Kevin Drum

Fraud? On Wall Street?

| Tue Apr. 21, 2009 12:03 PM EDT

When it comes to lobbying and campaign finance, the old saw is that the real scandal is what's legal.  That's pretty much the way I feel about Wall Street too these days.  Still, there's also the good old-fashioned illegal stuff:

In the first major disclosure of corruption in the $750-billion financial bailout program, federal investigators said Monday they have opened 20 criminal probes into possible securities fraud, tax violations, insider trading and other crimes.

....The report said little about who is under investigation and how the fraudulent schemes work, but investigators are already on alert for a long list of potential scams. Such schemes could include obtaining bailout money under false pretenses, bilking the government with phony mortgage modifications, and cheating on taxes with fraudulent filings.

Neil Barofsky, the special inspector general overseeing the bailout program, says fraud is likely to get even worse in the newest stage of the bailout since it allows investors to get in on the action with only a small bit of their own money at trisk.  The Treasury, in response to Barofsky's report, said his recommendations would be "considered."  How heartening.

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Mutual Fund Madness

| Tue Apr. 21, 2009 11:42 AM EDT

Ezra Klein points to the latest year-end report on mutual funds from Standard & Poors.  The highlight is pretty much the same as it is every year:

Over the five year market cycle from 2004 to 2008, S&P 500 outperformed 71.9% of actively managed large cap funds, S&P MidCap 400 outperformed 79.1% of mid cap funds and S&P SmallCap 600 outperformed 85.5% of small cap funds. These results are similar to that of the previous five year cycle from 1999 to 2003.

The belief that bear markets favor active management is a myth. A majority of active funds in eight of the nine domestic equity style boxes were outperformed by indices in the negative markets of 2008. The bear market of 2000 to 2002 showed similar outcomes.

And don't forget fees!  Not only do actively managed funds do worse than index funds, they charge you for the privilege of doing worse than index funds.

Hedge funds are no better, by the way.  Research is hazier here because hedge funds are more secretive, but as near as I can tell from the published data, their average return is no better than the broad market either.  The main difference is that instead of simply charging fees for helping you do worse than an index fund, they charge you gargantuan fees for helping you do worse than an index fund.

Isn't Wall Street grand?

Ragging on the Times

| Tue Apr. 21, 2009 10:55 AM EDT

The LA Times, that is.  Here is Doyle McManus today:

If it seems arbitrary — even unfair — to take the measure of a new president after just 100 days in office, you can blame Franklin D. Roosevelt.

No!  A thousand times no.  It's the fault of lazy journalists who insist on hauling out this tired trope every few years no matter how inane it is.  McManus even admits a few paragraphs later that "for most leaders since FDR, the first three months have been an unreliable guide to the years that followed."  That's true!  So why perpetuate this nonsense?

Elsewhere, the Times brings its readership up to speed on the news that Rep. Jane Harman was overheard in an NSA wiretap agreeing to intervene in the espionage case of two pro-Israel lobbyists.  This story has been reported in detail by both Congressional Quarterly and the New York Times.  It's been all over the blogosphere and cable news.  Harman's district is in Los Angeles county.  It's maybe 20 miles from the LAT's main office.  So what do LA readers get?  About ten bland column inches buried at the very bottom of A11.  With her name misspelled in the headline.  Jesus.

On the bright side, the Times won a Pulitzer yesterday for a multipart special on wildfires. Congrats to Julie Cart and Bettina Boxall.

Low Stakes Testing

| Tue Apr. 21, 2009 10:08 AM EDT

Do you know as much about economics as a bright high school senior?  Find out here!  I missed question #11, so anyone who wants to show that they're smarter than me is welcome to explain the allegedly correct answer in comments.

Chart of the Day - 4.21.2009

| Tue Apr. 21, 2009 8:00 AM EDT

I don't want to bum everyone out on Earth Day, so I'm going to link to Joel Makower's article in our current edition today instead.  Two decades after writing The Green Consumer, he says he's about ready to throw in the towel.  The problem is that when it comes to waste and recycling, it hardly even matters what individuals do.  Consumers, he says, are mere pikers:

Consider what I call "A Tale of Two Circles." Perhaps you've seen the bottom circle, a pie chart containing nine slices, representing the composition of the stuff we throw out — a.k.a. municipal solid waste, or MSW. It shows that paper makes up about a third of our nation's trash, while yard waste, food scraps, and plastics each represent about 12 percent. They are followed by smaller amounts of metals, rubber, textiles, leather, glass, wood, and other materials.

