Posts tagged ‘banks’

Greek Government Essentially in State of Default

Nice tax refund you have coming .... we think we'll keep it

The [Greek] government has decided to stop tax returns and other obligation payments to enterprises, salary workers and pensioners as it sees the budget deficit soaring to over 10 percent of gross domestic product for 2011.

For all the supposed austerity, the budget situation is worse in Greece.  Germany and other countries will soon have to accept they have poured tens of billions of euros down a rathole, and that they will have to do what they should have done over a year ago - let Greece move out of the Euro.

Government workers and pensioners simply will not accept any cuts without rioting in the street.  And the banks will all go under with a default on government debt.  And no one will pay any more taxes.  And Germany is not going to keep funding a 10% of GDP deficit.  The only way out seems to be to print money (to pay the debt) and devalue the currency (to effectively reduce fixed pensions and salaries).  And the only way to do all that is outside of the Euro.  From an economic standpoint, the inflation approach is probably not the best, but it is the politically easiest to implement.

The Goldman Sachs Strategy

For a while now, a few authors have been quipping at Zero Hedge that the best investment strategy is to do the opposite of what Goldman Sachs is telling is retail customers.  The theory is that if Goldman tells the public to buy, it means that they are selling like crazy for their own account.

This seemed a bit cynical, but on Friday Zero Hedge observed that Goldman was telling its retail customers to buy European banks.  This advice seemed so crazy -- the European agreement last weekly explicitly did not contain anything to help banks in the near term with over-leveraged bets on shaky sovereign debt -- that for the fun of it I played along.  I shorted a couple hundred shares of EUFN, a US traded fund of European financial firms (took a bit of work to find the shares to borrow).

Made 6% in one day.  Thanks Goldman.

Testing My Understanding

Today, US markets are rallying strongly (Dow up 400 points or so at the moment) on news of coordinated central bank action that, that .... that what?  It looks to me like the US and European banks are merely building up liquidity in preparation for potential bank runs.  I would have considered this bad news, kind of like news we just went to DEFCON 2, but for some reason the market is rallying (though there was also an ADP report saying hiring was way up last month, which is certainly good news).

As I wrote yesterday, there only appear to be 3 solutions to the European debt crisis and this is not one of them.  If I am right and patterns hold, the markets will wake up in a day or two and say, "wait, there is still trillions of Euros of deteriorating sovereign debt sitting on bank balance sheets with 40:1 leverage ratios" and fall back.  I am thrilled that our economy shows signs of life and I know that corporate profits have been good, but I don't see any way a European debt crash won't have substantial negative effects on the US.   If I am wrong, the market will continue up, up and away and you should stop ever listening to me because I clearly don't understand squat.

Update:  Yesterday I posited that real solutions were going to be a combination of 1) default/haircut 2) Make someone else pay back the debt and 3) print money.  I have heard it argued this morning that today's announcement may be evidence of #2 (ie, US taxpayers will bail them out) or more likely #3 (since the ECB can't print money, but the Fed seems to be doing a lot of it, lets get the Fed to print more money for the Europeans .... I don't understand the mechanics well enough to pinpoint who would bear the inflationary consequences of this, but betting on the US to be the world's patsy is never a bad bet).

Rearranging the Deck Chairs in Europe

My new column is up at Forbes, and discusses solutions to the European debt crisis.  The problem is that there are really only three, and all are bad, so most solutions being proposed either attempt to disguise that they are bad or to disguise that they are not really doing anything.  An excerpt:

The default option will almost certainly wipe out a lot of powerful banking and financial interests as well as make it very hard for governments to keep spending money at their historic pace.  This will certainly have a bad effect on the larger economy, but we should be careful accepting forecasts of economic catastrophe as most of these come from these same powerful bankers and politicians.   Every group, down to the local dog catchers, argue that the world will suffer a calamity if their particular profession is harmed.  What we do know is that large banks and financial companies are even more intertwined with the political elite in Europe than they are in the US.   We can be pretty certain that, push come to shove, a solution that saves the banks and allows politicians to keep spending will be preferred.

That is why the Europeans will likely end up printing money to pay off the debt.  They almost certainly would be doing so already,were it not for Germany’s strong memories of its Weimar inflation years, when exactly this kind of money printing to pay down government debt led to hyperinflation and political instability.  But the appeal to politicians of shifting the costs from themselves and banks to the average consumer is simply too great to pass up.  If Germany can be convinced, then the European Central Bank will print Euros.  If Germany cannot be convinced, then countries will leave the Euro and print Lira and Drachma.

The Fed and Crony Capitalism

I will leave aside the issue of the recently revealed massive loans from the Fed to various banks.  It can be argued that being the provider of last resort for short-term liquidity in the banking system is a legal, even legitimate, role for the Fed.

But scan this list.  Here are some of the "banks" that got close near-interest-free money from the Fed

  • Verizon
  • Chrysler
  • Caterpillar
  • Harley-Davidson
  • Baxter International

I presume these loans were nominally for their financing arms, but what is the systematic-risk argument for backstopping manufacturer's credit operations?

