Kevin Drum

Taming the Oil Bubble

| Fri Jan. 15, 2010 3:06 AM EST

Housing wasn't the only financially induced asset bubble in the aughts:

In a move aimed at limiting financial speculators' ability to drive up oil prices, the Commodity Futures Trading Commission on Thursday proposed restrictions on the number of energy contracts that any single investor can hold and new limits on the trading activities of Wall Street banks.

....The Commodity Futures Trading Commission seeks to establish a limit on how many contracts an investor could have across all regulated markets in which oil and natural gas are traded. This would broaden the limits that existed before 2001, since it would apply not only to contracts for future delivery of oil, but also to markets that involve the physical delivery of oil and natural gas.

That's important, because several Wall Street firms got involved not only in the speculative futures market but also in the physical markets, giving them tremendous potential for market manipulation. Morgan Stanley, as a player in the physical market, controls an estimated 15 percent of the home-heating oil supply in New England. Goldman Sachs owns shares of companies that own pipelines and refineries.

The case for a speculative bubble in oil is still, if you'll pardon the expression, a little more speculative than the airtight case for a housing bubble, but there's no question that the evidence seems to point more in that direction that it did a couple of years ago. Which is no big surprise, I suppose: after all, what we really had was a credit bubble, not just a housing bubble. And when there's lots of credit sloshing around, it's bound to drive up a lot of asset prices.

In any case, the position limits the CFTC is proposing are relatively modest. It's worth giving them a try.

Advertise on

Healthcare via Twitter

| Thu Jan. 14, 2010 7:15 PM EST

One of the things Twitter does for us is provide a glimpse into how reporters work. And guess what: they're as confused as the rest of us sometimes! Here's an ongoing Twitter exchange about the latest healthcare deal between Time's Karen Tumulty, the Washington Post's Ezra Klein, and the New Republic's Jonathan Cohn:

Tumulty: 2 me, it sounds like the big news in this #hcr deal is (at least as union guys explained it) allowing any employer 2 buy into the exchanges.

Klein: Yeah, I want to hear the White House on that.

Tumulty: Me too. Lots of details missing -- like what would they have to pay to get in? Would they have to reimburse feds for subsidies?

Klein: This is a bit unclear right now, but it sounds like this deal opens the exchanges to all employers in 2017. Trying to figure this out.

Cohn: so i missed the earlier question on this - was on with operator - did we get answers on the exchange questions?

Tumulty: not yet. WH: "There are a lot of the discussions going on now...not something that can be answered" in detail.

Klein: I just asked again, and I wouldn't say we did.

Cohn: yeah, just heard. so do we think labor guys just got it wrong on their conf call? they sounded a bit confused.

Cohn: I would have to agree with that assessment!

Tumulty: boy, these WH guys don't want to talk about that. do we think the union guys got ahead of themselves?

Cohn: So I didn't get much of an answer either -- and then they cut me off before I could follow up

Klein: My bet is the unions are right on their part of it. Employers: still up in the air?

Klein: Senior White House official: "Over time, the exchanges will open to more and more people."

Twitter: now bringing you the real-time confusion usually reserved for natural disasters and terrorist attacks even for boring stuff!

Not to worry, though. In a few hours all three of these folks will figure out what's going on and crank out a few hundred well crafted words explaining it. At least, they'd better. Because they owe it to me.

Quote of the Day Revisited

| Thu Jan. 14, 2010 6:52 PM EST

My Quote of the Day yesterday was from JPMorgan CEO Jamie Dimon, who told Congress, "We didn't do a stress test where housing prices fell." My reaction: "Wow." But Megan McArdle says I didn't get the whole quote:

I'm shocked to find that Kevin is shocked.  That's pretty much the standard explanation — at least, a partial one — for why lenders became willing to take on so much risk.  Massive house price depreciation had pretty much dropped out of their models, which mostly focused on prepayment risk.

This is not quite as crazy as it sounds. For one thing, Kevin has truncated the quote a little bit; the version I read has Dimon saying "We didn't stress test housing prices going down by 40%."

