Kevin Drum

Kevin Drum Smackdown Watch

| Sat Apr. 18, 2009 12:39 PM EDT

A couple of days ago I asked why Goldman Sachs was paying back its TARP money even though it also had an outstanding $5 billion investment from Warren Buffett on far more onerous terms.  Why not pay Buffett back instead?  What's more, why do a risky capital raising first?  If they're really well capitalized already, why not just pay back the money immediately?

A reader appears to have the all-too-obvious answer: they can't.  The terms of the TARP agreement say this about repurchasing shares other than the Senior Preferred shares issued by the Treasury:

The [Treasury's] consent shall be required for any share repurchases [...] until the third anniversary of the date of this investment unless prior to such third anniversary the Senior Preferred is redeemed in whole or the [Treasury] has transferred all of the Senior Preferred to third parties.

So until they pay back the TARP money, they can't repurchase Buffett's shares.  As for the capital raising, there's this:

Senior Preferred may not be redeemed for a period of three years from the date of this investment, except with the proceeds from a Qualified Equity Offering (as defined below) which results in aggregate gross proceeds [...] of not less than 25% of the issue price of the Senior Preferred.

Goldman got $10 billion in TARP money, and they weren't allowed to pay it back unless they raised at least $2.5 billion first.  So that's what they did.

Unless I'm missing something, this appears to answer all my questions.  Goldman paid back the TARP money first because they were required to, and they raised money before doing it because they had to do that too.  Mystery solved.

Advertise on

Financial Innovation

| Sat Apr. 18, 2009 12:16 PM EDT

Ben Bernanke gave a speech on Friday praising financial innovation and warning that we shouldn't be too hasty in dismantling the progress of the past few decades.  Ryan Avent comments:

According to Bernanke, no one, "wants to go back to the 1970s," but neither could Bernanke point to a truly helpful piece of financial innovation developed after that decade. His examples of successful financial products? Credit cards, for one, which date from the 1950s. Policies facilitating the flow of credit to lower income borrowers was another, for which he credited the Community Reinvestment Act of 1977. And, of course, securitization and the secondary mortgage markets developed by Fannie Mae and Freddie Mac in...the 1970s.

In fact, the only post-70s innovation Bernanke pointed to was the rise of subprime mortgage financing, which, Ryan points out, might not be quite the compelling example he thinks it is.  So what has financial innovation gotten us, aside from massive profits for clever bankers?

Beats me.  I remember that Dani Rodrik asked this question a few months ago, and I also remember that he didn't really get an awful lot of persuasive replies.  The broad answer usually boils down to "easier access to credit," but in hindsight, that wasn't necessarily such a terrific innovation after all, was it?  The innovation crowd probably ought to take another crack at this.

Friday Cat Blogging - 17 April 2009

| Fri Apr. 17, 2009 3:01 PM EDT

Spring has fully and completely sprung, and the backyard is now kitty paradise.  With any luck, it will stay that way for the next six months.  Enjoy your weekend, everyone.

Cuba Update

| Fri Apr. 17, 2009 2:52 PM EDT

The latest from Havana:

Cuba has offered a surprise olive branch to the United States ahead of Barack Obama's regional debut at the Summit of the Americas.

Raúl Castro, Cuba's president, said Havana was open to talks about "everything", including contentious issues which have bedevilled relations for half a century, in a further sign of thaw between the two governments.

"We have sent word to the US government in private and in public that we are willing to discuss everything, human rights, freedom of the press, political prisoners, everything."

And the American response:

The United States welcomes as an "overture" an offer of wide-ranging talks from Cuban President Raul Castro, Secretary of State Hillary Clinton said Friday.

"We have seen Raul Castro's comments. We welcome this overture. We're taking a very serious look at it," Clinton said [in Santo Domingo] at a press availability with Dominican President Leonel Fernandez.