When I was at McKinsey & Co, part of their relocation package was a $10,000 interest-free one year loan.  I had any number of new recruits say they did not need the loan.  I told them it was a business IQ test.  If you turned down the loan, we revoked your job offer (just kidding, of course).  I took the loan and dropped it into T-bills.

I wonder how many of these recipients really needed the money to survive or just got smart enough to claim dire need and took the money and just dropped it into something interest-bearing.

The True Cost of the Education Bubble

I hinted at it in my last post, but have addressed it in more depth in my column this week at Forbes.  A brief excerpt:

The theme from all these failures is distorted signals and corrupted communication.  People, no matter how savvy, cannot possibly research every nook and cranny of the economy before making an investment.  They make decisions, therefore, based on signals – prices, interest rates, perceived risks, and the profit history of other similar investments.  If these signals are artificially altered or corrupted, bad decisions that destroy wealth and growth will result.

Which brings me back to education.    I will tell you something almost every business owner knows:  We business owners may whine from time to time that banks won’t lend us money, but what really is in short support are great people.  Nothing has more long-term impact on an economy than amount and types of skills that are sought by future workers.  That is why everyone accepts as a truism that education is critical to economic health.

Unfortunately, there is good evidence that our education policies have already done long-term harm.   The signals we send to kids making their higher education plans have disconnected them from reality in a number of fundamental ways, causing them to make bad decisions for themselves and the broader economy.

Examples follow.  Read it all.

Two Lessons From the Last Five Years

I propose two lessons learned from the last five years:

  • There is no such thing as a risk-free return
  • There is no such thing as a perfect hedge
We are very, very close to seeing much of the financial system blow up because banks, particularly in Europe, have bought sovereign debt and leveraged it 30x to 40x.  The theory was that sovereign debt denominated in Euros, yen, or dollars was essentially risk-free.  Once that theory was proved to be bankrupt, financial institutions are now claiming all their sovereign debt is perfectly hedged.  I think we will find that untrue as well.  Hedging mechanisms don't work when the whole of the market is tanking -- its a similar problem to why earthquake insurance does not work.  No insurance company or counter-party can pay off when every single policy has a claim.

Bailed Out Banks Take On More Risk

I found this fascinating, if unsurprising, via Zero Hedge:

Ran Duchin and Denis Sosyura of the University of Michigan looked at the U.S.’ Capital Purchase Program. You may recall that this became the centerpiece of TARP once Hank Paulson decided that the money would be better spent directly buying into the banks as opposed to overpaying them for dodgy asset-backed bonds. (Mind you, other parts of TARP were spent overpaying for dodgy asset-backed bonds.)

The CPP lasted a little more than a year and invested $205 billion of taxpayer funds into various qualifying institutions. Not every bank that filled out the 2-page application was successful in gaining access. Others were approved but ultimately decided not to take the funds (probably because of the attached restrictions on pay and on paying out dividends.) In the end, 707 financial institutions received the funds.

Duchin and Sosyua looked at a sample of 529 public firms that were eligible for CPP and slotted them into categories based on whether they applied, whether they were approved and whether they ultimately took the money. They controlled for non-random selection (via measures of the banks’ financial condition, performance, size and crisis exposure); for changes in national and regional economic conditions; and finally for potential distinctions in credit demand.

They then viewed the banks’ CPP participation status in comparison with their subsequent risk appetite as demonstrated by (1) their consumer mortgage credit approvals or denials (viewed on a risk-profile controlled, application-by-application basis); (2) their participation in syndicated corporate loans for riskier credits and; (3) the risk profile of their investment asset portfolios. What did they find?

They found more risk, across the board.  There is a lot of detail, so I will leave it to you to go to the source for more, but Zero Hedge concludes:

The bail-out itself increased our chances of having the bail the banks out all over again. Moral hazard is no longer in the realm of the abstract

A few months ago I went through an unbelievable hassle refinancing my loan.  Based on current appraisals, my loan to value was less than 50%, but I still ended up coming to the table with more equity to reduce the new loan size.  I was staggered at how hard it was to close what should have been a dead-safe loan, given the LTV and my income and credit history.  The study actually has a finding related to that:

For mortgages the bailed-out banks increased their risk–

“after CPP capital infusions, program participants tilted their credit origination toward higher-risk loans by tightening credit standards for the relatively safer borrowers and slightly loosening them for riskier borrowers.”

–while at the same time ensuring that they didn’t trip off any alarms

“This pattern would be consistent with a strategy aimed at originating high-yield assets, while improving bank capitalization ratios, since the key capitalization ratios do not distinguish between prime and subprime mortgages.”

This is a fascinating sort of metric manipulation.  Having my loan go from 45% to 40% LTV does nothing, really, for the overall safety of the bank, but it improves their averages and makes them look safer, while all the way they are actually engaging in more risky behavior.