That's different. It's still not good, considering how high home prices had gotten, but it's not outright idiocy. Apologies. But then Megan says this:

Even if they had put housing price implosion in their models, where would they have gotten the data to fine-tune their models?  It's not enough to say, "We should model a broad national decline in house prices;" you need some values for how many people will default when house prices fall.  [Etc.]

....That's not to excuse the bankers for not trying; some allowance for the risk of a broad price decline would have been better than none.  But I'm not sure that it would have done much to alter their lending habits.  Going on historical data, the risk of a huge price drop within the average lifetime of a mortgage (which is less than ten years), would normally have been very small....

I'm not so sure about this. Remember: Wall Street is the home of the quant jocks these days. If they could model the fantastically complex derivatives that they routinely wrapped around mortgage securities, they could certainly have modeled this if they'd wanted to. It wouldn't even be that complicated compared to a lot of the stuff they do on an everyday basis. And as for the risk of a huge price drop being "very small," surely even a crude model should have shown that risk becoming pretty sizable as prices starting heading into the stratosphere? There were certainly an awful lot of inputs that suggested it.

I don't think Megan and I are actually disagreeing an awful lot here, but I still think this deserves some pushback. Bubbles aren't always as obvious as they seem in hindsight, but this one got too big to ignore as early as 2003-04. Any bank with allegedly sophisticated risk modeling should have been factoring in the possibility of bigger and bigger downsides every month after that.

Quote of the Day: Haiti

| Thu Jan. 14, 2010 3:29 PM EST

From Rush Limbaugh, reacting to the earthquake in Haiti that killed thousands, left millions homeless, wiped out hospitals and water distribution, and devastated the entire country:

I could sit here and be really cynical.  I'll hold off on the cynicism for a couple hours, I'll hold off on it.  I'm going to hold off on it, give the show's flow a chance to establish, 'cause it's going to be the Media Tweak of the Day.

....Yes, I think in the Haiti earthquake, ladies and gentlemen — in the words of Rahm Emanuel — we have another crisis simply too good to waste.  This will play right into Obama's hands. He's humanitarian, compassionate.  They'll use this to burnish their, shall we say, "credibility" with the black community — in the both light-skinned and dark-skinned black community in this country.  It's made-to-order for them.  That's why he couldn't wait to get out there, could not wait to get out there.

So I guess that's his Media Tweak of the Day. I wonder what it takes to get the conservative movement to disown this guy?

Conservative Healthcare

| Thu Jan. 14, 2010 2:50 PM EST

If healthcare reform passes, conservatives are planning to mount a constitutional challenge to the individual mandate on the grounds that the federal government doesn't have the right to force you to buy a product from a private corporation. This is doomed to failure, and Ezra Klein argues that that's a good thing for conservatives themselves:

Long-term, conservatism could suffer no greater disaster than the death of the individual mandate. This country will have a national health-care system, and sooner than later. The cost pressures make that inevitable. If you want that national system to be private, as most conservatives do, then your only hope is the individual mandate. That's been true in countries such as the Netherlands and Switzerland, and in Singapore, which is often upheld as a conservative model, contributions to health savings accounts are compulsory. Eliminate those options from the U.S. menu, and you're ensuring that Medicare, Medicaid or some sort of public option will eventually take over the market, as there's no constitutional issue with taxation in return for public services.

Exactly right. The Swiss model is basically about as conservative as you can get among national healthcare systems, and if that option were taken away we'd inevitably end up with something more like France or Sweden or Canada. Which would be fine with me, but not so great for conservatives. In fact, it might be even worse than Ezra says: if the individual mandate were killed but the rest of the current healthcare bill stayed intact, the private insurance industry wouldn't last out the decade. We'd have Medicare for All by the end of Obama's second term.1

Of course, movement conservatives don't believe any of this. They don't believe in things like "adverse selection" because language like that comes from pointy headed liberal healthcare professors. (Though they might want to ask a few insurance company executives whether they believe in it.) And they don't believe that national healthcare is inevitable because they're convinced that our current Rube Goldberg system really does provide the best healthcare in the world and can continue forever without bankrupting us. Or something. I'm not really sure what they believe. I'm not sure they do either. But they sure know what they're against.

