Richard Posner on the Goldman Sachs Bonuses

Judge Posner, who in addition to being the co-author, with his Nobel Laureate friend, of the Becker-Posner blog is an Atlantic correspondent, has this piece today on the Atlantic's website about the Goldman bonuses. Worth reading the whole thing, but here's an excerpt:

Goldman Sachs, we learned earlier this month, may end up paying more than $20 billion in bonuses to its employees in 2009. The controversial bonuses that American Insurance Group (AIG) had wanted to pay had been intended to reward performance before the company collapsed, and most of the recipients appear to have had no involvement in the decisions that precipitated the collapse.

The Goldman bonuses, in contrast, were intended to reward Goldman's employees for their outstanding performance during the economic crisis. The performance was made possible by the government's having bailed out Goldman in September 2008, when it is believed that, upon Lehman's declaring bankruptcy, Morgan Stanley was 24 hours away from following suit--and Goldman Sachs 72 hours. It was saved by receipt of bailout money and, more important, by being permitted to convert from a broker-dealer to a bank holding company. That entitled it to borrow from the Federal Reserve -- unlike Lehman Brothers, which was denied a Fed loan because it was a non-bank. That was not a sound basis for denying it a loan, but Goldman would have been in the same boat, had it not converted.

So the argument goes: Without government aid then, no $20 billion-plus in bonuses for Goldman Sachs's employees in 2009? Maybe zero in bonuses, maybe indeed, no Goldman Sachs at all. Against that background, the bonuses seem egregious. It seems that the government drove a bad bargain when it bailed out Goldman, that it should have demanded a big chunk of Goldman's future profits.

Posner goes on to note that the majority of the firm's profits in the last year came from proprietary trading, an activity, he argues, that is of limited societal value. Posner posits some negative political and economic consequences of this.

The image above accompanied Posner's Atlantic essay and was credited to Chris Hondros/Getty Images.

Blaming it on the Brooklyn College Guy

Who was responsible for bringing the global financial system to its knees? According to Princeton alumnus Michael Lewis, and MIT alumnus Jake DeSantis (one of the only current or former traders at AIG's Financial Products division willing to speak to Lewis on the record), it was Brooklyn College alumnus Joe Cassano (pictured above), a cop's son whose status insecurities caused him to yell a lot at his underlings over issues as trivial as who left the weights on the Smith machine¹. So claims Lewis in his Vanity Fair article on the implosion of AIG's Financial Products division, "The Man Who Crashed the World" (Hat Tip: Real Clear Markets). Allowing a number of AIG F.P.'s traders to impugn Cassano anonymously was apparently the price Lewis had to pay for his access, but the article is worth reading anyway, as Lewis's Wall Street articles usually are.


¹Given Lewis's familiarity with sports as well as finance, while reading the anecdote about the Smith machine, I wondered if Lewis would bring the Smith machine up later in the article as a metaphor for hedging risk, but no dice.

"Tilting at Green Windmills"

In a post last fall ("A Green New Deal?"), we mentioned Van Jones's explication of the idea, advocated by many progressives, that government subsidies for solar and wind energy would spur job creation. In his Washington Post column yesterday ("Tilting at Green Windmills"), George Will draws on research from a Spanish economist who suggests otherwise. An excerpt:

WASHINGTON -- The Spanish professor is puzzled. Why, Gabriel Calzada wonders, is the U.S. president recommending that America emulate the Spanish model for creating "green jobs" in "alternative energy" even though Spain's unemployment rate is 18.1 percent -- more than double the European Union average -- partly because of spending on such jobs?

Calzada, 36, an economics professor at Universidad Rey Juan Carlos, has produced a report which, if true, is inconvenient for the Obama administration's green agenda, and for some budget assumptions that are dependent upon it.

Calzada says Spain's torrential spending -- no other nation has so aggressively supported production of electricity from renewable sources -- on wind farms and other forms of alternative energy has indeed created jobs. But Calzada's report concludes that they often are temporary and have received $752,000 to $800,000 each in subsidies -- wind industry jobs cost even more, $1.4 million each. And each new job entails the loss of 2.2 other jobs that are either lost or not created in other industries because of the political allocation -- sub-optimum in terms of economic efficiency -- of capital. (European media regularly report "eco-corruption" leaving a "footprint of sleaze" -- gaming the subsidy systems, profiteering from land sales for wind farms, etc.) Calzada says the creation of jobs in alternative energy has subtracted about 110,000 jobs from elsewhere in Spain's economy.

James Kynge's Thesis: "China Continental"; John Authers's Follow Up

James Kynge laid out his thesis for China's continuing growth in the wake of declining exports in a recent Financial Times column, "China Continental". Excerpt:

China is going continental. Just as the US during the 19th century underwent a transition from export-oriented growth to a greater reliance on inner dynamism, so China is looking inwards for the engine to drive its economy.

In China’s case it is still early days, but evidence suggests the conventional view of an export-dependent, river delta-driven economy no longer matches the reality. The argument here is not that trade has somehow become unimportant to China, but rather that the energy generating the world’s fastest economic growth rate this year is increasingly coming from within.

A series of indicators reveals the shift to “China Continental” – the transition of the world’s most populous country into an increasingly self-propelling economic force.