China Bubble Bursting

I don't have time today to link all the evidence, but the combination of crashing real estate markets and the Chinese government jamming liquidity into its banks tells me the China bubble is bursting as we speak.

This is an interesting test of the Austrian view of depressions vs. the Keynesian / Krugman / Thomas Friedman / MITI view of government-orchestrated prosperity.  If the latter are right, then China is doing more right to keep their economy going than any country in history and you should go invest all your money in Chinese real estate.

However, if one believes the Austrian model about government-enforced mis-allocation of capital and labor leading to bubbles and crashes; if one believes that the technocrat-beloved MITI was largely responsible for the Japanese lost decade; if one believes that the US govenrment through articially low interest rates and government-directed reductions in underwriting quality helped create the housing bubble -- then the mother of all crashes is looming in China.  Because no country has done more to reallocate resources and capital based on the whims of a few technocrats  and well-connected industrialists than has China.  After all, this is why Thomas Friedman loves China, that it does not rely on the judgement of millions of individuals to allocate capital, but instead on the finger pointing of a few at the top.

The Great Bailout

Peter Tchir via Zero Hedge

The AIG moment was the first time that the US threw any pretense of real capitalism out the window.  Bear Stearns at least was done by JPM with government help.  Fannie and Freddie were taken over, but they were always quasi government entities.  It was AIG that was truly special.  The government didn't even attempt to see if the banks had managed their exposures at all.  The government didn't even care if they had.  They panicked and saved the banks from their own folly - they didn't give capitalism a chance.  The US has never truly recovered from that.  The entire system looks to government support more and more.  Since AIG the Fed has been running at least one massive easing program or another constantly.  The government is lurching from spending program to spending program to keep the economy churning.

At the first signs of weakness we beg for the FED or ECB or the government to do something big and fast.  The European credit crisis seemed a final chance to put some capitalism back into capitalism.  To allow dumb decisions to pay the price for failure.  To reward the institutions that had properly navigated through the risks.  There was even a brief moment when it looked like Germany would do that - would force those who failed to pay the price and support those who had taken the best steps.  But now with Dexia bailed out and some super SIV on the way, it looks like we are once again heading down a path of not allowing failure - in fact we are once again rewarding failure and living beyond your means.  It isn't communism, but it certainly doesn't fit any classic definition of capitalism.

Taxpayers to Fund Bank of America Derivatives Losses?

Or maybe it is more correct to say that the taxpayer is being set up to keep BofA counter-parties whole. From Bloomberg, via Zero Hedge:

Bank of America Corp. (BAC), hit by a credit downgrade last month, has moved derivatives from its Merrill Lynch unit to a subsidiary flush with insured deposits, according to people with direct knowledge of the situation.

The Federal Reserve and Federal Deposit Insurance Corp. disagree over the transfers, which are being requested by counterparties, said the people, who asked to remain anonymous because they weren’t authorized to speak publicly. The Fed has signaled that it favors moving the derivatives to give relief to the bank holding company, while the FDIC, which would have to pay off depositors in the event of a bank failure, is objecting, said the people. The bank doesn’t believe regulatory approval is needed, said people with knowledge of its position.

Three years after taxpayers rescued some of the biggest U.S. lenders, regulators are grappling with how to protect FDIC- insured bank accounts from risks generated by investment-banking operations. Bank of America, which got a $45 billion bailout during the financial crisis, had $1.04 trillion in deposits as of midyear, ranking it second among U.S. firms.

“The concern is that there is always an enormous temptation to dump the losers on the insured institution,” said William Black, professor of economics and law at the University of Missouri-Kansas City and a former bank regulator. “We should have fairly tight restrictions on that.”

Obviously I am not a huge fan of bank regulation, but if the taxpayer is going to insure deposits, then the government has got to set and enforce capital restrictions on how those deposits are invested.  How many times do we have to learn this lesson?  The S&L crisis and the Texas bank collapse of the 1980's was caused by the exact same BS, investing taxpayer insured deposits in increasingly risky investments.

Normally, in a free economy, we expect lenders to enforce rules and discipline on those to whom they lend, just as fire insurers in the 19th century developed the first building codes and inspections to protect their themselves.  But if depositors are insured, they are not going to get worked up too much about BofA -- I am a depositor but I know the Feds will make me whole if the bank crashes.  Deposit insurance provides comfort to depositors and pays some dividends in heading off bank panics, but at the same time it relieves the bank of any accountability for how the deposits are invested unless the US government takes on that role.  Of all the BS regulations financial firms have to put up with, this is the one that should actually exist, and the implication in this article is that despite thousands of pages of new regulation, these basic protections still don't exist.  Sure, they exist in law, but there seems to be nothing to stop an agency from issuing exemptions, and this Administration has shown itself to love giving exemptions.

This reminds me a ton of the AIG bailout.  For some reason, there are a group of Wall Street companies (cough Goldman cough) that seem to have immense political power to protect investments in which they are a counter-party.  To this point, people have been expecting that the BofA holding company might soon fail, but the underlying banks would be fine and just sold off in pretty good shape.  Most of the trash is apparently at the holding company level.

