Holy cow – what it means to be too big to fail.
AIG Risk & Bankruptcy Report
Holy cow – what it means to be too big to fail.
Touché, David Brooks! Best editorial. Ever. A small taste:
There are times when Masters of the Universe must be Masters of the Grovel. If you are a hedge fund manager and you find yourself in conversation with a person from Ward Three, apologize for ruining the Hamptons, and subsequently, the entire global economy.
I heard a disturbing bit of market intelligence from an investment banker friend. Apparently, several large hedge funds (e.g., $8bn+ under management) put on the “hope” trade in December. In the hope trade, these large hedge funds that were down a lot in the first 11 months of 2008 decided to go “all in” in December and try to bid up equity prices before the end of the calendar year. By boosting prices–which were up about 20% for the month of December–they were able to report higher returns for the entire year in the hopes of staving off distributions. A large asset manager who used to manage almost all my money seemed to be engaged in something similar, so this story seems highly plausible to me. (I have managed to extract myself from my manager after sustaining major but not critical injuries to my personal account.)
So far, the strategy has been OK. But has added even more risk to the US economy. If prices go down (as they have so far in 2009) and the limited partners decide to withdraw their money in March, it could put a lot of additional downward pressure on the stock market. Especially with the baby boomers at or near retirement age, stock declines and net capital outflows could become a vicious cycle. Translation: a run on the stock market!
This scenario isn’t set in stone. If you think that economic conditions will materially improve by March, then perhaps the ‘hope’ trade will pay off. Does that seem likely to you? Soon, the day of reckoning may be upon us!
Having trouble understanding how these trillion dollar bank bailouts work? Krugman does a great job in describing the problem is simple yet precise terms in his column today. The conclusion: buying the toxic assets–the policy proposal being pushed right now–almost certainly won’t solve the problem.
I suppose the rise of these swindlers is inevitable, but I find it still find it disheartening to hear about. I think that honest restructuring of consumer debt is a central aspect of getting out of the financial mess we’re in, and the existence of these misleading or potentially fraudulent folks talking about restructuring will undermine the trust necessary to make restructuring work.
The government should take aggressive action to ensure that restructuring is done properly, or else it is going to be even harder to fix our financial system.
Today, the NYT is reporting that Merrill Lynch’s problems are causing Bank of America to need more bailout money and there is talk about nationalizing the banks. Here’s an email that I sent out to some of the smartest Wall St guys I know on Sept 18, 2008, where my concerns were roundly dismissed. Here’s what I wrote then (emphasis added now):
When Nick and I were playing golf at Stanford yesterday, Nick said that something that puzzled me. He said that bank of america won’t go under with countrywide and merrill lynch because they have all these deposits. There was something to that effect in the NYT too, and John Mack is using it as a justification for merging with wachovia. But here’s the puzzle: deposits are a *liability* for a bank.
So, the answer to the puzzle is that banks have reserve requirements that protect banks (and hence the deposits). And many of the deposits are FDIC insured. I also was thinking about Glass-Steagall act. By covering risky bets with reserve capital, what’s really happening here is that investment bankers are undermining the purpose of reserve requirements.
In other words, as McCain and Obama decry the bailout of AIG, everyone is missing the fact that Thaine and Mack are planting the seeds of a potential crisis of even greater proportion. If/when the government has to bailout large commercial banks to cover deposits, we will be in deep, deep doo doo. And I wonder if anyone is watching as this happens.
Am I just being henny penny here?
So, I do not think that we’ve reached the bottom of the financial crisis yet.
This article in the WSJ raises a provocative question: if government policies brought us the current crisis, shouldn’t we abolish government rather than double down with a gianormous stimulus package?
So, this part is quite interesting:
In the book, these relentless wealth redistributionists and their programs are disparaged as “the looters and their laws.” Every new act of government futility and stupidity carries with it a benevolent-sounding title. These include the “Anti-Greed Act” to redistribute income (sounds like Charlie Rangel’s promises soak-the-rich tax bill)…
but then it starts stretching a little bit:
…and the “Equalization of Opportunity Act” to prevent people from starting more than one business (to give other people a chance). My personal favorite, the “Anti Dog-Eat-Dog Act,” aims to restrict cut-throat competition between firms and thus slow the wave of business bankruptcies. Why didn’t Hank Paulson think of that?
