So, what is in the Venn diagram that has the financial bailout, the University of Illinois and People magazine meeting in an intersection? Neel Kashkari. Kashkari, who was tapped by Paulson to lead the $700 billion infusion some weeks ago, holds both a B.A. and master's degree in engineering from the University of Illinois at Urbana-Champaign (as well as an M.B.A. from Wharton). Now, he can add to his resume that in 2008 he was included in the "Sexiest Man Alive!" issue of People magazine. Trying to keep everyone's publicist happy, People lists not only the "sexiest man alive," but other sexy men in various categories. Kashkari is in the "Sexy A-Z" category under "B. . . is for Bailout Guru." The editors are saying that Kashkari is sexy, but I guess in a miscellaneous sort of way.
Interestingly, UIUC is overrepresented in the "Sexy A-Z" category, so you may wonder what's going on out here in Champaign-Urbana. Nathan Gunn, a tenured professor of voice in the School of Music, was "O. . . is for Opera Singer."
Permalink | Finance| Popular Culture | Comments (1) | TrackBack (0) | Bookmark
Part II of the Yale Law Journal Symposium on Sovereign Wealth is now on-line, with contributions by Arina Popova (Cravath) and Paul Rose (Ohio State).
Permalink | Finance | Comments (0) | TrackBack (0) | Bookmark
I am working on a project exploring public perception of hedging and speculation. Because of this interest, I noticed two articles in the NYT a week or so ago (yes, I'm a little behind on blogging). The first article was titled "Some Regret Locking in Price for Oil," and reported that customers who rely on home-delivered heatin oil to heat their homes in the winter were given the chance to lock in the price of that heating oil this summer. Many did, but of course the market price for heating oil is now down to around $3 a gallon. This summer, customers signed contracts for fixed prices above $4 a gallon. If the price of heating oil had continued to rise, then the customers would feel very smart; instead the price has dropped and now they are complaining to their heating oil companies.
The second article, "Fuel Hedges Cause a Loss at Northwest," appeared in a different section of the paper. Although fuel has gone down, any profits were wiped out because of its hedges on fuel oil. The article doesn't say what types of hedges Northwest bought or what the terms were, but it should be a wash if Northwest was truly hedging. Other than the costs of the hedging contracts, true heding shouldn't cause a true loss, although it could wipe out a potential profit due to falling fuel costs.
So in these two stories, the customers and Northwest did the same thing -- tried to be prudent in the face of rising fuel costs. For Northwest, who is a user of fuel to create a product, hedging should reduce risk -- both downside risk and upside potential. However, for the customers, who are end-users of fuel, their fixed-price contracts reduced their exposure to the risk of rising oil prices but left them vulnerable when the price declined. But that's the nature of future contracts, right? They are investments, and sometimes investments go down and sometimes they go up.
However, in the case of the heating oil customers, some vendors are negotiating with their customers and not making them bear the full loss. A condominium is mentioned as being able to negotiate a different price for 2009, and a later blog entry on the NYT City Room reports that a Long Island woman quoted in the article was contacted by her oil company, which reduced her price per gallon by $.50. The company said it made sense from a customer relations standpoint.
Permalink | Finance | Comments (1) | TrackBack (0) | Bookmark
As I wind down my stint on the Glom with many thanks to my generous hosts and indulgent audience, I am floored at how far I have strayed from the plan. Two months ago, this was going to be an orderly rollout of brainwaves on somewhat scholarly topics and works in progress. Two weeks ago, this was going to be an interesting way to practice our countercyclical trade. But events intervened with way too many notes for my meagher processing capacity. Paper piles grew, laptop froze, phone, TV and radio talked over one another. I hereby abandon any attempt at coherence with the following loose parting thoughts:
- Following up on David's post, here is today's word from Anne-Marie Slaughter on regulatory networks in the aftermath of the crisis. Slaughter highlights the role of the Basel Committee. At the G-7 press conference this evening, Paulson pointed to the Financial Stability Forum for future regulatory coordination. Note their April and October reports on "Enhancing Market and Institutional Resilience".