The MSW pie chart is well known in environmental circles and is the grist for a range of claims and disputes. The plastics industry, for example, uses it to "prove" that plastic bags are less of an environmental problem, at least a solid waste problem, than their paper counterparts. Aluminum, wood, and glass industries use it to make their own cases. Everyone, it seems, finds some solace in the numbers.

But there's another circle — a much, much bigger one, totaling about 10 billion tons of waste a year, or roughly 40 times the MSW pie. This circle doesn't have an official name — indeed, it's virtually unknown in environmental circles, and the EPA doesn't publish it. I've dubbed it gross national trash, or GNT....The thinnest slice of the pie — a minuscule 2.5 percent sliver of the whole — is municipal solid waste.

Read the rest here.

How Not to Deal With Pirates

| Tue Apr. 21, 2009 12:46 AM EDT

Robert Farley passes along the news that a Dutch naval vessel raided a pirate ship this weekend but then released all seven captured pirates because NATO has no authority to arrest pirates:

This, my friends, is not change we can believe in. Especially since the same thing happened again yesterday; a Canadian frigate operating under NATO authority chased down a group of pirates over the course of seven hours, forced them to surrender at gunpoint, and then released them....I'm reluctant to join in the right-wing chorus of denunciation against bureaucrats and lawyers, but someone somewhere in NATO has screwed up badly. There isn't the faintest question that Canada and the Netherlands have the authority to arrest and collect evidence against pirates, and the idea that the aegis of NATO would make that impossible is infuriating.

Anybody feel like defending the bureaucrats and lawyers here?  Anybody?

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On the Color of Swans

| Tue Apr. 21, 2009 12:24 AM EDT

Rotwang sez:

I'm tired of Nassim Nicholas Taleb. He isn't as brilliant as he thinks he is. He may be a quant jock, but he talks about an idealized laissez-faire capitalism as if he's never read a history book. Dude, this is the way the system works. This IS the system. The bubble bursting was not some unforeseeable event. It's happened many times. Lots of people foresee it. They just don't foresee the timing.

That's kind of my untutored feeling too.  If an asset bubble followed by a banking crisis is a black swan, then black swans must be about as rare as black point guards.  Our current crisis is bigger than most, but it's hardly unprecedented.

UPDATE: In comments, ack says:

This is completely and utterly wrong! Nassim Taleb has two independent arguments:

1) Due to a cognitive limitation, people tend to underestimate the likelihood of improbable bad events ('black swans'). Therefore, you can out-bet the market by continually betting that bad events will happen....Taleb has even described the current crisis as a 'white swan,' and argued that it was totally forseeable.

James Joyner makes the same point at greater length here. Consider me corrected.

Wealth and Wall Street

| Mon Apr. 20, 2009 6:58 PM EDT

Gabe Sherman has a piece today in New York magazine about how gobsmacked the Wall Street crowd is that people are pissed off at them these days.  There are a million things you could say about it — and since I'm coming late to this, a million things probably have been said about it — but I just want to excerpt this one piece:

Wall Street people are not moral idiots (most of them, anyway) — it’s not as if they’ve never pondered the fairness of their enormous salaries. “One of my relatives is a doctor, we’re both well-educated, hardworking people. And he certainly didn’t make the amount of money I made,” a former Bear Stearns senior managing director tells me. “I would be the first person to tell you his value to society, to humanity, is far greater than anything that went on in the Bear Stearns building.”

That said, he continues, “We’re in a hypercapitalistic society. No one complains when Julia Roberts pulls down $25 million per movie or A-Rod has a $300 million guarantee. We have ex-presidents who cash in on their presidencies. Our whole moral compass has shifted about what’s acceptable or not acceptable. Honestly, you can pick on Wall Street all you want, I don’t think it’s fair. It’s fair to say you ran your companies into the ground, your risk management is flawed — that is perfectly legitimate. You can lay criticism on GM or others. But I don’t think it’s fair to say Wall Street is paid too much.”