And now the article plunges off the deep end and the analogy seems to be only relevant at the highest level of government bashing:
These acts and edicts sound farcical, yes, but no more so than the actual events in Washington, circa 2008. We already have been served up the $700 billion “Emergency Economic Stabilization Act” and the “Auto Industry Financing and Restructuring Act.” Now that Barack Obama is in town, he will soon sign into law with great urgency the “American Recovery and Reinvestment Plan.” This latest Hail Mary pass will increase the federal budget (which has already expanded by $1.5 trillion in eight years under George Bush) by an additional $1 trillion — in roughly his first 100 days in office.
Well, I think that Ayn Rand is a dystopic future that is not inevitable. And I hope–and believe–that despite some similarities between the current crisis and the book’s premise, that Obama is both not doomed and in fact unlikely to make the same mistakes that animate that famous book.
I’ve started two highly-rated and related conversations about the economy over on e-thePeople. The first one, “Things are worse than you think they are,” talks about how the government has been cooking the books on key economic figures like unemployment, inflation and the GDP and how this deception has contributed to our current crisis (hat tip to my bro for finding this great source for the article.) The second talks about what we can do to get out of this mess (“Economic Stimulus: Burden or investment of a lifetime?“).
The upshot so far to me of these conversations. on the first count, the e-peeps are not too surprised that the government rigging the books but have mixed feelings about whether Obama will come clean. On the second count, some seem mostly cautious about predicting whether the stimulus will work or not, and that we should heed the lessons of FDR. I guess that makes sense because Obama hasn’t spelled out what he plans to do yet.
Both conversations are worth a scan if you have a chance.
The NY Times had this editorial today about incentive bonuses. In the article, he presents seemingly strong evidence that bonuses shouldn’t matter. In experiments in India and MIT, participants who were offered truly substantial rewards performed *worse* than people who were offered small rewards. His conclusion: don’t pay large performance bonuses to investment bankers.
I take exception to the author’s interpretation of the experiments. It misunderstands how incentives operate. Offering higher rewards doesn’t necessarily make individuals perform better. I can only run so fast, and try as I might, I can’t shave a minute off my fastest mile run even if you offer me $1 million or even $1 billion.
However, there are runners out there who can beat my time 60 seconds or more. And some of them are doing more lucrative things, like professional sports or even investment banking etc. If you offered them the right price, you might be able to get them to leave those other jobs and participate in your race.
So, Dan Ariely is way off the mark in drawing the conclusion that investment banks could perform just as well without performance bonuses. Run back to the Ivory Tower at Duke, Dan!
McCain is calling for regulation changes to end mandatory sales of retirement funds at age 70 1/2. Why should people be forced to sell when the market is “hurting”? Ugh! Since when does McCain know how and when the market will recover? In fact, he’s stumbled on to part of the problem: retirees *need* to take out money from the market continuous to live on! That is at the heart of the current (and ongoing) financial crisis.
And ladies and gents, it is only going to get worse as more and more baby boomers approach retirement age. Demographics are destiny!
So, my last two posts have argued (1) that we are faced with a deeper crisis than even the media have lead us to believe and (2) that there is a better alternative to the proposed bailout (and both the bailout and my plan are superior to doing nothing). Now, I want to turn to reform. How can we avoid making the same mistakes again in the future?
In a discussion I launched on e-thepeople, someone referred me to the “genesis plan.” In it, the plan proposes changes regulatory changes to limit/end off balance sheet vehicles, to reform credit derivatives and to re-impose limits on leverage for financial institutions. I find the links between the causes and effects to be well-argued, so I think his proposal deserves serious consideration.
As a long-term regulatory reform package, I think it dovetails nicely with my short-term plan to encourage a quick recovery from the current asset bubble we are in.