Kynge lists a few different specific metrics to back up his case, including increases in China's retail sales and domestic cargo traffic, and survey results on consumer spending intentions, before addressing China skeptics in his conclusion:

Sceptics argue that China’s performance this year has come through huge but ultimately unsustainable government intervention. Such spending, they say, will boost growth for a time but achieve little but industrial overcapacity in the longer run. These arguments are not without merit, but they miss a newer, more interesting prospect; that Chinese growth is increasingly self-generating and continentally driven.

Recent moves in the commodity markets support Kynge's thesis, as John Authers noted in his Financial Times column today ("China's health gives rise to fresh growth theory"):

Industrial commodities, that benefit most from economic growth, have surged, with lead and copper up more than 50 per cent in three months. Gold, an inflation hedge, has barely gained.

Authers went on to summarize the debate about China's economy (both sides of which have been fleshed out by Kynge and Zeihan, respectively):

As a whole, even before yesterday's strong headline to the US jobless report, world markets were plainly working on the assumption that China has saved the world from Depression. Is the market right to do so?

There are two camps. The optimistic side, laid out by James Kynge in the Financial Times last week, is "China Continental"; like the US in the late 19th century, China can turn itself into a great economic power, by building links to its interior and unleashing its buying power.

The pessimistic side suggests China has poured money into the public sector, and will merely form excess capacity. The huge demand for industrial metals may be artificial.

Electricity generation is down year-on-year. Supply managers surveys show new export orders are barely expanding. So maybe China is caricaturing the US in the 1930s, and paying some people to dig holes and others to fill them in.

If so, the gains could soon be in for another ugly recoupling. Either way, nothing just now is more important than the health of the Chinese economy.

More on the Inflation Debate: Hussman and Wolf Weigh In

In his market commentary this week, "Anything But Academic", John Hussman weighed in on the debate between Paul Krugman and John Taylor. Dr. Hussman first summarizes Dr. Krugman's thesis:

Krugman's argument boils down to the recognition that "monetary velocity" is currently very low - that is very accurate. The problem is that unless it remains low indefinitely, the more than doubling of the U.S. monetary base over the past year, along with the additional issuance of Treasury debt, leaves a far larger quantity of government liabilities to be absorbed until and unless those liabilities are extinguished by fiscal surpluses. The only way to absorb them without driving up the price level is to hold down velocity indefinitely, or to have an equal expansion in real economic output without any further expansion on the monetary side.

And then summarizes Dr. Taylor's thesis (while parenthetically noting his personal connection to Taylor):

In the other academic corner is John Taylor, an economics professor at Stanford (and more to the point, one of my former dissertation advisors), who wrote in the Financial Times last week “To bring the debt-to-GDP ratio down to the same level as at the end of 2008 would take a doubling in prices. That 100 percent increase would make nominal GDP twice as high, and thus cut the debt-to-GDP ratio in half, back to 41 from 82 percent. A 100 percent increase in the price level means about 10 percent inflation for 10 years^[1], but that would not be smooth – probably more like the great inflation of the late 1960s and 1970s, with boom followed by bust and recession every three or four years, and a successively higher inflation rate after each recession.”

Dr. Hussman seems to agree with Krugman's benign view of inflation in the short-term (i.e., the next few years) but share Taylor's view of a doubling of the price level within the next 10 years. Hussman also included an entertaining anecdote in his column which I'll quote below.

There's an economists' riddle that goes “Why are the debates in academia so bitter?” – the answer – “Because the stakes are so low.”^[2] Now, very often, that's true. I remember a presentation that Paul Krugman gave at Stanford where he was talking about a model of economic development. Paul drew a diagram on the board, and as he described it, he drew a few little arrows indicating migration of businesses from one area to another. A respected economic theorist at Stanford, Mordecai Kurz (who never drew an arrow without a differential equation), immediately jumped up and shouted “You haven't described the dynamics!!” to which Paul responded that he was indicating a general movement of economic activity toward one place to improve efficiency. Dr. Kurz pounded the table and screamed “Then erase the arrows!! ERASE THE ARROWS!!” and then stormed out of the room and slammed the door behind him. I think that was probably the exact moment that I decided to go into finance.

Martin Wolf also weighed in on this debate in his Financial Times column earlier this week, "Rising government bond rates prove policy works". It's worth reading in its entirety, as is Hussman's commentary, but here are the most salient excerpts:

Is the US (and a number of other high-income countries) on the road to fiscal Armageddon? Are recent jumps in government bond rates proof that investors are worried about fiscal prospects? My answers to these questions are: No and No. This does not mean there is no reason for worry. It is rather that there are powerful arguments against fiscal retrenchment right now and strong reasons for welcoming recent moves in the bond markets.

[...]

People need to believe that the extraordinarily aggressive monetary and fiscal policies of today will be reversed. If they do not believe this, there could well be a big upsurge in inflationary expectations long before the world economy has recovered. If that were to happen, policymakers would be caught in a painful squeeze and the world might indeed end up in 1970s-style stagflation.

The exceptional policies used to deal with extreme circumstances are working. Now, as a result, policymakers are walking a tightrope: on one side are premature withdrawal and a return to deep recession; on the other side are soaring inflationary expectations and stagflation. It is irresponsible to insist either on immediate tightening or on persistently loose policies. Both the US and the UK now risk the latter. But their critics risk making an equal and opposite mistake. The answer is both clear and tricky: choose sharp tightening, but not yet.

The illustration above, by Ingram Pinn, accompanied Martin Wolf's column.

