Sunday Camel Blogging

Here's a pair of pictures from my trip to the Santa Ana zoo yesterday. On the left is the zoo's bald eagle, looking stern and patriotic.  On the right is one of the zoo's camels with Interstate 5 in the background. Impressive critters, no?

Termite Infestations in the Financial System

Should private equity shops be regulated by the SEC? Felix Salmon listens to a debate between two Democrats and comes away unimpressed with both of them:

The main reason for PE shops to be regulated, of course, has very little to do with fiduciary responsibility, and everything to do with the fact that leverage is a systemically-dangerous thing, and regulators need to know where it is and how it’s being put to use. But it can be hard to explain systemic tail risk to the kind of people who only really understand the meaning of a pie chart when they bake an actual pie.

Precisely. In fact, I'd go further: even if it were true that private equity funds don't generally operate with abusive levels of leverage today, the fact remains that Wall Street boffins are always on the lookout for new ways to overleverage themselves. If banks and hedge funds are regulated but PE funds aren't, then eventually some bright boy will figure out a way to leverage a PE fund at 50:1 while still making it look like it's an ordinary equity shop with modest leverage. The only way to have even an outside chance of preventing this is to regulate any entity with a substantial amount of money — and that most definitely includes PE funds. If they keep their leverage modest, the regulation will be light and little harm is done. But if they start to go overboard because someone figures out a new angle that no one's ever thought of before — and you know someone will eventually — a regulator who's already familiar with the operation has at least a fighting chance of catching it before it blows up the world.

Leverage is like a termite infestation: it swarms anywhere there's food, but you hardly even notice it's there until things get out of hand and your house starts to fall down. Substitute "money" for "food" and "the entire global economy" for "your house," and that's leverage. Constant vigilance is the only defense.

Having said that, though, I'd like to defend the practice of baking pies to understand the meaning of pie charts. It sounds like a delicious alternative to reading New York Times op-eds.

From Karl Taro Greenfeld, writing in Bloomberg Businessweek:

It's as if the great advances of human civilization, in everything from animal husbandry to mathematics to architecture to manufacturing to information technology, have all crescendoed with the Crunchwrap Supreme, delivered via the pick-up window.

The rest of the story is all about how Taco Bell — which is headquartered just down the road from me — has revolutionized its drive-through business over the past ten years or so. Still, this part is a little dispiriting:

The program was so successful that in 2009 the brand was the first to finish in the top five in QSR magazine's Drive-Thru Performance Study in both speed and accuracy, averaging 164 seconds per vehicle with an accuracy rate of 93.1 percent...."They [i.e., the entire fast-food industry] have gotten to a place where it is probably as fast and accurate as it is going to be," says Blair Chauncey, of QSR magazine. "We got to the point where they were separated by a few seconds and everyone's accuracy was above 90 percent. Everyone has gotten so good." We are all of us, right now, living in the golden age of drive-thru.

So that's that. The pinnacle of Western achievement is an accuracy rate of about 90%, and it's not getting any better. That means that your order is going to be screwed up one time in ten when you go through a drive-through lane. I guess we'll have to wait for Star Trek-style food replicators in order to see further improvements.

Germany's Revenge

Tyler Cowen points us to a long but, typically for Morgan Kelly, worthwhile and entertainingly written column about Ireland's banking woes. You should read the whole thing, but here's a big chunk to get you started:

Ireland’s Last Stand began less shambolically than you might expect. The IMF, which believes that lenders should pay for their stupidity before it has to reach into its pocket, presented the Irish with a plan to haircut €30 billion of unguaranteed bonds by two-thirds on average. [Irish Finance Minister Brian] Lenihan was overjoyed, according to a source who was there, telling the IMF team: “You are Ireland’s salvation.”

The deal was torpedoed from an unexpected direction. At a conference call with the G7 finance ministers, the haircut was vetoed by US treasury secretary Timothy Geithner who, as his payment of $13 billion from government-owned AIG to Goldman Sachs showed, believes that bankers take priority over taxpayers. The only one to speak up for the Irish was UK chancellor George Osborne, but Geithner, as always, got his way. An instructive, if painful, lesson in the extent of US soft power, and in who our friends really are.

....Given the political paralysis in the EU, and a European Central Bank that sees its main task as placating the editors of German tabloids, the most likely outcome of the European debt crisis is that, after two years or so to allow French and German banks to build up loss reserves, the insolvent economies will be forced into some sort of bankruptcy.

....Make no mistake: while government defaults are almost the normal state of affairs in places like Greece and Argentina, for a country like Ireland that trades on its reputation as a safe place to do business, a bankruptcy would be catastrophic....Worse still, a bankruptcy can do nothing to repair Ireland’s finances.