The losers in all this are the counter-parties to these various derivatives, who would rather have a better set of assets to grab if the ship starts sinking.  Of course, they don't have any right to this -- they didn't make these original deals with the depository banks, they made them with Merrill Lynch and other trash BofA has bought.  But never-the-less, the Fed seems fired up to give these guys a special deal.  It reminds me of the Solyndra deal where the Administration allowed certain private parties to move ahead of the US Government on the creditor list, though at least in Solyndra's case these parties actually put some money into the pot for the privilege.  This seems to be a straight giveaway, and it is no surprise that the FDIC is apoplectic.

I Do Not Think That Word Means What You Think It Means

I am sympathetic to the OWS hatred for bailouts and crony capitalism, but struggle to understand how they intend to fix the consequences of the exercise of government power in the private world with yet more exercise of government power in the private world.

Apropos of very little, I found this bit from Matt Taibi funny (emphasis added)

1. Break up the monopolies. The so-called "Too Big to Fail" financial companies – now sometimes called by the more accurate term "Systemically Dangerous Institutions" – are a direct threat to national security. They are above the law and above market consequence, making them more dangerous and unaccountable than a thousand mafias combined. There are about 20 such firms in America, and they need to be dismantled

I am pretty sure that, by definition, a single industry cannot have 20 monopolies.

Though I share the same concern, my solution is to just let them fail.  Right now, the cost of capital for these large companies is lower than the cost of capital for smaller companies because, even though many of them have far worse balance sheets than smaller banks, investors feel they have too big to fail protection.  Let a few fail and have the cost of capital shoot up for larger companies and you can be pretty damn sure they market itself will break up these companies.

In some ways it reminds me of the market premium given in the 1960's to multi-industry conglomerates like ITT.  When the capital markets made their cost of capital low, everyone tried to copy their conglomerate strategies.  When these strategies started failing and companies like RJ Reynolds found their diversification into shipping and shower curtains was a business disaster, capital dried up for these Frankenstein monsters and most of them were broken up.  All without a hint of government intervention, either to save them or kill them.

Its telling that no one on the Left or with OWS who gives this advice for financial institutions takes their own advice with, say, auto companies.  GM should have failed and likely been broken up as well.

Google and Government

This is a pretty interesting interview with Eric Schmidt of Google.  I am running out the door and don't have time to excerpt it, but in short, Schmidt is quite critical of the ability of government to intelligently regulate technology.

His solution is telling.  There is nothing here about reducing the power and scope of government, despite his clear and concise description of its consistent structural failures.  His solution:  more power for my guys.  That way, when Washington plays its game of sacrificing the less connected in favor of the well connected, we will do OK.

I am working on this concept for my next Forbes column vis a vis the Occupy Wall Street movement.  The OWS folks seem incoherent to us, because, in short, they complain about people having unfair power over them and then their solution is ... to give other people more power.   I have reconciled this in my mind with a cold war analogy.  Everyone accepts the arms race as a fact, and so the only way to survive is to have more nukes than the other guy.  The only way to deal with power, is to get more power for my side.

Frankly, its time for disarmament.  As a retailer, I get irritated with credit card processors, but I understood when Congress was considering regulation of interchange fees that giving the Feds the power to set credit card terms, rather than the banks, was not going to make things any easier, just shift the costs from more to less favored constituencies (and consumers are always the least favored constituency).

More later as I sort this out in my head.

Definition of Insanity

I am amazed that the US equity market can fall for the same load of BS over and over again

Stocks finished with strong gains amid optimism about plans to recapitalize euro-zone banks.

Two thoughts

  1. There is simply no source of money (and will) anywhere large enough to fill in the European debt hole.  Heck, there isn't enough money and will to fix Greece, and that is a small percentage of the problem
  2. Even if the current hole could nominally be recapitalized, it would be virtually meaningless because the no one in Europe is fessing up to anywhere near the total extent of the problem.

Countries are going to start to default in Europe, and I don't see any way around it.  The Euro isn't toast but its going to have a lot fewer members in 3 years.  And speaking of bad news, I don't see any way to avoid a massive Chinese bubble burst in the next 3 years either.

Federal Financing Bank?

Bruce Krasting at Zero Hedge has been on the case of the Federal Financing Bank.  I am still unclear if the agency is actually providing the cash or just the guarantee, but it was the one rolling out the Solyndra loan (under DOE auspices, I suppose).