- With deposit guarantees and bank nationalizations proliferating, the question of who is responsible for deposits with foreign bank branches is sure to resurface in many ways and many places. Iceland's banks in the U.K. are controversy du jour, but it will not stop there. This old spat between Citi and Wells Fargo over WF's deposits in Citi's Manila branch looks poignant in light of current events: Citibank, N.A. v. Wells Fargo Asia Ltd. (Citibank I) 495 U.S.660 (1990) and Wells Fargo Asia Ltd. v. Citibank (Citibank II) 936 F.2d 723 (1991).
- As to the executive compensation controversy, EU finance ministers have announced principles of their own here (see pp. 13-14; the whole document is a worthwhile window on the EU crisis response). It may look general verging on platitudinous, but French Economy Minister Lagarde suggested this morning that at least some national authorities plan rather substantial measures.
- Those interested in circuit breakers may want to take note of broken circuits in Iceland, Indonesia, Romania, Russia and Ukraine this week. Shutting down stock markets has not done much for confidence so far, but of course who knows how much worse it could have been without, whether this translates to larger markets, etc. Proving negatives is tricky.
- Bloomberg has a readout of the Lehman CDS auction here. It will be fascinating to see how the CDS stock affects what happens in bankruptcy.
- There are people who make a living interpreting G-7 communiques (here is today's). I know not to go there, but refer you to Felix Salmon for the day's accomplishments. David Wessell called it "theater" on Washington Week -- not a compliment in this environment. Let us see what the G-20 do tomorrow.
- Morris Goldstein has a lucid take on regulation in the aftermath. See his recent talk here; video here.
- Further to the mark-to-market controversy, regulatory accounting adventures are crisis perennials. U.S. v. Winstar 518 U.S. 839 (1996) is famous. My favorite example is this 1989 letter from the SEC to the U.S. Treasury, which allowed banks to reduce developing country debt by 30-50% without booking losses. Download sec.Mulford Letter.pdf (reprinted from Hay & Paul, Regulation and Taxation of Commercial Banks during the International Debt Crisis).
Many thanks and all the best.
Permalink | Finance| Financial Crisis| Globalization/Trade | Comments (2) | TrackBack (0) | Bookmark
Jeff Lipshaw does a back of the envelope calculation here; his answer is that it appears that well governed companies are losing more value, on average, than the rest of the market. I suspect other factors may be contributing to the decline - many of those companies are financials, and Jeff's calculation isn't weighted in that or other ways - but the observation is very interesting.
Permalink | Finance | Comments (0) | TrackBack (0) | Bookmark
EESA is a week old and already irrelevant--or at least the TARP part where the Treasury is supposed to be buying up bad mortgages and mortgage-backed securities. As world markets continue to tumble, it's clear that EESA has had little positive impact on bank lending or market confidence. We always knew that buying up bad bank assets was only an indirect way to pump up bank capital. Now, it looks like more drastic measures are afoot.
Yesterday, central banks coordinated emergency interest rate cuts in an attempt to spur lending globally. The Treasury is now considering 3 aggressive moves to get bank lending back on track:
1. injecting capital directly into banks by buying equity stakes ;
2. guaranteeing interbank debt; and
3. extending deposit insurance to all bank deposits.
The interbank debt guaranty is a UK proposal, where such a guaranty is being implemented. The move to buy equity stakes raises strong doubts as to the efficacy of last week's plan to buy up mortgage assets. Existing EESA authorization is likely broad enough to encompass purchase of bank equity stakes. EESA's definition of "troubled assets"--authorized to be purchased under TARP--includes "any other financial instrument that the Secretary . . . determines . . . is necessary to promote financial stability."
Keep your fingers crossed.
Permalink | Economics| Finance | Comments (6) | TrackBack (0) | Bookmark
Iceland may ask for a loan from the IMF to go along with the $5 billion from Russia. Until this bit of news, many folks I know were scratching their heads in wonder at why Russia and not the Fund. Maybe it was false pride. Maybe they thought Russia's friendship (see Ed Luce in the FT) was preferable to IMF conditionality. Maybe in today's weird world, where raising money from foreign sovereigns is Wall Street Normal, a Russian loan looked like a market solution.