....National survival requires that Ireland walk away from the bailout. This in turn requires the Government to do two things: disengage from the banks, and bring its budget into balance immediately.

First the banks....The original bailout plan was that the loan portfolios of Irish banks would be sold off to repay these borrowings. However, foreign banks know that many of these loans, mortgages especially, will eventually default, and were not interested. As a result, the ECB finds itself with the Irish banks wedged uncomfortably far up its fundament, and no way of dislodging them.

This allows Ireland to walk away from the banking system by returning the Nama1 assets to the banks, and withdrawing its promissory notes in the banks. The ECB can then learn the basic economic truth that if you lend €160 billion to insolvent banks backed by an insolvent state, you are no longer a creditor: you are the owner. At some stage the ECB can take out an eraser and, where “Emergency Loan” is written in the accounts of Irish banks, write “Capital” instead. When it chooses to do so is its problem, not ours.

I suppose this analogy is wrong in a hundred different ways, but I can't help thinking that this is a lot like the aftermath of World War I, except in reverse. This time it's Germany acting as the imperious victor, demanding that the citizens of Ireland (and Greece and Portugal) immiserate themselves for years to pay back loans that they will never be able to pay back. It's easy to see why this is happening — thrifty Germans rather predictably don't feel like they should have to bail out spendthrift euro countries on the periphery — but it's also easy to see that there's no way it can end well.2 Likewise, it's easy to see why Geithner and others don't want to force still-fragile French and German banks to eat huge losses that could destabilize the global banking system in hard-to-predict ways. But again, it's also easy to see that there's really no choice. One way or another, neither Ireland nor Greece will ever be able to make good on their debts, and that means that either creditors or taxpayers in the rest of Europe — or both — are going to take a bath.

Would it be better to take that bath now, or better to wait a couple of years for the economy to recover before doing what has to be done? I don't know. But if I had to guess, I'd say that another two or three years of uncertainty (at best) or disaster (at worst) isn't worth the risk. Like it or not, Europe's banks and its taxpayers are probably better off dealing with this problem now. And it's not as if Ireland or Greece would be getting off without any pain, after all. Part 2 of Morgan's plan is to bring the Irish budget into balance, which would cause even more wrenching austerity than they're going through now. There's plenty of pain to go around.

1NAMA is a "bad bank" set up a couple of years ago to hold the worst toxic waste of the Irish banking system.

2Edited to make clear that I'm not especially defending the German attitude, just noting that it's perfectly understandable.

Friday Cat Blogging - 6 May 2011

Domino was sunning herself in the doorway yesterday — it's been in the high 80s all week here — and I happened to have the camera out when Inkblot decided he wanted to go inside. What a hulking presence! Domino is obviously not excited by the idea of letting him by, but as it turned out, all went smoothly. Over on the right, however, we see how to make Inkblot look positively puny: just put him inside a gigantic garden pot. Perspective is everything.

Need more cats? Check out Slate's "The Cats of War." Good stuff.

No, We Will Never Be Oil Independent

Republicans have lately ratcheted up their "Drill Baby Drill" rhetoric, and they can now frequently be found claiming that the United States has enormous oil reserves that could make us energy independent if only we opened up drilling everywhere within shouting distance of our borders. This came up yet again during last night's Republican debate and I briefly thought about mentioning how inane this has all become in a blog post. But it was only a few minutes until dinner time, so I skipped it.

Luckily, Michael McAuliff at the Huffington Post has done it for me. You can click the link for details, but the bottom line is that if we damned the torpedoes and drilled like maniacs in every single oil-bearing formation in the country, it would....barely make a dent. Global oil prices would hardly respond at all and we'd continue to import huge amounts of oil every day.

We do have lots of coal, and we also potentially have lots of natural gas depending on whether fracking can be done without destroying the environment. The jury is still out on that. But oil? Forget it. We just don't have very much no matter how crazy we go.

The bin Laden Announcement

If President Obama had delayed the announcement of Osama bin Laden's death, it might have given the CIA more time to trawl through the data seized in the raid and track down other al-Qaeda leaders. So why announce it right away?

Following the operation, officials across U.S. government agencies told their Pakistani counterparts what had happened. As they did, the U.S. government was considering not immediately announcing that they had killed bin Laden, a U.S. official tells Time. But the Pakistanis, uncomfortable with having the information leak out slowly, “encouraged the United States to go public right away,” according to the U.S. official.