In July, it was still sending cash of some sort to Solyndra - it may be that this was just a drawdown of money under its original loan commitment, or it may be new money.  A couple of things you can see are:

  • A heck of a lot of money was still going out the door to solar programs, likely with no oversight
  • Ford, the supposedly bailout-free company, sure seems to be gobbling up a lot of government guaranteed loans for something.
  • We were lending to Solyndra at 0.89% interest.
All told, a whopping 3/4 of a billion dollars of government guaranteed loans to private companies went out the door in July alone.
Other observations from the report:  The report is hard to read, as it is hard to correlate the new financing activity to changes in the balance sheet.  But there is just a ton of loan activity to rural electric companies.  Wasn't rural electrification an issue in the 1930's?  Isn't it time to let rural electric companies stand on their own two feet and get their own money from the capital markets?
There is also a lot of activity issuing HOPE for Homeowners money - it looks like the government is lending (to banks?) at 0.01% interest.  What is the difference between a 0.01% thirty year loan and a gift?

When Investors Have Police Forces

I have argued many times that private investors, over the long haul, will make better investment choices than the government, in part because they have better incentives and information to guide their decision-making.  The straw-man argument against this is to point out anecdotes of failed private investments.  Heck, I can do that.  Pets.com famously blew through $300 million of private capital with a corporate strategy that never made much sense to people.

The Pets.com investors were chagrined, and probably learned a lesson from their mistake.  Certainly most of us thought the blame, if blame existed, for the debacle rested on the investors for pouring money into a bad proposition.  Certainly no one accused the management of fraud -- I am sure they were diligently, honestly trying to make the company a success, even if they were misguided as to where that success lay.

As it turned out, everyone, not just the Pets.com investors, learned from the mistake.  The failure was an important driver in an industry-wide rethink as to what a successful Internet business model might look like.  This benefit only came because people were willing to acknowledge not just that the Pets.com investment was flawed, but that it represented a systematic mistake that was being made vis a vis Internet startup investments.

Now, consider solar manufacturer Solyndra.  It failed this week, likely taking with it most of $535 million in taxpayer money that the Obama Administration was so eager to give them that it short-cutted its internal processes to fork over the cash more quickly.

Many of us on the outside would love to see the government rethink such investments in a systematic way, and reconsider if it is even possible for the government to make such investments, and in particular whether "green jobs" investments make any sense at all.

But the likelihood of that kind of introspection happening in the public world is about zero, and my bet is that Obama is going to propose more of the same tonight in his speech.

In fact, the Department of Energy (the source of the loan) and the FBI have today sent armed agents into Solyndra looking for evidence of fraud.   While Zero Hedge argues that fraud would be bad for Obama, in fact I think it would probably be the best possible outcome and one he is hoping for.  If he can say, "wow, you and I both got tricked here by some evil folks we are going to put in jail" it deflects attention from the fact that he put a half billion dollars of taxpayer money into a business plan that never made a lick of sense.

Another me-too solar manufacturer with a factory in California of all places was never going to compete in a global commodity market.  This company's plan was always to sell dollars for 50 cents and to make it up on volume.  I don't see how any investor thought this was going to work.  My guess is that the private investors didn't know much about solar and invested because it had a certain hip-ness to it, or less charitably, they knew it never made sense but hoped that Uncle Sam, once it was already in for a half billion, would keep more money flowing or perhaps agree to buy out their production at above market prices.

There may have indeed been fraud, but as in the case of Pets.com, it is perfectly possible no real internal fraud existed and they ran through a ton of money against a stupid business plan that should never have been funded.  Obama would greatly prefer to call it fraud rather than his own failure of judgement.  As an aside, Fannie and Freddie are pursuing exactly the same course in suing banks, arguing that they were defrauded by the banks in buying mortgages, a fairly laughable proposition in the great scheme of things when one considers Fannie and Freddie were at the forefront of the industry in driving down lending standards and promoting the expansion of the mortgage market.

Financial vs. Operating Investors

Kevin Drum argues that Conservatives have vastly over-estimated the effects of capital gains tax changes on investment.

I can't agree with parts of the article that seem to argue that all taxes have limited effects on behavior (this is easily disproved, just look at what the tax code does for preferences of issuing debt vs. equity, or even look at the mortgage market).  But I have always suspected that the political focus on the capital gains tax represents another piece of evidence that financial players (Wall Street, banks) dominate much of economic regulation.

All things being equal, a low capital gains tax is fine.  If I sell some stock, its nice to pay a lower tax on the profits, particularly since at some level those profits have already been taxed once at the corporate level.  Financial players who buy and sell securities live and die by the capital gains tax, and I suppose for businesses there is some advantage in that it perhaps reduces the cost of debt and equity.

But as a business person with my own company, that capital gains tax is largely irrelevant to my investment decisions.   That is because all my investments are made to generate cash flow, and thus the regular tax rate is the ordinary income tax rate.  Perhaps one time in my life, if ever, the capital gains tax will be hugely relevant when I sell my business, but that is at some time in the future so nebulous that it does not affect my behavior.   Other than the double taxation argument, I have never understood why those who take their investment gains in asset value appreciation rather than in income should get different tax treatments.

Rent-Seeking

I know the FDIC is often in a hurry to place assets from failed banks, but this deal appears absurd

The only way I can find that their math might be wrong is if in the loss payment calculation, the contract might add the value of the promissory note to the short sale proceeds, but that does not change the gravy train here.