1Hell, maybe we liberals should join in the challenge. Go ahead and pass healthcare reform with the individual mandate, get the mandate tossed out in court, and then wait for private health insurers to collapse. Sounds like a pretty good plan. Too bad the court challenge would never work.

More on the Bank Tax

| Thu Jan. 14, 2010 2:08 PM EST

My first post this morning was a reflexive reaction to the paltriness of the proposed bank tax. But a bit of early-morning pissiness probably isn't very convincing. So here's James Kwak with a more considered reaction:

From Q4 2008 through Q2 2009, large banks had a funding cost that was 78 basis points1 lower than that of small banks....[So] the tax isn’t nearly big enough! It’s being calculated as 15 basis points of uninsured liabilities, calculated as assets minus Tier 1 capital minus insured deposits. 15 basis points is a lot less than 78 basis points. And if the FDIC cost of funds data are based on all liabilities (not just uninsured liabilities), then charging 15 basis points on uninsured liabilities only increases the overall cost of funds by about 7 basis points (at least in the administration’s example). This doesn’t come close to compensating for the TBTF subsidy.

The point of the tax shouldn't simply be to pay back the cost of TARP, which is just a small part of what the government did to help out the banking sector in 2007-08. It should also be used to level the playing field. Big banks get funding at lower cost because they are, supposedly, safer than small banks. But guess what? That's a mirage. They fail just like small banks, but they do so less often and get bailed out when it happens. So why give them an advantage that serves mainly to let them grow ever more gigantic? A properly designed tax — one that's both bigger and more graduated, so that it goes up as banks get larger — would be a much better one. More here from Simon Johnson and Peter Boone.

1A basis point is a hundredth of a percent. So 78 basis points is 0.78%, which is quite a bit when you're talking about loan books that amount to trillions of dollars.

Advertise on

Fixing the Financial System

| Thu Jan. 14, 2010 1:42 PM EST

The first session of the FCIC bank hearings yesterday — the one where Phil Angelides got to grill bank CEOs — is the one that got all the attention, but Mike Konczal says the second session was actually more interesting. That was the one where a group of three financial industry experts were able to talk plainly and simply about what needs to happen going forward:

The three panelists gave very specific ideas about where reform needs to take place to get our financial sector back on track. The first key is bank leverage, how much money they lend for how much they keep in pocket. The higher this ratio, the more risky their firm is.

Right now you can qualify as minimally leveraged at 25-to-1, which means you lend out $25 for every $1 you actually own, which is unmanageable according to the participants. These ratios need to come down for the largest firms. Fannie-Freddie are even worse; the participants claimed that they had a 95-to-1 leverage at one point (just 18 basis points of capital), a monstrously risky number for any firm, much less a large one.

What about Glass-Steagall, the New Deal law that split up investment banking from commerical banking? There was disagreement among the participants, with a general agreement that it should be updated for the capital markets of the 21st century. Banks that are diversified with both commercial and investment wings survived better than normal investment banks, an argument that the deregulation was successful. However this leaves a situation where the Federal Discount window, the safety net the Federal Reserve provides banks to avoid disastrous bank runs, is being used to fund high-risk hedge fund like proprietary trading operations. So the suggestion is to update Glass-Steagall for the 21st century where risky operations are silo’ed away from normal operations.

....While discussing the over the counter derivatives market with Brooksley Born, it was clear that derivatives reform was one of the most necessary items. Derivatives need to clear on a central exchange, with a data repository. Solomon predicted the price of derivatives would fall quickly, in the same way that stock commissions fell back when regulation was brought to that market on the so-called “May Day.” This is why banks, who keep this money from bespoke derivatives, want to derail this without getting too many fingerprints on it.

Regular readers know that I think this is basically right. Leverage is far and away the key issue: put in place a set of simple rules that regulate leverage to sensible levels; regulate it everywhere, not just within banks themselves; and regulate it in all its various forms. If we did that and accomplished nothing else, I'd consider regulatory reform a qualified success.