Today's New York Times feature on Iceland starts with the improbable "People go bankrupt all the time. Companies do, too. But countries?" Actually, countries probably go bankrupt way more often than people on a per capita basis (if only because there are fewer countries and most live longer than people or companies). Here are some examples. Deep inside, a concession: "Nations have gone bankrupt before, of course, but countries like Argentina -- not a country that thinks of itself as closer to Europe than the developing world." Actually, Argentina often thinks of itself as Italy. And Russia is in the G-8. And the U.K. is nationalizing banks. Anyway, it goes to show that we are all emerging markets now. Submerging, actually.
Permalink | Finance| Globalization/Trade | Comments (2) | TrackBack (0) | Bookmark
Awhile back, Gordon posted about speaking with journalists on the phone, and even sponsored a poll seeking to get professor-reader input on chatting with the media. I for one almost always talk to reporters who call me. Especially local reporters from the C-U or Chicagoland area. We're a state school. I kind of think that's my job. Anyway, a local news radio person called yesterday to talk about "what's been going on with the banks," and I'm afraid our conversation just annoyed him. Here are at least three reasons he'll never call me back:
1. He wanted me to explain the entire credit crisis in 2 sentences or less. I can't do it. I pride myself on being able to explain fairly complex areas of law and finance briefly and succinctly, but the interconnectedness of the mortgagor, mortgage broker, holder, purchaser, investor, insurer, etc. takes more than two sentences (unless the sentences are run-on and very ungrammatical). There is no quick and easy soundbite answer. I can't explain the theory of relativity in 10 seconds either. I'm not going to misrepresent the actual situation by saying something pithy but not apt like "Wall Street gobbled up Main Street mortgages like they were candy and now has a bad case of Montezuma's Revenge."
2. He asked me who the bad guys were in this scenario, and I wouldn't give him one. I told him that we may found out that this is no one's fault and that there are no bad guys. A chain of people misassessing risk multiplied into a very big problem. Although it's hard to sell $700 billion to the taxpayers without someone going to jail, I could easily believe that there are no bad guys.
3. He asked me if the situation was going to get worse, and I said yes and no. I said that we might return to an era where it is hard to get a mortgage. People just won't be able to pick up the phone or get on the internet and get a $300k mortgage without a credit history or documentation of earnings. I made the mistake of saying, "And that's probably not a bad thing." That's when we got disconnected.
Permalink | Finance | Comments (7) | TrackBack (0) | Bookmark
Apropos David's and Gordon's posts, for years now, G-7 gatherings have served to highlight the group's waning relevance. Having China to lunch every summer made no dent in the global imbalances that landed us in the current puddle, and made the old-power finance ministers look less, not more important. As reform proposals mushroomed (e.g., Bradford and Linn at Brookings, Bergsten at the Peterson Institute), G-groups old and new seemed to just plod along in search of coherent missions.
Today's tandem rate cut is a hopeful sign for good old-fashioned macro coordination, especially in the wake of recent European flailing. The officially-coordinating cutters were the central banks of Canada, the United States, the United Kingdom, Sweden and Switzerland, along with the European Central Bank. This covers six out of the seven G-7 and ten out of the eleven (yes) G-10 (Japan cheered). China and a few other G-20 went along without admitting to formal coordination. This FT exposition is most helpful.
Wednesday's actions make the G-7 and IMF meetings in a few days a much more interesting prospect. Recent events do not exactly rebut criticisms of the G-7, but they may spur its morphing into a credible successor and/or prod a sensible evolution of the G-missions. To wit, Bloomberg reports a special meeting of G-20 finance officials this weekend (they will be in Washington anyway for the IMF/World Bank annual meetings).
It will be interesting to see the extent to which all this translates into regulatory convergence.
Permalink | Finance| Globalization/Trade | Comments (0) | TrackBack (0) | Bookmark
NYU's Nouriel Roubini has been a consistent and delightful prophet of doom for years. His Twelve Steps to Financial Disaster from last winter are classic, famous, and kind of scary seeing as he looks way more right than wrong. Scary is seasonal, and it seems the market for Roubini paraphenalia is one of the few up these days -- here is a Halloween mask to start your collection (ok, so it's free ... but then again, people are lending money for free to the U.S. Treasury!). I hope Nouriel's business, RGE, takes this as a prod to start a merchandising operation. The Stimulus We Need.