^[1]Here Dr. Hussman, a former options mathematician, repeats the basic math error Dr. Taylor made in his Financial Times column: due to compounding, it wouldn't take 10 years for 10% annual inflation to double the price level; it would only take about 7.3 years. This error was noted by an FT letter writer earlier this week, who in turn made his own mathematical error in his letter, which was corrected by a subsequent letter writer. All of this raises the question of why one of the world's leading business newspapers didn't have a numerate enough editor to catch Taylor's error in the first place.

^[2]Dick Armey, the economics professor and former GOP House Majority Leader once shared this same quote when asked by a reporter if the debates in academia were more civil than those in Congress.

Are Inflation Fears Overdone?

So say (separately) the editors of the Financial Times and New York Times columnist/Princeton economist Paul Krugman.

In an editorial yesterday ("US not in bondage") the FT editors wrote,

Shock, horror: US government bond rates are jumping. Soon, goes the story, long-term interest rates will leap, the Federal Reserve will monetise, inflation will soar and civilisation will end. Actually, no. What is happening is precisely the normalisation the Fed has sought. The government is not off the fiscal hook. But it does have at least some time.

[...]

What has happened, quite simply, is normalisation of inflation expectations

[...]

Does this mean nobody needs to worry? Certainly not. Desirable normalisation could yet become a panic over the massive prospective bond issuance. Now that the worst of the panic has passed, the administration and Congress need to agree a credible plan for elimination of the huge structural fiscal deficits. As the Congressional Budget Office’s forecasts demonstrate, President Barack Obama’s budget proposal is not such a plan: it leaves deficits of between 4 and 6 per cent of gross domestic product as far as the eye can see. This will need to change soon. But, right now, everybody needs to keep calm. Normalisation is a big success, not a danger.

In his New York Times column yesterday ("The Big Inflation Scare"), Dr. Krugman made a similar point: Inflation isn't a near-term concern, but we do

[H]ave a long-run budget problem, and we need to start laying the groundwork for a long-run solution.

Krugman also brought up the example of Japan, which has borrowed massively in recent years without driving up its interest rates or inflation. What many Americans fear -- our country losing its triple-A credit rating and having its government debt exceed 100% of its GDP -- has already happened in Japan (The CIA World Factbook says Japan's public debt exceeds 170% of its GDP). And yet, Japan's borrowing costs are significantly lower than ours. For example, according to Bloomberg, the current yield on 10-year U.S. Treasuries is 3.46%, versus 1.49% on the 10-year Japanese government bond.

I've wondered for some time about why Japan has so much lower borrowing costs than the U.S., despite having a lower sovereign debt rating and a much higher ratio of debt to GDP, but I haven't heard a convincing explanation yet. When I asked The Atlantic's Megan McCardle about this, she said the answer was Japan's Postal Savings System, but according to Wikipedia, prior to the beginning of its privatization in 2007, that system only held about 20% of Japan's government debt. Perhaps someone will leave a more convincing answer in the comment thread below.

John Mauldin's Latest

A few excerpts from this week's Thoughts from the Frontline newsletter, "Faith Based Economics":

On America's Fiscal Challenges:

The following headline caught my eye: "Obama Says US Long-Term Debt Load is 'Unsustainable.'" Yet they announced a $1.8 trillion deficit, which is really going to be at least $2 trillion, and are getting ready to pass health-care programs that will mean at least a trillion in deficits for as long as one can project.

How will they pay for it? Even getting rid of the Bush tax cuts will only produce a few hundred billion a year, which is nowhere near enough. They project much lower medical costs in the future, because they assume they are going to figure out ways to cut costs and make medical care more efficient¹. As if no one has ever tried that.

[...]

You cannot propose massive increases in spending without either creating crushing debt that the markets will simply not allow, pushing interest rates much higher and really slowing growth and hurting the economy. It is a simple fact that you cannot increase the debt-to-GDP ratio without limit.

We found the limit on personal and corporate debt this past year. We pushed the limits until the system crashed. And now the US government wants to basically do the same thing. They are planning to see where the limits on government debt-to-GDP will be. Unless cooler and more rational heads in the Democratic Party prevail, this is not going to be pretty. Sometime in the middle of the next decade we will hit the wall, and it will make the current crisis pale in comparison.

The only way to solve the problem is to grow GDP more rapidly than debt, and for that to happen you have to have policies which are shaped for the growth of the economy or massive savings by consumers. And right now we have neither. Cap and trade is hugely anti-growth. So are high corporate taxes, and Obama is proposing to effectively raise corporate taxes by closing loopholes for income earned outside the US. Much better would be to lower the overall corporate level to a competitive world rate and then require the offshore income to be taxed.

Some Potential Good News about Health Care:

This week I visited the Cleveland Clinic and went through their Executive Health Program (more on that below). I got to visit for several hours with my doctor, Michael Roizen, of YOU: The Owner's Manual fame (not to mention all his subsequent books). They have now sold over 20 million copies, and I highly recommend them.

I have long been a student of medical trends, and long-time readers know that I think the next really big boom will be in the biotech world. I asked Mike what three things he thought would have the biggest impact in the next five years in medicine. What he said gave me hope, because he thinks there may be some advances in medicine that could help solve some of the basic health issues we all face, and at the same time give us some relief from the high and rising costs of medical care. I was aware of most of the research, but did not know that we were as close as it appears we actually are.

Briefly, he feels there are three developments in late-stage trials that could have major impacts. The first is the development of sirtuin, which so far seems to be delaying the effects of diabetes but also seems to work for a host of diseases that are inflammatory in nature (including many heart-related issues). It essentially delays the symptoms for 30-40 years. While the current trials are for very specific diseases, he thinks sirtuin will have a wide applicability and that it could be huge, as inflammation is the cause of a number of diseases. This could prolong useful life and forestall a number of debilitating conditions.