Credentialism: A Problem that Cuts Both Ways

From the Chronicle of Higher Education via TaxProf Blog

If you want to get a job at the very best law firm, investment bank, or consultancy, here’s what you do:

1. Go to Harvard, Yale, Princeton, or (maybe) Stanford. If you’re a business student, attending the Wharton School at the University of Pennsylvania will work, too, but don’t show up with a diploma from Dartmouth or MIT. No one cares about those places. ... That’s the upshot of an enlightening/depressing study about the ridiculously narrow-minded people who make hiring decisions at the aforementioned elite companies. ... These firms pour resources into recruiting students from “target schools” (i.e., Harvard, Yale, Princeton) and then more or less ignore everybody else. Here’s a manager from a top investment bank describing what happens to the resume of someone who went to, say, Rutgers: “I’m just being really honest, it pretty much goes into a black hole.”

Being, I suppose, an insider to this process (Princeton - Harvard Business School - McKinsey & Company) I'd like to make a few comments

  • First and foremost, this problem cuts both ways.  I can imagine outsiders are frustrated with the lack of access.  But as an insider I can tell you  (cue Admiral Akbar) It's a Trap!  You go to Princeton, think, wow, I did well at Princeton, it would be a waste not to do something with that.   You are a competitive sole, so getting into a top grad school is an honor to be pursued just like good grades.   So you go to Harvard Business School (it could have been Harvard Law) and do well.  And what is the mark of achievement there? -- getting a job at a top consultancy or top investment bank.  So you take the McKinsey job, have your first kid, and what do you find out?  Wow, I hate this job!  In fact, the only thing I would have hated more is if I had taken that Wall Street job.   Eventually you find happiness running your own company, only to discover your Ivy League degrees are a liability since they intimidate your employees from sharing their ideas and most of the other guys you know successfully running businesses went to Kansas State or Rutgers.
  • My only data point inside this hiring process is from McKinsey about 15-20 years ago, so it may be out of date.    But at that time, the above statement would be BS.  Certainly hiring was heavily tilted to the top Ivies and a few top business schools.  But we had people with undergrad degrees from all over - in fact most of our office in Texas had undergrad degrees from the Texas state schools  (at lot from BYU too -- McKinsey loved the Mormons).  At the time, McKinsey was hiring hundreds of people out of business school around the world each year.  No way this could have come from only a few schools.
  • My hypothesis is that this may be more a regional than an industry bias, limited to Boston/New York/East Coast.  Since many top law firms and consultancies and investment banks are in NYC, they reflect this local bias.  But I would bet these same firms and industries hire differently outside of the East Coast.
  • There is some rationality in this approach - it is not all mindless snobbism.   Take Princeton.  It screens something like 25,000 already exceptional applicants down to just 1500, and then further carefully monitors their performance through intensive contact over a four year period.  This is WAY more work and resources than a private firm could ever apply to the hiring process.  In effect, by limiting their hiring to just a few top schools, they are outsourcing a lot of their performance evaluation work to those schools.

A New Bailout?

I just got a note from Bank of America telling me that some of my accounts now have unlimited deposit insurance from the FDIC through 2012, above and beyond traditional limits.   We are worried about reckless banks so we are ...  further reducing and socializing the costs of risk-taking?  Notice I received below, I cannot yet find any info on FDIC site.  As usual click to enlarge.

Hair of the Dog

This is pretty incredible.  It's like the last two years didn't even happen.

A national consumer coalition plans to file a series of landmark federal fair housing complaints beginning Dec. 6, challenging a widespread practice by banks and mortgage lenders: requiring borrowers who apply for FHA loans to have FICO credit scores well above the 580 minimum set by the FHA for qualified applicants with 3.5 percent down payments....

Because FHA insures lenders against losses from serious delinquency or foreclosure, there is "no legitimate business justification" for rejecting applicants solely on the basis of FICO scores that are acceptable to FHA, the complaints contend.

Subprime mortgage customers are generally defined as those under a credit score of 620.  I am surprised that anyone in this environment is offering 3.5% down to any buyer  (though here is the government actually advertising the fact).  But giving 3.5% down to subprime borrowers?

Even with the FHA guarantee, banks have learned that the cost of default for them is not zero.  Only someone who has been in a cave for two years could somehow ascribe this action to discrimination rather than an obvious reaction to the ongoing mortgage crisis.  The government is still out acting irresponsibly, and when private institutions (who actually have to live with the cost of their decisions) try to behave like adults, they get hauled into court.

By the way, this sure does seem to bolster the argument that community banking standards and the pressure from the government and community groups to drop lending standards played a large role in the housing crisis.  If we are seeing this kind of pressure even after the housing disaster, what kind of pressure was at work, say, in 2005?

Via Mark Calabria, who has more

Update: Flashback

"In 1995, HUD announced a National Homeownership Strategy built upon the liberalization of underwriting standards nationally. It entered into a partnership with most of the private mortgage industry, announcing that "Lending institutions, secondary market investors, mortgage insurers, and other members of the partnership [including Countrywide] should work collaboratively to reduce homebuyer downpayment requirements."