Permalink | Finance| Holidays| Humor | Comments (0) | TrackBack (0) | Bookmark
"Unfreezing" is the hopeful word of the day. Everyone has been talking about a "credit freeze," but the credit markets made a dramatic turn early this afternoon. What happened?
The turn didn't happen upon news of the globally coordinated interest rate cut. Indeed, the reaction all morning was negative. One CNBC commentator suggested that the key may have been the President of the European Central Bank Jean-Claude Trichet, who said:
"We are there to be up to our responsibility, we call all authorities or institutions -- whether private or public -- to be up to their responsibilities, and we expect the market participants ... to be themselves up to their responsibilities.
"[Market participants] had clearly underestimated risks in the past, before the turbulences started. I would not like them, with the pendulum going totally in the other direction, to overestimate risks in general."
By the way, Reuters attributes the shift in stocks to "bargain hunting."
Permalink | Finance | Comments (5) | TrackBack (0) | Bookmark
While Larry Ribstein is shadow boxing with SOX II, I am looking at today's interest rate cut by central banks around the world and wondering how long it will take before talk of a new global financial services regulator begins to gain traction in the US.
We in the US tend to be a tad self-absorbed, so we see Lehman failing and other U.S.-based investment banks floundering, and we reflexively think about domestic solutions. In the meantime, the rest of the world is absorbing the shock waves emanating from New York and thinking that a global financial system may require supranational oversight. The idea is already being promoted in England and elsewhere.
Will it catch on here?
It's not surprising that the global coordination described by David was initiated by central banks, not elected politicians. Civil servants are more inclined to take a long view and less inclined to play to local interests. My hunch is that U.S. politicians will remain focused on domestic solutions (is there any doubt that SOX II is already being drafted?), but the SEC, the Fed, and other domestic agencies will step up their efforts at global coordination, encouraged by the IMF, the World Bank, and other existing institutions. These things take time, but the drift in the direction of a new global financial services regulator is already perceptible.
Permalink | Finance| Globalization/Trade| Securities | Comments (4) | TrackBack (0) | Bookmark
My friends who practice international political economy have long flogged the fuzzy line between states and firms, public and private capital. It has been truly striking in recent days to see the distinctions dissolve in mainstream policy talk.
- Lehman 2008 is Argentina 2001 – a long-overextended debtor whose lenders should have known better. Both marked lines in the sand for official assistance; Argentina’s turned out to be cleaner – no one else collapsed in its wake.
- Wall Street now is Asia ten years ago. In this view, both are victims of liquidity runs that brought about self-fulfilling collapse, except “[f]or countries then, read banks (or markets) today.”
Iceland is a hedge fund. Russia, poised to inject capital in Iceland, must be … an offshore billionaire … or China.
This rhetorical turn has interesting implications for regulation. There is no true lender of last resort or regulator for countries going down the tubes – the IMF’s attempt to fill that role in recent decades illustrates the point, sometimes tragically so. Does the new talk reveal regulatory impotence? ... (And for the optimists:) reframe the mandate for international cooperation?
Permalink | Finance| Globalization/Trade | Comments (1) | TrackBack (0) | Bookmark
I get a lot of questions about future regulation of the $60+ trillion CDS world in the wake of the crisis. (Here is Sunday's 60 Minutes backgrounder featuring Frank Partnoy.) Bear, AIG and Lehman were major shocks that reopened some long-closed debates on overseeing the OTC derivatives market, including the ten-year-old truce on regulating swaps. Two options come up with some frequency: Central Counterparty Clearing and chasing more or most CDS contracts onto regulated exchanges. Monday's meeting at the New York Fed was an important step on the path to the former. For policy views and design preferences, see this 2006 speech by Fed Gov. Kroszner.
...
The $8.4 Countrywide settlement is in the press. (See here the NYT article and Angie Littwin's post on Credit Slips.) This quote from Illinois AG Lisa Madigan caught my eye: "We have created the first comprehensive, mandatory loan modification program with the largest loan servicer in the country ..." So far, all the modification efforts -- legislative and executive -- have been voluntary and piecemeal. Devil in the details, forthcoming.
Permalink | Finance | Comments (0) | TrackBack (0) | Bookmark
... that coincidentally happens to be both the size of the U.S. TARP and of Germany's blanket guarantee of private savings, extended on Sunday. Ireland went first, with a blanket guarantee of all liabilities for six big banks.