It's hard to know what to say about this.  It just leaves you speechless.  And this guy is one of the more self-aware ones.

Later on Sherman quotes another Wall Streeter who's livid over Obama's plan to raise tax rates slightly on the rich.  "He doesn’t want to have any wealth creation," the guy wails, and that really seems to get to the heart of all this.  Financial industry players sincerely seem to view all "wealth" as equal.  If the market pays you a lot, it's because you're responsible for creating a lot of wealth, and that's that.  The fact that the wealth you created was largely divorced from even a notional real-world benefit to the larger economy doesn't matter.  Money is money.

Still, both these guys are right: the big players in the financial industry get paid a lot because they're responsible for creating gigantic streams of money for their firms.  As long as that stays the case, they're going to continue making truckloads of money no matter what we do.  But if we reduce that stream of financial rents to levels more related to the actual value it creates in the real world, pay levels will become more reasonable too.  That's what we should focus on.

Dishing on Chrysler

| Mon Apr. 20, 2009 5:58 PM EDT

This afternoon brings yet another story in which the most interesting question is, Who leaked this?

Top officials at Chrysler Financial turned away a $750 million government loan because executives didn't want to abide by new federal limits on pay, sources familiar with the matter say.

....The Treasury Department previously had loaned Chrysler Financial $1.5 billion....During March, when it seemed that the first loan would run out, the Obama administration began working on a deal to lend the company another $750 million.

Quickly, most of the agreement fell into place. But on April 7, Treasury asked Chrysler Financial to have its top 25 executives sign waivers regarding their compensation, sources said....Within a week, the company responded that some of the executives had refused to give their approval.

Sure, this is sort of interesting on its own merits.  Mainly, though, it seems interesting as a shot across the bow in the war between Washington and the business world over executive pay.  Someone in the White House apparently wants word of this particular round in the fight to become very public indeed.

Chart of the Day - 4.20.2009

| Mon Apr. 20, 2009 12:53 PM EDT

A few days ago, when I read that bank lending had dropped 2.2% in February, I didn't think too much of it.  In fact, it didn't really sound all that bad.  Given that we're in the middle of a serious recession, a decrease of 2.2% seemed like it might be reasonable even if there were no bank crisis at all.

But I wasn't reading closely enough.  First: this is not a year-on-year decline.  It's a one-month decline, which annualizes to about 30%.  Second: that number is a median.  Total lending decreased 4.7%.  Third, it's an average, and some banks cut back a lot more than others.  The Wall Street Journal reports:

According to a Wall Street Journal analysis of Treasury Department data, the biggest recipients of taxpayer aid made or refinanced 23% less in new loans in February, the latest available data, than in October, the month the Treasury kicked off the Troubled Asset Relief Program.

....In February, nearly half of lending by the 21 banks was to consumers, up from about one-quarter in October. But excluding mortgage refinancings, consumer lending dropped by about one-third between October and February. Commercial lending slumped by about 40% over that period, the data indicates.

That's a big drop, even for the middle of a recession.  What's more, as the Journal's chart shows, some of the biggest drops came from Citigroup and JPMorgan, both recipients of big TARP bailouts.  Even with all that TARP money, they're apparently not capitalized well enough to keep lending at a healthy level — which means that far from being able to pay back their TARP dough, they might very well need even more.  Pat Garofalo at the Wonk Room:

If a bank is truly healthy and can pay back TARP money while maintaining lending, more power to it. If, however, a bank is paying back TARP because it wants to get out from under the program’s restrictions — while not lending and clinging to other government funded rescue programs — that’s problematic.

For instance, Wells Fargo (which received TARP money) has posted a profit and maintained lending. If it announces a desire to exit TARP, the administration should seriously consider the offer. However, this is going to make it transparently obvious which banks are in the best shape. The administration will then have to decide whether the others will ever be anything more than zombies — limping along thanks to government support without actually doing any good — and be honest about the need to take them over and wind them down.