Second, there is a late-stage-three trial due out soon that promises to increase muscle mass. I have been reading about such developments, but was not aware that something might be available within a few years. This promises to help people stay active a lot longer than currently possible, which will be a good thing if we are going to live longer.

And finally, there is a study and trial which shows that DHA may delay the onset of Alzheimer's disease, which eats up a significant portion of US medical budgets.

It would be a sad irony if pending universal health care legislation leads to price controls which dry up the funding for these potentially cost-saving advances.

¹Megan McArdle had a good post on this on her Atlantic blog earlier this week, "Medicare is going to bankrupt us, which is why we need universal health care". Excerpt:

Perhaps predictibly, someone showed up in the comments to my post on Medicare and Social Security to argue that liberal analysts have very serious plans to cut Medicare's costs, which is why we need universal coverage, so that we can implement those very serious plans.

I hear this argument quite often, and it's gibberish in a prom dress. Any cost savings you want to wring out of Medicare can be wrung out of Medicare right now: the program is large and powerful enough, and costly enough, that they are worth doing without adding a single new person to the mix. Conversely, if there is some political or institutional barrier which is preventing you from controlling Medicare cost inflation, than that barrier probably is not going away merely because the program covers more people.

John Mauldin, Best-Selling author and recognized financial
expert, is also editor of the free Thoughts From the Frontline
that goes to over 1 million readers each week. For more
information on John or his FREE weekly economic letter
go to: http://www.frontlinethoughts.com/learnmore

Hussman's Latest

In In his latest market commentary, "Comfortable with Uncertainty", Dr. Hussman shares some thoughts on dealing with market uncertainty, describes a new autism-related discovery by the Miami Institute for Human Genomics (with which Hussman is involved via his eponymous foundation), mentions that he was the subject of a Money magazine profile (though doesn't link to the article), and throws in a little self-deprecating humor to boot. A few brief excerpts:

On dealing with uncertainty:

In his book On Being Certain, neurologist Robert A. Burton quotes F. Scott Fitzgerald – “The test of a first rate intelligence is the ability to hold two opposed ideas in the mind at the same time and still retain the ability to function.” Buddhist teacher Pema Chodron calls it “being comfortable with uncertainty” – being willing to take every aspect of reality as the starting point, without wasting energy wishing things were different, without denying reality as it is (even if your next step is to work toward changing things), and without needing to know what will happen in the future. “The truth you believe and cling to makes you unavailable to hear anything new. The best thing we can do for ourselves is to be open to an unknown future.”

Burton offers the same advice. Tolerating the unpleasantness of uncertainty, he writes, “is the only practical alternative to cognitive dissonance, where one set of values overrides otherwise convincing contrary evidence. Each position has its own risks and rewards; both need to be considered and balanced within the overarching mandate: Above all, do no harm. Science has given us the language and tools of probabilities. We have methods for analyzing and ranking opinion according to their likelihood of correctness. That is enough. We do not need and cannot afford the catastrophes born out of a belief in certainty.”

Hussman humor:

See, I really can write a whole weekly comment without repeating that the bondholders of mismanaged financial companies should be required to accept debt-for-equity swaps or haircuts, with the alternative being government receivership. Didn't even mention it.

Oops.

The photo of Hussman above, by Nigel Parry, accompanied the Money article ("Best Bear Market Fund Manager Around") to which Dr. Hussman (perhaps in his excitement about the autism discovery) apparently forgot to include a link in today's market commentary.

An Astronomer with a Sense of Humor

A humorous letter to the editor in today's Financial Times, "Buy me a massive telescope or pay the consequences":

From Dr Charles Beichman

Sir, “Give me a billion dollars for my accelerator or I’ll kill your economy.” These words should strike terror into the hearts of bureaucrats everywhere. And the next time they hear them, those responsible for funding big science should immediately just hand over the money.

As your article (“Of couples and copulas,” April 25) on David Li^[1] describes, the flood of theoretical physicists, aka the “quants”, coming into Wall Street after the cancellation of the SuperConducting Super Collider (SSC) created the financial weapons of mass destruction whose power to annihilate wealth is now obvious.

With the loss of trillions of dollars throughout the world economy, how much safer we all would have been if Congress had just paid the ransom over a decade ago and kept all those physicists safe in their laboratory at the Waxahachie, Texas, site of the SSC. So, please, listen carefully when I say that we have one or two major space telescopes that need funding. Otherwise I might consider moving to Wall Street.

Charles Beichman,
Executive Director,
Nasa ExoPlanet Science Institute,
California Institute Of Technology, US

The image above, of David Li's Gaussian copula function, comes from the Wired article by Felix Salmon linked to in the footnote below.

^[1]Creator of the Gaussian copula default function ("the formula that killed Wall Street").

Mark Hulbert Whistles Past the Graveyard

In his column in yesterday's New York Times business section (Strategies: "The Road Back from the '29 Crash Wasn't So Long After All"), Hulbert writes that, although the Dow didn't match its 1929 peak until 1954, investors who bought and held the Dow at its 1929 peak would have been made whole in real terms four and a half years later, thanks to double digit deflation and double digit dividend yields. Of course, today we have a fiat currency and a Federal Reserve committed to fighting deflation, and dividend yields on Dow stocks average in the low single digits, so Hulbert's example doesn't seem terribly apposite.