As governments everywhere are taking over financial and quasi-financial institutions everywhere in the heat of the moment, Willem Buiter proposes "a permanent shareholding for the state." The predicate in a nutshell is this: "As the financial sector grabs for the public nipple at the first sign of trouble, it is imperative that the price of the milk obtained at the public breast be made painfully high - both to achieve fairness and political acceptability and to encourage more responsible behaviour in the future." It strikes me as a mother and a bureaucrat that parenting is harder than nursing.
Permalink | Corporate Governance| Finance | Comments (1) | TrackBack (0) | Bookmark
Since the credit crisis began, “beggars can’t be choosers” (BCBC) has become an increasingly prominent argument against restrictions on sovereign wealth fund investments in the United States. Here is one of my favorite examples, arguing against disclosure lest the citizens of Wealthland get wind of their government losing money on Wall Street while being badmouthed in Washington. Whatever your views might be on sovereign investment, BCBC strikes me as a lousy premise for regulation. Even now. But I heard a more nuanced and sensible variation on the argument at a conference yesterday: the fact that investment flows are drying up raises the potential cost of regulatory overreach; it should not preempt a debate on the merits.
Of course this may be a distinction without a difference. Greg Ip at The Economist observed at a talk today that Sen. Schumer had led the fight against the Dubai Ports deal a few years ago, but now may send banks hither and yon in search of capital. Here is some evidence of Schumer moderation, but hardly a turnabout. Schumer puts a surprising lot of stock in the IMF-brokered (NOT/NOT IMF-written) principles coming out next week. My two cents on the principles and the sovereign wealth brouhaha are here (a short version sans footnotes coming up in The International Economy).
Permalink | Finance| Globalization/Trade | Comments (0) | TrackBack (0) | Bookmark
Yes, yes, the bailout bill passed 263-171, and the Dow is up 1% as of this writing, but did you see what happened during the vote? 50 point drop. Just the sensible pricing of risk by those cool heads on Wall Street, no question.
Permalink | Finance | Comments (2) | TrackBack (0) | Bookmark
Fortis, the failed financial conglomerate jointly rescued on Sunday by the governments of Belgium, the Netherlands, and Luxembourg, has assets several times the size of the Belgian economy. Each of the three governments took 49% of Fortis’s banking subs in their respective countries; the total price tag was just over $16 billion. Gives one pause about the prospects of financial regulation at the national level. At least we have a global lender of last resort, says Brad Setser.
Permalink | Finance| Globalization/Trade | Comments (0) | TrackBack (0) | Bookmark
The folks at the Glom kindly scheduled this guest blog to coincide with the release of the IMF-brokered code of conduct for sovereign wealth funds, due out in early October. Who knew we would be in the middle of the Greatest Crisis since the Great Depression. With the Paulson package defeated and oblivion upon us, it seems appropriate to start with a long view on sovereign wealth and crises:
Earlier this month, the FT reported that KAMCO, Korea’s state-owned asset management company, is looking to buy just under a billion dollars’ worth of distressed U.S. assets. Ten years ago, KAMCO was reorganized in the wake of the Asian Financial Crisis to take bad loans off the books of Korean banks. At the time, there was huge opposition to selling assets to foreign investors at fire-sale prices. KAMCO more or less finished cleaning up at home by 2003, and began developing its international asset management and advisory business. Now it is time to go shopping. Assuming some version of an AMC will come out of the U.S. Congress before the world ends, at least we have something to look forward to in a few years. FWIW, Badbank Harmony (KAMCO’s consumer arm) is a fetching name.
Permalink | Finance| Globalization/Trade | Comments (0) | TrackBack (0) | Bookmark
The quick and dirty: "In what is by far the largest bank failure in U.S. history, federal regulators seized Washington Mutual Inc. and struck a deal to sell the bulk of its operations to J.P. Morgan Chase & Co."