Maybe something comes of this, maybe it doesn't.  But Fidel Castro never would have made such a conciliatory statement, and George Bush never would have responded positively to it if he had.  Times have changed on both sides of the Florida Straits.

Do Not Call

| Fri Apr. 17, 2009 1:47 PM EDT

From the LA Times this morning:

Satellite television provider DirecTV Inc. agreed to pay $2.31 million to settle charges that it made more than 1 million calls to its customers who had — as was their right — placed themselves on a Do Not Call list, the Federal Trade Commission said Thursday.

And why did the company make the calls? To ask the customers to remove themselves from the list, the agency said.

I've been getting daily recorded calls for the past couple of months telling me that THIS IS MY LAST CHANCE to reduce my credit card interest rates.  Finally, instead of hanging up immediately, I decided to listen to the whole spiel and get through to an operator to ask to be taken off their list.  The first one hung up on me.  The next day I tried again.  The operator said "Thank you sir" and then hung up.  The next day I tried yet again.  Finally, I got an operator who actually acknowledged my existence.  And the calls stopped.

That was two weeks ago.  Yesterday the calls started again, though I haven't gotten one yet today.  Apparently, then, the lesson is that it takes three tries to get credit card companies to leave you alone, and even at that they only leave you alone for two weeks.  $2.31 million is too good for these people.

(And anyway, as my credit card company ought to know, I don't carry a balance on my card.  So I don't care about my interest rate anyway.  Idiots.)

Predicting Chaos

| Fri Apr. 17, 2009 1:10 PM EDT

Joseph Nye recently wrote an op-ed complaining that academic political scientists have become too cloistered.  He'd like them to get out more, work on real-world problems, and take positions in government where they can apply their skills and knowledge.

Over at Dan Drezner's site, Georgetown's Raj M. Desai and James Raymond Vreeland fire back, and among other things they say this:

Nye complains about the methodological rigor in contemporary political science as an impediment to its relevance. This is ironic, given that it is precisely this rigor that has allowed modern political science to improve its forecasting power — something that is presumably vital to policymaking. We now have better statistical tools to predict, for example, the likelihood of state failure, civil conflict, democratic breakdown, and other changes in governments. Game-theoretic models can be used to analyze trade disputes and war, as well as the behavior of international organizations, terrorist movements, and nuclear states with greater precision and clarity than just a few decades before.

Really?  Modern political science has improved its forecasting power?  I didn't have the energy to click on all the links above, but I did click on the first one, which took me to the website of PITF, the Political Instability Task Force.  And sure enough, a 2005 paper titled "A Global Forecasting Model of Political Instability" claimed to be able to predict state failure with a surprisingly simple model:

Because the onset of instability is a complex process with diverse causal pathways, we originally expected that no simple model would have much success in identifying the factors associated with the onset of such crises....It was to our considerable surprise that these expectations turned out to be wrong.

....To give but one example, we found early on that lower-income countries showed a higher risk of instability. This is one of the best-established results in the conflict literature, of course, so we sought to improve on it. We not only tried substituting such other standard of living indicators as infant mortality, calories consumed per capita, nutritional status, percent living in poverty, life expectancy, and others for real per capita income, we also tried using a basket of quality-of-life indicators in a neural model that we hoped would provide a far more sophisticated and accurate specification of how income affected instability. Yet no model, no matter how complex, performed significantly better than models that simply used infant mortality (logged and normalized) as a single indicator of standard of living.

....What did matter?....As we have said, to our surprise, a quite simple model without interaction terms and with few nonlinearities is consistently over 80% accurate in distinguishing countries that experienced instability two years hence from those that remained stable.

The model essentially has only four independent variables: regime type, infant mortality [], a “bad neighborhood” indicator flagging cases with four or more bordering states embroiled in armed civil or ethnic conflict, and the presence or absence of state-led discrimination.

Interesting!  Maybe.  But aside from technical questions about whether this model really works (where's the annual prediction of which countries are going to implode within the next 24 months?), does this demonstrate that Nye was right or wrong?  PITF was government sponsored in the first place, so you'd think its academic results would now be in use at the State Department?  Are they?  And if not, why not?