John Hussman's Latest: "Money Doesn't Grow on Trees"

From Dr. Hussman's latest market commentary, "Money Doesn't Grow on Trees":

On the BofA/Merrill Lynch deal:

[I]nstead of Merrill Lynch's bondholders taking a loss on their bonds, or swapping their debt for BofA equity, those bondholders will now be made whole for all of the losses that Merrill incurred, with 100% principal and interest, right alongside of the bondholders of BofA that are being protected. That's what these bureaucrats want during their stint in government service, that's how they advise our elected officials, and then their revolving door takes them right back to Wall Street.

On what it would take for the banks to earn their way out of their losses:

[T]he earnings to recover the losses have to come from somewhere, which implies a redistribution away from where they were going before. Really, money doesn't grow on trees. We've got an economy running with outstanding debt of about 350% of GDP. Even a moderate percentage of that as loan losses will represent a significant share of GDP. To reallocate enough funds to fill that hole, we would have to keep deposit rates near zero, and corporate lending rates high, so that financial institutions would earn a persistently wide spread, or “net interest margin.” Over the short-term, that's what's been happening, so ironically, banks are more “profitable” today than they probably will ever be. Unfortunately, that “profitability” is an artifact of a) unsustainably wide net interest margins, and b) a failure to adequately book losses, at the encouragement of government bureaucrats.

[...]

In order for U.S. financial institutions to earn their way out of the losses, they will have to accrue and retain an amount on the order of 25% to 35% of GDP. From where will they reallocate that amount?

[...]

If banks were able to sustainably charge high interest rates on loans and pay low interest rates on deposits, the earnings of the banks would come at a cost to what would otherwise have been retained: corporate earnings and private savings. Essentially, savers will earn less, and corporate borrowers will pay more. To accrue 25-35% of GDP to cover the debt losses (which is a mainstream estimate, not a worst-case by any means), you would have to persistently depress non-financial corporate profits and personal savings by about 25% for well over a decade.

As Dr. Hussman goes on to reemphasize, this is a high price to pay to provide 100% protection to the bondholders of poorly-run financial institutions.

"Mad Ireland"

That was the headline of Megan McCardle's post on her Atlantic blog in response to Paul Krugman's New York Times column today about Ireland, "Erin Go Broke". In his column, Dr. Krugman suggested that Ireland got into trouble (it's economy is projected to contract by as much as 10% this year) because it was too free market oriented, noting that Ireland was ranked #3, behind only Hong Kong and Singapore, on the Heritage Foundation's Index of Economic Freedom. What Krugman didn't mention is that Australia, which was ranked #4 on that Index last year (and is ranked #3, switching places with Ireland, on the 2009 Index of Economic Freedom) is weathering the economic storm much better than Ireland or the United States. Australia is in a recession now, but its economy is projected to contract by less than 1% this year. So perhaps having a free market economy wasn't the proximate cause of Ireland's economic troubles.

Megan's post in response to Krugman's column isn't worth quoting here -- the best part of it was the headline, in response to which I wrote,

Hey, is that an allusion to Auden in the headline (from his poem "In Memory of W.B. Yeats"*)? If so, nice: the sign of a tasteful and expensive education (to borrow Neal Stephenson's phrase).

[...]

*I'm thinking of the great line "Mad Ireland hurt you into poetry", which I think of whenever I flip the channels and see Celtic Woman on a local PBS station. I wonder if "Mad Ireland" hurt them into doing their 50-piece Enya covers.

The photo above, of what apparently are the stars of Celtic Woman, is from the Celtic Woman website. Note that the neither the photo nor the name "Celtic Woman" gives a sense of the scope of the enterprise that is Celtic Woman. It appears to be comprised of dozens of Celtic women, along with dozens of Celtic men.

"No Easy Workout"

That headline appeared above a photo of gym-goers working out on treadmills and stair masters at the soon-to-be foreclosed on Fayetteville Athletic Club, in a front page article about distressed debt in the business section of yesterday's New York Times. Apparently the business section's online editors don't have the same sense of humor, since the online version of the article eschews the clever pun of that headline and photo. Instead, the online version leads with this headline, "After the Bank Failure Comes the Debt Collector", and the photo above, of Fayetteville Athletic Club owners Robert and Katherine Shoulders.

The article notes that the Shoulderses borrowed $10 million from a local bank to renovate and expand their health club, and when that bank failed, they stopped paying their interest payments. Then Rick Williamson, "a Chicago banker turned junk-loan buyer", swooped in and bought the Shoulderses' loan at an FDIC auction for 34 cents on the dollar, and sued to foreclose on their property. One question raised, but not answered, by the article is why the Shoulderses didn't bid on their own loan at the FDIC auction (or have a friend do so). According to the article, the Shoulderses were willing to pay the FDIC $6 million upfront to forgive their loan -- so why not bid $4 or $5 million at the auction for their own loan (which Williamson bought for $3.4 million)? Williamson might have backed out then, and the Shoulderses wouldn't today be in danger of losing their business.

Also mentioned in the article was Andy Beal, the self-made billionaire and buyer of distressed debt who was the subject of a previous post here ("A Different Kind of Banker"):

The single biggest buyer at these [FDIC] auctions has been Andrew Beal, a banking billionaire from Texas who made his fortune buying distressed debt during the savings and loan crisis.