The shareholders and creditors of WaMu are the big losers. WaMu customers appear to be unaffected. The big winner is JP Morgan (see WSJ story linked above):
The deal will expand J.P. Morgan's footprint westward and into the South. Most importantly, it will give J.P. Morgan an instant presence in two states where it is now virtually non-existent: California and Florida. Although both states have been battered by the housing market collapse, they still offer significant potential for J.P. Morgan, which can pitch a slew of financial services that weren't big business for WaMu, such as wealth management and commercial banking. WaMu has nearly 700 branches in California and operates more than 250 branches in Florida.
The crazy thing is that this story looks ho hum beside the bailout negotiations.
Permalink | Finance | Comments (3) | TrackBack (0) | Bookmark
When I meet someone who claims to live by just a few “tried and true” simple rules, I tend to wrinkle my nose. How unsophisticated! Un-nuanced! Anti-intellectual, even! After all, the world is a complicated place. Life by platitude must, therefore, oversimplify, over-generalize and exclude the gray areas that matter.
Oddly, though, many of the most successful people I know – successful in all kinds of ways – from making fortunes to finding inner peace—share a certain certainty about things. They have a few simple rules, and they live by them.
So, for example, over the last few days I am quite certain the boring certainty of a John Bogle (of Vanguard Group fame) is looking pretty sophisticated. While not completely unscathed, if you followed the standard asset diversification advice given by such unsophisticated, old-fashioned guys like Mr. Bogle, your volatility these last few days would have been quite tolerable. More importantly, you would be in a position to hold on, play another day (or decade for that matter) and see your portfolio recover and indeed prosper as good times return. In fact, counter-intuitive as it may feel, assuming you didn’t “lose your seat” last week, you should be looking at your nest egg with an even greater sense of ease. Last summer your nest egg was much less likely to grow as a source of wealth for your needs than it is from here. While I now have less of it, I am much more confident that the money I do have will be adequate for the job I expect it to perform.
Of course, this is precisely why the Fannie Mae’s, Lehman’s and AIGs of the world have gone to heck. Instead of making certain that they would always “keep their seats” and “live to play another day,” they piled the chips on double zero and rolled the dice. They did that because along the way they forgot to “keep it simple.” Higher returns require higher risk. “Absolute return strategies” that offer returns above that of government bonds do not offer “absolute” returns by definition. A simple rule tells us that. No risk, no reward. Ask any hedge fund manager how he makes money after the world quickly discovered the easy money one could make in the early days of arbitrage or currency trading. He’ll tell you, he takes risk.
So let me offer one more anti-intellectual suggestion. As we ponder the regulatory solutions to the current mess, my suggestion is we keep it simple. The reason why financial institutions blow up is the same reason houses go into foreclosure. People take risks they cannot fully insure. Normally people are pretty good about avoiding such extreme positions because they understand the downside and wisely avoid it. So if I am going to lose my 20% down payment on this condo if I can’t support next year’s mortgage payments, I’ll buy a cheaper one where I am certain I can “keep my seat” in a down-turn. By appealing to human’s natural optimism and avarice while at the same time masking or often eliminating the downside cost, the home lending market created a “heads I win, tails who cares” environment for home buyers that eliminated the “old fashioned” calculus that defined prudent home buying and finance.
Similarly, both a hedge fund manager and the CEO of an investment bank or multi-line insurer (both being not much more than a hedge fund in some other drag), face a similar temptation. If I take cheap and plentiful financing (put simply, borrowed money), put it into so-called “absolute return” investments (put simply, those complicated deals that some Math PhD can demonstrate will not lose money in any scenario within a standard deviation of x and certainty level of y, blah, blah, blah), I get to keep 20% of the upside (which the model and my own natural optimism tell me is very likely to be big) or take early retirement (or hit the beach until the next cycle of mania comes) if it all blows up (which it probably won’t). Well, hindsight bias tells us that it was obvious this was a bad choice for Fannie, Freddie, Lehman, Bear, etc. But put yourself into their position ex ante if you can. It’s a “no brainer.” I for one, would swing and swing hard, just like they did. Black Scholes tells me that the option value alone of the proposition means a rational person would put as many chips as possible on the most volatile positions he can get away with. And that is exactly what they did.
So how do we keep it simple if we are going to “regulate” this problem? We change this equation. Make people play with their own money, and lose it if they are wrong. That means, for one, no bail outs. It also means that the new transparency the world needs through regulation is the means to better understand whether the people on the other side of a trade have any skin in the game. It turns out, as a simple rule has told us all along, it makes a big difference when we deal with people with something to lose.