Advertise on

Prosecuting Torture

| Fri Apr. 17, 2009 12:30 PM EDT

Several emailers want to know why I support Obama's decision not to prosecute the CIA agents who engaged in torture of prisoners during the Bush administration.  To be honest, I'm not entirely sure that I do, but in case you're interested, here are the arguments against prosecution that have run through my mind:

First: I hate the idea of spending time prosecuting the little guys while the big fish go free.  If there's anyone we should be prosecuting, it's Bush, Cheney, Addington, Bybee, Yoo, and Tenet.  Until that happens, it's hard to justify prosecuting their underlings.

Second: Every agent would be entitled to a vigorous defense, which would almost certainly require them to make extensive use of classified information.  The government would naturally invoke the state secret doctrine in virtually every case, which would make it nearly impossible to conduct trials that are both fair and reasonably public.

Third: This would be a very, very big operation involving hundreds of prosecutions.  It would almost certainly drag on for many years, and although I'm not a lawyer, my sense is that successful prosecution would be extremely difficult.  The result would quite likely be a long, gruesome, process that would mostly disappear from public view except toward the end, when nearly everyone is acquitted.  Frankly, this might be worse than nothing at all.

Fourth: "I was just following orders" is obviously not an acceptable excuse in cases of clearly illegal instructions.  On the other hand, CIA agents should be able to rely on OLC opinions without constant fear that a successor administration will decide on different legal interpretations.  There isn't a hard and fast rule here, but it's legitimately something that needs to be balanced.

Anyway, my mind is still not made up on this.  It's just a really hard problem.  But I will say that I find #1 persuasive almost all by itself.  If we're going to prosecute the top guys, that's one thing.  But if we don't, it would be a massive miscarriage of justice to prosecute the field agents just because that's politically more feasible.  We really don't want to live in a country that does such things.

CDS and Bankruptcy

| Fri Apr. 17, 2009 11:31 AM EDT

Via Megan McArdle, the Financial Times reports that credit default swaps may be responsible for forcing more companies into bankruptcy proceedings.  The problem, apparently, is that normally bondholders have an incentive to negotiate a deal that would stave off Chapter 11, since a judge in a bankruptcy settlement is likely to force them to take big haircuts on their debt.  If they can do a little better in a negotiated settlement, they'll play ball.

But if their debt is insured via CDS, and the U.S. government has made it clear that CDS will be paid off 100% even if the insurer is underwater, they're actually better off if the company defaults.  From the FT on a couple of recent failures:

"We have seen CDS becoming a significant factor" when negotiations on out-of-court restructurings fail, said Alan Kornberg, the partner in charge of the bankruptcy practice at Paul, Weiss, Rifkind, Wharton & Rice, speaking generally. "We used to talk about the practice theoretically but now we see cases where it is hard to get lenders to agree to tender or to compromise and then you find out that these holdouts had significant CDS protection."

....Some creditors, including Citigroup, which held a small exposure to AbitibiBowater, hedged themselves in the CDS market, meaning their economic interest in the deal was different to lenders who had not bought credit insurance, according to people familiar with the matter. Citigroup declined to comment.

Lawyers say CDS holdings were also a factor in the default and filing for Chapter 11 protection of General Growth Properties this week. Restructuring advisers expect many more such cases involving so-called fallen angels, or firms originally investment grade, since CDS was widely sold on such names.

Presumably this happens because CDS buyers get paid off in the event of a Chapter 11 proceeding, but they don't if they've negotiated the haircut themselves.  This makes sense, since doing otherwise would align incentives too far in the other direction (i.e.,  bondholders would have no incentive to negotiate any value at all in a settlement if they're going to be made whole regardless).  Megan suggests that maybe CDS issuers should be allowed to join reorganization negotiations, the same way ordinary insurers are.  Perhaps so, though that doesn't help with the trillions of dollars of existing CDS whose terms are already set in stone.