By the end of February, Mr. Beal had paid more than $200 million to buy $438 million worth of loans, according to agency records. Some of the loans came from the failed Arkansas bank.

Mr. Beal is hardly averse to risk. He is famous for trying (and failing) to build his own space satellite launch company, and for luring some of the world’s best poker players to a series of games, with him as a participant, and betting pots worth $2 million. Mr. Beal, in a telephone interview, said he went to great lengths not to push people out of their businesses, but at times he had no choice.

“Borrowers force us into litigation,” he said. “They don’t want to perform on their loan, they won’t talk to our workout people. What are we supposed to do, send them a vase of roses?”

Goldman Sachs 666

Another Goldman-related item in today's FT is this blog post by Tracy Alloway, "The Devil and www.goldmansachs666.com", which mentions the existence of an anti-Goldman Sachs website, GoldmanSachs666.com, run by a fellow named Mike Morgan. Here's Mr. Morgan's disclosure note from his site:

Disclosure: Yes, I am short Goldman Sachs stock. I believe this company is evil and should not exist. We need to begin to break up companies that have as much control over world finances as Goldman Sachs.

Ms. Alloway takes something of a cheeky tone in her post on GoldmanSachs666.com, but what Mike Morgan is calling for above isn't too far off from what Alloway's FT colleague John Gapper called for in his column on Goldman today¹:

More fundamentally, we now know unambiguously that Goldman is a “systemically important financial firm”. In other words, Goldman is too big to fail and would be bailed out by the US government if its balance sheet failed. That privilege should come with weighty conditions.

Note that Goldman’s status is a choice, not a tag it has unwillingly been given. It could avoid this by shrinking itself into an institution like a private equity group or a merchant bank, which can take all the risks it desires because its partners lose everything if it fails.

¹The same column we mentioned in the previous post, "John Gapper Brings the Crazy".

"John Gapper Brings the Crazy"

Add the FT's John Gapper to Megan McCardle's crazy contingent¹ for questioning the political influence Goldman Sachs wields via its alumni in government. In his column today ("Don’t set Goldman Sachs free, Mr Geithner") Gapper writes:

Goldman wants to escape the burdens of political control while retaining the benefits of public backing. That does not seem like a good deal for the taxpayer.

There are obvious political risks in letting Goldman roam free while other banks remain bound by the troubled asset relief programme (Tarp). It would exacerbate suspicions that Goldman, with its long history of producing Treasury secretaries, gets special treatment. These were not soothed by the decision to pay off all Goldman’s credit default swaps with American International Group, now controlled by the state.

The bigger danger is the long-term precedent it would set. Goldman wants to bolt before Congress or Mr Geithner, who still operates as a one-man band while the nomination process for his senior staff meanders along, has the chance to change fundamentally how it operates.

So far, it has faced mildly irritating limits on how much it can pay staff but nothing on the scale of the 1933 Glass-Steagall Act, which imposed structural reforms on Wall Street after the excesses of the Jazz Age. It would never acknowledge it, but its political campaign is going just fine.

[...]

[Goldman CEO Lloyd] Blankfein criticised Wall Street’s past pay practices as “self-serving and greedy” but Goldman is still putting aside 50 per cent of revenues – $4.7bn in the first quarter – for the bonus pool. Inside, it may feel “humbled”, as Mr Blankfein said, but it looks like the same old bank.

The same, that is, except for one thing – Goldman is now backed by the US government. That is why Mr Blankfein wants to repay the Tarp money. Once it has repaid the $10bn, Goldman hopes to go back to paying employees what it wants, buying and selling more or less what it fancies and operating as before.

He is peddling an illusion. Even if Goldman repays the equity, the world has changed irrevocably because it is a government-backed enterprise.

The illustration above accompanied Gapper's column in the FT.



¹New readers can see this previous post for an explanation: "David Weidner Brings the Crazy".

Partying Like It's 2009

Apparently, it's not all doom & gloom for "Dr. Doom". Below are a few excerpts from Helaine Olen's profile of him in this month's Portfolio ("The Prime of Nouriel Roubini").

It’s Saturday night. A stream of young fashionistas and other assorted Manhattan scenesters pours into a fashionable Tribeca building. They’re all headed for the loft of a middle-aged economist—a man whose name would hardly have registered with anyone but the most obsessive CNBC watcher a few years ago. A doorman on duty surveys the scene and rolls his eyes. “Another Roubini party,” he mutters.

[...]

Bad times have certainly been good for Roubini’s social life. For years, he has been a manic host of everything from small dinner parties to big bashes. The soirees are more crowded of late, attracting everyone from members of the hedge-fund set to a former Miss Ukraine and propelling the bachelor economist onto the tabloid gossip pages. (He has become a New York Post regular, and CNBC often plays disco music when he appears on the air.)

Roubini’s partying side may have remained below the media radar but for his energetic use of Facebook. He kept his profile on the social-networking site open to the general public until a few months ago, something more privacy-minded users typically choose not to do. On his profile, he said he was single and interested in meeting women, and he posted photos of himself hamming it up with females who look two or three decades younger than he is.

[...]

“I’m a serious professional economist. I live in New York and have a social life,” Roubini says. “I have book parties and social dinners. And, you know, people will take pictures of you with your friends, and there are some attractive women. It doesn’t mean I go out with them. They’re my friends. I have nothing to hide.” When I send him a thank-you email, I can’t resist adding, “If you ask me, the deep mystery at the center of your life is why you would want to subject your apartment to that sort of abuse.” He quickly wrote back, “I do not subject my apt. to abuse. It is nice to have friends over, and I have a housekeeper that cleans up everything afterward.”