That's sort of interesting. Most likely, though, it wasn't so much that the Pakistanis "encouraged" us to announce the raid quickly as it was that they made it clear that the chances of keeping the raid secret were close to zero. Not only was there that downed helicopter in the middle of Abbottabad, but bin Laden's wife and daughter were in Pakistani custody, and word of that would almost certainly leak through ISI or other military sources almost instantly. At least, that's my best guess.

Old Hidden Fees, Meet New Hidden Fees

David Lazarus writes about Bank of America's latest attempt to improve its bottom line via hidden fees:

In the past, BofA would charge 90 days worth of interest for early withdrawals from a CD good for 12 months or less. In other words, a $10,000, 12-month CD with an annual yield of 0.3% would entail an early withdrawal penalty of about $7 if you took out the entire amount.

Now BofA is charging a flat $25 plus 1% of the amount withdrawn for CDs with terms under 12 months and 3% for longer terms.

That means the early withdrawal penalty for that same $10,000, 12-month CD now runs $125 — a nearly 1,700% increase. The penalty for a five-year, $10,000 CD is $325 — a roughly 1,600% increase.

This is yet another example of a fee that (a) most people don't really know much about, (b) most people don't think they'll ever incur, and (c) generally gets paid by people in some kind of distress. In the modern banking industry, that makes it a perfect target for a huge increase. They will do anything — anything — to avoid charging simple, flat, open fees. That would require actual competition with other banks, after all.

Unfortunately, I don't really know what the answer to this is. I have a visceral aversion to doing business like this, but I also understand why they do it: any bank that charged simple, flat, annual fees would lose all of its good customers, who would migrate to banks that make most of their money from penalty fees that they'll never have to pay. Bad customers, conversely, would eventually migrate to the bank with flat fees as they came to realize that it was a better deal for them. So the nice bank would have lots of bad customers and the evil bank would have all the good customers.

If every bank charged simple, open fees, there would be an equilibrium of sorts. But how do you get there? And should we even try? I'd like to, but I can't pretend it's very likely to happen, or even that it's in the top 20 problems facing the poor. So here we stay.

Republicans and Medicare

Proposing to gut Medicare has been politically disastrous for Republicans, and it was pretty obvious that it was going to be a disaster even before they voted on it. So why did they do it? Jonathan Bernstein and Jon Chait offer a few possible reasons:

  1. Fear of primary challenges.
  2. Didn't realize it would be unpopular.
  3. Incompetence.
  4. Creates leverage for budget negotiations.
  5. Helps their deficit narrative.
  6. Makes it easier to pass if they win the presidency in 2012.

Well, sure, I guess it could be any of those things. But Jon Chait almost certainly nails the real reason at the end of his post: "I think Republicans more likely just got caught drinking their own Kool-Aid about how the public agrees with their vision."

Yep. It's the nature of political parties to overreach now and again, but usually they learn from their overreaching. Democrats, for example, have wanted to pass universal healthcare for decades, but they've learned from their losses and introduced steadily more moderate plans each time around. Eventually they finally passed one. But Republicans never seem to get it. They win a big victory (or even a not-so-big victory) and then see sugar plums dancing in front of their eyes when they read the poll numbers. America is a conservative country! Now let's cement their support by being real conservatives!

But America, as always, is ideologically (moderately) conservative and operationally (moderately) liberal. This hasn't changed much since the Nixon era, but Republicans just can't seem to wrap their heads around it. So Ronald Reagan implodes over Social Security in 1982, Newt Gingrich implodes over Medicare in 1995, George Bush implodes over Social Security in 2005, and the tea party Republicans implode over Medicare in 2011. Americans, in the least surprising news ever, still don't trust Republicans to screw around with Medicare or Social Security. Even Republicans don't trust Republicans to do it. Probably it's because Republicans have hated both programs from the beginning and keep trying to wreck them every time they get their trigger fingers anywhere close to the levers of power.

What makes this even weirder is that in just the past decade Republicans have helped their political cause by standing up for Medicare: first in 2003 when they passed the prescription drug plan and then in 2010 when they won a big House majority by beating up Democrats for cutting Medicare. But despite all this, they still don't get it. They're still convinced that someday Americans are going to blink their eyes and suddenly agree that Social Security and Medicare are liberal boondoggles that need to be privatized and slashed. It's just an astonishing unwillingness to accept reality.

Good News, Bad News

Yesterday we had a slew of bad economic reports, including a huge rise in the number in new unemployment claims. Today we have good news: the number of new jobs is up strongly. Conclusion: who knows? Basically, we're undergoing a fragile, unsteady recovery, and I'm not sure you can say an awful lot more than that with any confidence. Steve Benen's chart showing the long-term trend is below.