Sigh.  Yet another problem for CDS fans to address.

A Question for Goldman Sachs

| Fri Apr. 17, 2009 1:31 AM EDT

Back in September, Goldman Sachs received a $5 billion capital investment from Warren Buffett that requires interest payments of 10%.  A month later they received a $10 billion capital injection from the Treasury that requires interest payments of only 5%.  Given that Buffett's terms are far more onerous, Richard Bove wants to know why Goldman is planning to pay back the Treasury's investment:

"If you were thinking of shareholders first, you would get rid of the most onerous amount first, and that would benefit shareholders....However, if you pay off TARP you are eliminating all of the restrictions on paying management," Bove told "You shouldn't be diluting existing shareholders to pay off TARP so you can pay management more money."

This should become a case study in principal-agent research.  If Goldman management were primarily concerned with shareholder value, they'd pay off Buffett.  But if they're more concerned with their own personal welfare, they'll pay off Treasury.  Apparently they've made their choice.

Needless to say, though, they're not planning to give up all the other government aid they're getting.  From the Washington Post:

Even as they clamor to exit the most prominent part of the bailout program by repaying government investments, firms continue to rely on other federal programs to raise even larger amounts of money....The Federal Deposit Insurance Corp. has helped companies [] borrow more than $336 billion through the end of March, by guaranteeing to repay investors if the firms defaulted. And financial firms hold more than $1 trillion in emergency loans from the Federal Reserve.

Goldman Sachs declared a "duty" to repay the Treasury after posting a first-quarter profit. The chief executives of several large banks at a meeting last month urged President Obama to accept repayments. But no company has similarly pledged to leave the government's other aid programs.

The explanation appears to be simple: Only the capital investments by the Treasury require the companies to make significant sacrifices, such as restricting executive pay.

"The capitalization efforts are actually the most important and are doing the most good, but they come with strings attached, and because they come with substantial strings attached they are getting the most push-back from the banks," said Douglas Elliott, a financial policy expert at the Brookings Institution. The other programs "have no strings attached," he said. "What's not to like about it from the perspective of the banks?"

Perhaps it's time to attach strings to anyone who takes advantage of any extraordinary aid from the government.  If that happened, I wonder how many of these rock-jawed titans of capitalism would still be willing to put their money where their mouths are?

UPDATE: It turns out this is less mysterious than I thought.  Apparently Goldman Sachs paid back the Treasury money first because they were required to under the terms of the TARP agreement.  Details here.

All About Fundraising

| Thu Apr. 16, 2009 10:36 PM EDT

CQ reports:

“Raise money early” is probably the most oft-repeated advice given to the 40 House Democrats singled out by party officials to receive special assistance, as they prepare to defend against potentially serious challenges in the 2010 elections.

A CQ Politics analysis of campaign finance reports filed by the midnight deadline shows that these members are fast learners — they gathered an average of $266,000 in campaign receipts for the first three months of this year.

How depressing.  They've been in town for all of 12 weeks, and instead of spending their time on the million and one real problems we have, they're spending their time raising $20,000 a week.  How many hours a day do you think that takes?

Actually, I read a great piece on exactly this subject once.  I forget where, though.  Washington PostNew Republic?  Not sure.  But it was all about a freshman House member and the endless hours he spent down in the basement of party headquarters (or somewhere), where they have a room full of little booths furnished with nothing but a desk and a telephone.  He'd go down there every day armed with a list of phone numbers of car dealers and bank presidents and assorted other potential donors from his district, and he'd methodically work his way down the list, calling each one and cajoling them for a few hundred or a thousand bucks.  He did this every single day.  For hours.  It gave new meaning to word demeaning.

Anyway, like I said, I don't remember where I saw it.  Which is too bad, because it was a really great piece.  If it rings a bell with anyone, let us know in comments.