The upshot? In 1990, one in 200 home purchase loans (all government insured) had a down payment of less than or equal to 3%. By 2006 an estimated 30% of all home buyers put no money down.

"The financial crisis was triggered by a reckless departure from tried and true, common-sense loan underwriting practices," Sheila Bair, chair of the Federal Deposit Insurance Corporation, noted this June. One needs to look no further than HUD's affordable housing policies for the source of this "reckless departure." If the mortgage finance industry hadn't been forced to abandon traditional underwriting standards on behalf of an affordable housing policy, the mortgage meltdown and taxpayer bailouts would not have occurred."

Backwards

Well, as usual, the progressives have the rights and roles of private individuals vs. government exactly backwards, from Kevin Drum:

As I said earlier, I'm on the fence a bit about whether an indiscriminate release of thousands of U.S. embassy cables is useful. After all, governments have a legitimate need for confidential diplomacy. But when I read about WikiLeaks' planned financial expose [release of private emails from a private corporation], I felt no such qualms. A huge release of internal documents from a big bank? Bring it on!

The government and public officials acting in a public capacity have no rights to privacy of their work and work products from the public that employs them (except to the extent that privacy pays some sort of large benefit, which I would define pretty narrowly).  While things like the recent Wikileak are certainly damaging to things like sources and foreign relations, I have sympathy for such a mass dump when the government so systematically defaults to too much secrecy and confidentiality for what should be public business, mainly to avoid accountability.  The public has the right to know just about whatever the government is doing, in detail.

In the private sector, ordinary citizens have no similar "right to know" the private business of private entities, the only exception being in criminal investigations where there are clear procedures for how confidential private information may be obtained, used, and protected.  Had the proposed email dump related to alleged misconduct, I would have been pretty relaxed about it.  But the proposed document dump is just voyeurism.  One may wish for more accountability processes vis a vis banks, but in a country supposedly still founded on the rule of law, we don't get to invent new ex post facto rules, such as "if your industry pisses off enough Americans, all the material that was previously legally private is retroactively made part of the public domain."

Drum may be gleeful now, but someday he just might be regretful of establishing a precedent for consequence-free theft and publication of private information.   Had, for example, the words "big bank" in the paragraph been replaced by, say, "Major newspaper," we would likely see Drum in a major-league freak out, though the New York Times corporation has exactly the same legal status as Citicorp.

Everyone thinks his own information is "different" and somehow on a higher plane than other people's information.  Drum likely thinks his communication by email with sources is special, while I would argue release of my confidential internal communication about new service offerings and pricing strategies would be particularly damaging.  The way we typically settle this is to say that private is private, and not legally more or less private based on subjective opinions by third parties about the value of the data.

Quantitative Easing: Wacky Progressive Economics or Financial Annealing?

This post is based on playing around with some analogies to try to understand quantitative easing in my own mind.  I can't decide if this approach is helpful or just wanking.  I fear it is the latter, but if we banned all banned all intellectual wanking in blogs,  my feed reader would be virtually empty.

I haven't really written much about the Fed's latest round of quantitative easing, dubbed QE2.  Basically they plan to print some significant fraction (I see different numbers in different articles) of a trillion dollars and use the newly created money to buy government bonds  (they don't actually print the money but create it out of thin air in the memory banks of computers).  As I understand it, the theory is that this will boost the price (and thus reduce yields) on the government bonds on the balance sheets of private banks.  This will in turn have two effects:  improve (at least on paper) the balance sheets of banks, hopefully making it more likely to lend; and it will reduce the yield on the bonds on their balance sheets, hopefully making private loans look like a better investment in comparison.

I am not an economist, and so won't get embroiled in issues I don't understand, but it strikes me that even if one accepts the theory of QE, it will be difficult to have any measurable impact as long as Congress  and the administration keeps generating new debt at astounding rates.

But what is really happening here is that the dollar is being devalued.  This is one of the semantic quirks that make me laugh -- when Argentina or Zimbabwe do this, its called devaluation.  When a western nation does it, it is called quantitative easing.  Because, uh, we are much smarter or something.   But I have to believe that a lot of progressives have hitched their wagon to QE2 out of the hope for some inflation (wow, the revenge of William Jennings Bryant).   Because inflation and dollar devaluation would nominally achieve some of the goals they are hoping for, including:

  • making Chinese imports more expensive, creating a wealth transfer from consumers to a few politically powerful exporters
  • re-inflating the housing bubble while devaluing long-term fixed rate mortgages, creating a wealth transfer from creditors to debtors
  • continuing the wealth transfer from average workers (who typically don't have COLA's) to government and union workers (who typically do have COLA's)
  • acts as wealth transfer from individuals to government since it creates an effective income tax rate increase, as key income levels in the tax tables, particularly where AMT kicks in, are not indexed for inflation

It is impossible to argue that devaluing a currency is a path to wealth generation.  It can't be, though progressives, as always, are willing to tolerate a total reduction of wealth as the price for the type of re-distributions discussed above.

