emissions. In the European Union's Emissions Trading Scheme, emissions permits were given away to polluters at first. This led to a glut of permits and windfall profits for some emitters.

...."I think it's unlikely we will pass a cap-and-trade bill with 100 percent auction," Bingaman told reporters at the Platts Energy Podium.  He said such a system has the risk of substantially increasing the burden on some utilities and major emitters.

There are lots of bells and whistles that you can add to a cap-and-trade plan: safety valves, circuit breakers, banking, offsets, and other buzzwords by the truckload.  Some are mostly good (banking), some are mostly bad (offsets), and some are in between (safety valves and circuit breakers).  All of them are things we should care about getting right, but they're also things where, inevitably, we're going to have to compromise.

Auctioning permits is different.  This is the one thing that ought to be a deal-breaker in any cap-and-trade plan.  I talk about this in my cap-and-trade piece in the print magazine this month:

4. There 's no such thing as a free permit. One of the key issues with any cap-and-trade system is how you allocate permits. Power plants would like to get them for free, and at first glance this seems appealing. If you set the overall carbon cap at 90 percent of current levels, and allocate only that number of permits, that should reduce carbon without raising prices for the consumer. After all, the power plants didn't have to pay for the permits, so there are no costs to pass along. Right?

Oddly enough, no. The economic theory involved is a little hairy, but those permits have a value on the open market, and that means that in many cases marginal producers can make more money selling their permits than by producing power. They'll only be willing to produce power if they can raise prices enough to make the power-producing business more profitable than the permit-selling business, and eventually everyone will jack up prices to follow suit.

This may sound abstract—even a bit fantastical—but it's absolutely real. In fact, when permits in phase one of Europe's ETS system were handed out for free, electricity prices rose and power companies pocketed a windfall profit (which Britain's Department of Trade and Industry estimated at about $1.1 billion a year in the UK alone). Dale Bryk, an attorney with the Natural Resources Defense Council (NRDC), puts it bluntly: "If you ask them point-blank if they'll charge customers for free permits, they won't tell you. But they know they will."

A better way is for the government to hold an auction to set the price of permits. This has a couple of extremely salutary effects. First, it puts everyone on a level playing field (since Congress has no ability to allocate permits to favored interests). Second, and even better, the money from selling the permits goes to the federal government, not to the carbon emitters. That's a pretty useful revenue stream, one that would probably start out at about $20 to $30 billion per year and go up steadily as the cap came down and the price of carbon permits increased.

There are loads of special interests who hate the idea of a 100% auction, of course.  But once you start giving away permits, you'll never stop.  It is, plain and simple, a massive giveaway to existing power plants, and as the Europeans learned it makes a mockery of any serious cap-and-trade plan.

This all sounds very wonky, but it's a hill to die for if you care about reducing greenhouse gases.  Without a 100% auction, cap-and-trade is a bad joke.  Somebody needs to tell Bingaman to start listening to the coal lobby a little less and start caring about effective public policy a little more.

UPDATE: I was going to add something about the politics of this, but the post was already long so I decided to skip it.  Luckily, Matt Yglesias does it for me:

When you’re a Democratic Senator, you often face a conflict of interests. On the one hand, you would really like to sell out to anti-reform special interests. On the other hand, you can’t openly portray yourself as someone who wants to sell out. One appealing option is to do what Bingaman does here and just cite unspecified political obstacles. Not that the obstacles aren’t real. But in the U.S. Senate they’re also people, with names. But instead of naming names, Bingaman’s just offering the vagueness play. He’d love to do the right thing, but it’s “unlikely” to happen. And everyone can do this. Nobody needs to be the Senator who’s against a public plan in health care, or who’s against a 100 percent auction. Instead, everyone’s just being practical for the sake of someone else.

Quite so.