Still, Roubini can’t help himself: After [gossip website] Gawker cheekily noted that both he and dating columnist Julia Allison were going to attend the World Economic Forum in Davos, he made sure to be photographed with her there. Gawker’s dry comment: “Nouriel Roubini partying with intellectual peers.” Roubini’s response to me: “She’s a very smart cookie. Very smart. She can intelligently discuss lots of things.”

The photo above of Roubini and a few of his party guests accompanied the article in Portfolio.

Has Nassim Nicholas Taleb Jumped the Shark?

That's a question¹ that came to mind when reading his op/ed in today's Financial Times, "Ten principles for a Black Swan-proof world", parts of which seem strikingly simplistic. Below are a few examples, with commentary.

4. Do not let someone making an “incentive” bonus manage a nuclear plant – or your financial risks. Odds are he would cut every corner on safety to show “profits” while claiming to be “conservative”. Bonuses do not accommodate the hidden risks of blow-ups. It is the asymmetry of the bonus system that got us here. No incentives without disincentives: capitalism is about rewards and punishments, not just rewards.

I wouldn't be surprised if nuclear plant managers do have some sort of incentive bonuses -- and why wouldn't they? The lesson here should be that bonuses need to be structured so the interests of shareholders and managers (and, yes, taxpayers) are aligned, not that bonuses need to be eliminated. In the case of a nuclear plant manager, for example, his bonus might be tied to meeting certain goals for safety, efficiency, etc. Obviously, a bonus that encouraged him to ignore safety would be stupid, but there's no reason to structure a bonus that way.

6. Do not give children sticks of dynamite, even if they come with a warning. Complex derivatives need to be banned because nobody understands them and few are rational enough to know it. Citizens must be protected from themselves, from bankers selling them “hedging” products, and from gullible regulators who listen to economic theorists.

Why deprive investors of the means to hedge their risks? You could argue, as Soros has, that certain derivatives (e.g., credit default swaps) should be limited to those who have an insurable interest, but why ban them altogether?

9. Citizens should not depend on financial assets or fallible “expert” advice for their retirement. Economic life should be definancialised. We should learn not to use markets as storehouses of value: they do not harbour the certainties that normal citizens require. Citizens should experience anxiety about their own businesses (which they control), not their investments (which they do not control).

Where to begin with this one? If citizens shouldn't depend on financial assets for their retirement, on what should they depend? On defined benefit pensions (which, aside from being scarce in the private sector, are themselves dependent on financial assets)? Taleb seems to be suggesting that business owners put all of their assets into their businesses instead of putting some into passive investments, but what of the majority of citizens who don't own their own businesses?

10. Make an omelette with the broken eggs. Finally, this crisis cannot be fixed with makeshift repairs, no more than a boat with a rotten hull can be fixed with ad-hoc patches. We need to rebuild the hull with new (stronger) materials; we will have to remake the system before it does so itself. Let us move voluntarily into Capitalism 2.0 by helping what needs to be broken break on its own, converting debt into equity, marginalising the economics and business school establishments, shutting down the “Nobel” in economics, banning leveraged buyouts, putting bankers where they belong, clawing back the bonuses of those who got us here, and teaching people to navigate a world with fewer certainties.

Then we will see an economic life closer to our biological environment: smaller companies, richer ecology, no leverage. A world in which entrepreneurs, not bankers, take the risks and companies are born and die every day without making the news.

"Clawing back the bonuses of those who got us here" makes some sense, but does Taleb really believe our economy ought to have "no leverage"? Does he envision people buying homes for 100% cash, with no mortgages? Wouldn't the more reasonable suggestion be that we have less leverage instead of no leverage?


The image above, of the Happy Days character Fonzie (played by Henry Winkler) jumping the shark comes from Media Bistro.

¹For those unfamiliar with the phrase, see the Urban Dictionary's definition of "jumping the shark".

An Economic Stimulus Idea That Seems to Work

One economic stimulus idea that has been proposed a number of times is for the government to spur auto sales by offering a voucher good towards the purchase of a new car¹ to owners of old cars. The first I remember reading of such a proposal was last summer, but here are a couple of more recent examples, from the Brookings Institution ("Refuel Economy with Cash for Old Cars") and from the chairman of Ford in the USA Today ("Cash in Old Cars for New Ones"). As the Brookings piece notes, Germany included this sort of voucher program as part of its stimulus package it implemented in January. The German version offers vouchers of 2,500 euros to citizens who scrap cars that are at least nine years old. According to an article in today's Financial Times ("Berlin hit by cost of car incentive scheme"), this German stimulus program is having a big effect, both in Germany and in other parts of central Europe. A few excerpts from the article make this point:

“In February and March, we made about three times the sales we had in the first quarter of last year,” says Bernd-Uwe Prochnow, sales director at a Volkswagen dealership in Frankfurt. “And the first quarter of last year wasn’t bad at all.”

Car sales nationwide rose 11.9 per cent in February, making Germany the world’s only bright spot for the car industry.

[...]

Car-scrapping incentive programmes introduced by Germany and other European Union countries² are having a dramatic impact on central European car factories, and could help boost the region’s slumping economies, write Jan Cienski in Warsaw and Thomas Escritt in Budapest.