But excepting the re-distribution arguments, it strikes me that the only possible argument for this devaluation is that the economy is somehow trapped in a local minima from which the escape energy is too high.  This would make QE a bit like annealing in a metal, where metal that is heated up and cooled too fast can be hard and brittle.  The only way to get it to be ductile is to re-heat it and then allow it to cool slower.

This is kind of a pretty comparison, but in large part it is probably BS.  The economy is way, way, way more complex and multi-variate than crystallization in a metal.  Even if we were trapped in a local minima, which by the way it is pretty much impossible to determine, we don't know what kind of energy should be applied to the system to move it out.  In fact, if we wanted to use this analogy, it would make far more sense to me to remove barriers to entrepreneurship and wealth creation which likely form a large part of the energy barrier that keeps us in such a local minima.  In fact, the annealing analogy would likely point one in the direction of decalcifying markets and increasing labor mobility rather than massive government interventionism.  It is much easier for me to argue that the missing energy is entrepreneurship rather than liquidity.  Apparently, the German finance minister agrees with me:

The American growth model, on the other hand, is in a deep crisis. The United States lived on borrowed money for too long, inflating its financial sector unnecessarily and neglecting its small and mid-sized industrial companies. "¦I seriously doubt that it makes sense to pump unlimited amounts of money into the markets. There is no lack of liquidity in the US economy, which is why I don't recognize the economic argument behind this measure. "¦The Fed's decisions bring more uncertainty to the global economy. "¦It's inconsistent for the Americans to accuse the Chinese of manipulating exchange rates and then to artificially depress the dollar exchange rate by printing money.

Update: Chinese bond rating agency downgrades US treasuries

The United States has lost its double-A credit rating with Dagong Global Credit Rating Co., Ltd., the first domestic rating agency in China, due to its new round of quantitative easing policy. Dagong Global on Tuesday downgraded the local and foreign currency long-term sovereign credit rating of the US by one level to A+ from previous AA with "negative" outlook.

Things I Am Tired of Hearing

Because I take cash deposits at a number of campgrounds around the country, we have accounts with 30+ different banks.  Every few weeks one of them asks for some outrageously intrusive piece of information or paperwork.  And I ask them, what is this for, and get told that it is "a new requirement of the federal government."  I appreciate the feds have put in all kinds of new bank account controls in a misguided attempt to do something about terrorism (side bet:  most of these have more to do with the drug war than terrorism).  But in most of these cases, either my 29 other banks are breaking the law, or my bank is misguided.  Or worse, BS'ing me by falsely blaming their own information acquisitiveness on the feds.

Today I had a tiny, tiny telephone company in southern New Mexico call me to say they needed my drivers license and a utility bill from a New Mexico resident to add a phone line.  This new phone line is 1) for my corporation and 2) about the 8th account with this same phone company.  Given the area they operate, I may be their largest customer in town.  I told her I thought the requirement that a corporate officer give up his drivers license to get an extra corporate phone line was absurd, and further if they wanted a personal utility bill in New Mexico they would be waiting forever.  After being kicked up to their supervisor, I was told that they would settle for proof of my corporations federal tax ID # and a copy of my lease for the campground in question proving I was the legal occupant.  When asked why -- I mean, do they really have a problem with people paying the phone bill for locations that are not theirs -- they said it was now required by the federal government.

Really?  this sounds like BS.  Again, my 30 other phone companies would probably like to know they are breaking the law.  But who knows, maybe the feds really care.  If I had to bet, this would again be chalked up to the war on terror, but if I really could get to the bottom of it, I would find its about the drug war -- one time somewhere a drug dealer set up a phone line in an assumed name in an abandoned building and now I have to get fingerprinted and have an FBI check to get a phone line (don't laugh at the latter, one still has to get fingerprinted for every liquor license as a holdover from 80 years ago when gangs ran speakeasy's).

Facts vs. the Narrative

The narrative is that small business credit markets are frozen.  John Stossel argues the facts say otherwise?

More melodramatic prose from today's Washington Post: "White House moves to free up lending for small businesses."  "Unfreeze the markets." "Free up lending." Given such language, I would think that loans to small businesses have stopped. The market must be broken, right?

... lending to [small] companies has fallen. Federal data show that lending to small businesses by community banks declined by about $8 billion, or 2 percent, between September 2008 and September 2009.

A decline of two percent. TWO PERCENT. That constitutes a credit "freeze"? Considering the rash of bank failures from 2008 - 2009 due in large part to bad loans made by banks, a decline of two percent in loans to small businesses strikes me as a prudent response.

So does our science-based President address the narrative or the facts?  Here is a hint:  narratives can affect elections, while facts are often ignored.  Therefore, Obama is proposing to use $30 billion of TARP money to so something about the $8 billion drop in small business lending.