Beyond that, regulating derivatives is more important than repealing Glass-Steagall. I like the idea of firewalling risky securities trading away from core banking functions, but I'm basically not convinced that repealing Glass-Steagall was a key cause of the banking crisis. After all, some commercial banks did fine and some failed. Some investment banks did OK and some failed. Some merged superbanks did fine and some failed. It's pretty hard to find a thread there. However, the combination of the repeal with the 2000 passage of the Commodity Futures Trading Act, which kept derivatives unregulated and turned huge Wall Street banks into casinos, was disastrous. So yes: put in place a firewall, and pay particular attention to regulating derivatives. The housing bubble could still have happened without them, but it was the derivatives market that supercharged it.

And that would be the ballgame. Sure, there are other aspects of regulatory reform that I'd like to see enacted, but serious leverage limitations alone would make reform a qualified success, and the addition of serious derivative regulation would make it a historic success. I'd pretty much trade everything else away if I could get just that.

The Bank Tax

| Thu Jan. 14, 2010 12:39 PM EST

The New York Times reports today:

President Obama plans to call on Thursday for taxing about 50 big banks and major financial institutions for at least the next decade to recoup all taxpayer losses from the bailout of Wall Street.

The tax on banks, insurance companies and brokerages with more than $50 billion in assets would start after June 30 and seek to collect $90 billion over 10 years, according to a senior administration official who briefed reporters late Wednesday.

Ouch! That's hitting 'em where they hurt. Why, that comes to....$9 billion per year.  So Morgan Stanley and Goldman Sachs and Citigroup can probably be expected to fork over, oh, maybe $500 million each. I wonder if their accountants will even notice it?

Our Grim Future

| Wed Jan. 13, 2010 6:52 PM EST

The Center on Budget and Policy Priorities — which desperately needs a more user-friendly name, by the way — says that our long-term federal deficits are unsustainable. In order to get them to sustainable levels we need a combination of tax increases and spending cuts equal to about 4.9% of GDP. Here's a start:

If policymakers were to allow all of the 2001 and 2003 tax cuts to expire as scheduled at the end of 2010 — or fully offset the cost of extending those tax cuts they choose to extend — this alone would shrink the fiscal gap by almost two-fifths, from 4.9 percent of GDP to 3.0 percent.

Sounds good. Except that this would take us back to the fiscal hellscape of the late Clinton era, and who wants that?

The CBPP report is pretty discouraging, but the really discouraging thing about it is this: "Policymakers should also expect to return to long-term deficit reduction multiple times over coming decades; the problem is far too large to address in a single legislative package." Strictly speaking, this is true: you wouldn't want to literally do this in a single piece of legislation. But if we were even close to having a sane political class in this country, it wouldn't be that hard to hit this target: (1) Let the Bush tax cuts expire. Nobody was overtaxed in the 90s. (2) Do a conventional fix for Social Security. This would be good for another 1% or so. (3) Get serious about reining in Medicare costs. Squeezing another 1% via Medicare changes wouldn't be that difficult if both parties were willing to treat it as a real problem instead of a chance for demagoguery. (4) Add in a modest assortment of spending cuts (smaller military, unprivatized student loan, reduced ag subsidies) and revenue increases (estate taxes, carbon taxes, financial transaction taxes) and you'd get the rest of the way there. If you don't like these suggestions, feel free to sub in your own ideas here.

For a country as big and rich as the United States, this stuff isn't even very painful. We could do it in a single legislative session and 99% of the country would barely notice the effects. And yet it's the next best thing to impossible. It doesn't speak well for our future.

Quotes of the Day: Senate Edition

| Wed Jan. 13, 2010 4:20 PM EST

From Harold Ford, who recently moved from Tennessee to New York and is running for the Senate:

Q. Have you been to Staten Island?

A. I landed there in the helicopter, so I can say yes.

And from Harry Reid, on whether it was a good idea to negotiate over healthcare reform with Olympia Snowe:

As I look back it was a waste of time dealing with her, because she had no intention of ever working anything out.

For the record, I once stepped off the Staten Island Ferry and walked around for a few minutes before taking the next ferry back, and a couple of years ago I spent several hours crossing Interstate 278 in a massive traffic jam on my way to JFK. So I've been to Staten Island too. And I don't think Olympia Snowe was ever very serious about healthcare reform either — at least, not based on the lame excuse she gave for not supporting the final Senate bill even after it was redrafted to her liking.