The turnround at factories making smaller and cheaper cars has been striking. During much of November and December, the Dacia factory in Pitesti, Romania, stood empty, its workforce at home on 80 per cent pay. However, Dacia, owned by France’s Renault, produces the €5,000 ($6,600, £4,500) Logan, Europe's cheapest production car, which has become a winner thanks to Germany’s €2,500 government rebate available for new car purchases.

Recently François Foumont, Dacia's general manager, said surging west European demand meant exports would account for three-quarters of the company’s production this year, against two-thirds in 2008. Dacia said it sold 25,500 vehicles in Germany last year, and German orders this year already exceeded that number.

In the Czech Republic, Skoda, a subsidiary of Volkswagen, has seen its sales to Germany more than double to 11,000 in February, and the factory in Mlada Boleslav has gone back to full-time production after working only four days a week in January.

Petr Vanek, a spokesman for Hyundai, which has a factory in the Czech Republic, said the plant shipped 20 cars a month to Germany in January and February, but last month delivered more than 2,000. Hyundai is now hiring about 500 workers.

Fiat, which makes small cars in southern Poland, exported 47,417 cars in March, almost 10,000 more than in the same period a year ago.

The image above, of a welder working on a Logan sedan in the Dacia factory in Romania, comes from this ViaMichelin.com site

¹Some have proposed making vouchers good for the purchase of newer used cars too, which would indirectly boost new cars too.

²The article mentions that France offers a voucher program as well, but the French vouchers are worth only 1,000 euros.

"David Weidner Brings the Crazy"

Somehow I doubt we'll see a post with that headline on Megan McCardle's Atlantic blog in response to Weidner's MarketWatch column today, which questions the influence Goldman Sachs has exerted on the government's response to the financial crisis ("Government Sachs is in control"¹). Last month Megan used a similar headline when a Member of Congress raised similar questions about Goldman Sachs ("Maxine Waters brings the crazy"). In that post, Megan embedded the video below, of Rep. Waters questioning Treasury Secretary Geithner, and opined that,

She seems to get all of her questions off of the fringier conspiracy sites.

Some commenters dismissed Waters because of her previous comments, or because she flubbed some basic terminology in this video (e.g., referring to Geithner's deputy -- a Goldman Sachs alumnus -- as his "CEO"), but as I wrote in the comment thread of Megan's post at the time,

Maxine Waters is neither crazy nor stupid, as some here seem to think. She and her family members seem to have done quite well in business dealings trading off of her position²: she has to have some savvy to have been able to do that and not get in trouble with the law (at least so far). Since her family's success in business seems to have been from rent-seeking, she probably assumes that's how big business works too, which may explain her apparent contempt for corporate CEOs. In the case of Goldman Sachs, she may not be entirely off base. It's certainly not unreasonable to ask questions about the ubiquity of Goldman Sachs alumni in influential positions, and how that may have influenced government policies that, so far, have been very good for Goldman Sachs.

¹In his column, Weidner wrote,

Since the fall of Bear Stearns Cos. a little more than a year ago, Goldman has taken more than $20 billion in taxpayer cash through loans, payments and backstops.

[...]

In the last year, Goldman has benefited from Paulson's selective bailouts, a fortuitously timed ban on short selling, a liberal interpretation of bank holding company rules and soon, an easily gamed auction of distressed securities run by the government.

A conspiracy theorist might think this run of fortune has something to do with the former Goldman executives having influential roles in the Treasury Department.

²See this previous post for some examples, "Peering Under the TARP: Foul Waters"

"Fighting Recklessness with Recklessness"

That's the title of John Hussman's latest market commentary. Excerpt:

Look. You can play hot potato with the toxic assets all day long, and only outcome will be that the public will suffer the losses that would otherwise have been properly taken by the banks' own bondholders. You can tinker with the accounting rules all you want, and it won't make the banks solvent. It may improve “reported” earnings for a spell, but as investors who care about the stream of future cash flows that will actually be delivered to us over time, it is clear that modifying the accounting rules doesn't create value. It simply increases the likelihood that financial institutions will quietly go insolvent. I recognize that the accounting changes may reduce the immediate need for regulatory action, since banks will be able to pad their Tier 1 capital with false hope. But we have done nothing to abate foreclosures, and we are just about to begin a huge reset cycle for Alt-A's and option-ARMs. As the underlying mortgages go into foreclosure, it will ultimately become impossible to argue that the toxic assets would be worth much even in an “orderly transaction.”

Meanwhile, in a bizarre convolution of reality reminiscent of Alice in Wonderland, the Financial Times reported last week: “US banks that have received government aid, including Citigroup, Goldman Sachs, Morgan Stanley and JPMorgan Chase, are considering buying toxic assets to be sold by rivals under the Treasury's $1,000bn plan to revive the financial system.” And why not? They can put up a few percent of their own money, and swap each other's toxic assets financed by a bewildered public suddenly bearing more than 90% of the downside risk. The “investors” in this happy “public-private partnership” keep half the upside while ordinary Americans take the downside off of their hands. Some partnership.

With regard to the economy, there is quite a bit of optimism that the recent market advance represents a forward-looking call that the economy will recover in the second half of the year. Indeed, some analysts have noted that year-over-year consumer spending has only declined very slightly, hailing this as evidence that economic concerns are overblown. The difficulty is that consumer spending has never declined on a year-over-year basis, except in this downturn, so that slight decline is actually the worst showing for consumer spending in the available data. Likewise, capacity utilization has plunged to levels seen only in 1974 and 1982, both which were accompanied by far deeper valuation extremes than at present.