Permalink | Finance | Comments (12) | TrackBack (0) | Bookmark
No one likes The Paulson Plan. If you don't enjoy CSPAN, you won't think much of the following video of hearings before the Senate Banking Committee, and I admit that most of it is pretty dull. But you can hear a few drumbeats: why should the taxpayers pay for this? what about people who need help with their mortgages? why should those who got us into this mess not have restrictions on their compensation? where is the oversight?
You also hear occasional references to future changes in the regulatory system ("complete overhaul" were the words used by one member of the Committee).
And then there was this question from Senator Robert Menendez (New Jersey): "How many times can the administration be wrong and still instill confidence?"
Isn't that really the heart of the matter? We simply don't trust Paulson, Bernanke, Cox, etc. to get this right. Last week, Robert Reich asserted, "The crisis on Wall Street right now is less about solvency and about capital than it is about trust. And the real question is, How do you restore trust to a system in which, basically, nobody trusts the numbers that are supplied by big banks on securities?" The question this week is, How do you restore trust to a system when we don't trust those who are trying to intervene? My sense is that this lack of trust, more than the details of the Paulson Plan, lies at the heart of the widespread discontent with the proposal.
Permalink | Finance | Comments (5) | TrackBack (0) | Bookmark
I have been traveling all week, but trying to keep up with the biggest U.S. government bailout since, well, since Wednesday. Thanks to the rest of the Glom for keeping us all informed ("the depression will be liveblogged").
Is this bailout a good idea? That's the question I was asked by my fellow conferees at my non-corporate conference. My answer has to be "compared to what?" as my friend David Hyman likes to say. The market seems to think it's a good idea, but that could be short-sighted. However, not being a macroeconomist, I can only guess that the alternative was worse than the (attempted) cure. Is it a great thing to have the federal government increase the national debt (in a time of a very expensive war) to bailout private institutions with taxpayer money? No. Would the market be able to right itself, after breaking more than a few Wall Streeg eggs, eventually? Not sure.
Do either of the candidates seem to know what's going on? No. As little as I know, the candidates seem to know less. What with McCain calling for Chris Cox's resignation (huh?) and Obama saying the AIG bailout was necessary to protect AIG's insurance policy holders (who are not at risk), it seems clear that a little information can be dangerous.
Is restricting short selling a good idea? Before the bailout began, there had been an outcry to regulate "speculation" more heavily. Short selling, particularly naked short selling, is an easy target for those who think that speculation (as opposed to investing and hedging) makes the markets more volatile and produces inefficient pricing. However, that thesis is far from proven or accepted -- but the rhetoric seems to work with the public and the regulators. If there is any time to restrict short selling, it would be when the markets are in freefall and there is some sort of "snowball" effect -- similar to reasons why trading is suspended from time to time. However, I would think that the window for this would be very short (not two weeks), similar to a temporary suspension in trading. In both hedging and speculation, there is a winner and a loser, and picking and choosing when to favor the loser is usually indefensible.
What's the easiest prediction to make from the financial crisis? More law school applicants.
Permalink | Finance | Comments (6) | TrackBack (0) | Bookmark
For those who scoffed at my suggestion last Sunday that the regulatory response to recent events on Wall Street would be analogous to the New Deal (ahem and ahem), I offer today's WSJ:
History has thrown a handful of men together this week with a task that they themselves might have brushed off as unthinkable just days ago: Give the U.S. financial system its biggest makeover since the 1930s. And do it quickly.
In fairness, even I am surprised at how quickly my prediction is being fulfilled.
Remember, though, you read it here first.
Permalink | Finance | Comments (6) | TrackBack (0) | Bookmark
In his excellent post on the (il)legality of the AIG takeover, David suggests a last-ditch argument to legitimize the U.S. government's action: "emergencies are emergencies, and when that happens the rules go out the window, and hopefullly regular elections mean that the officials the people trust are dealing with the emergency." This prompts the question, was this an emergency?
The problem here was with AIG's derivatives business, not with its insurance business. Consider this explanation from the lead WSJ story on the takeover:
AIG was a major seller of "credit-default swaps," essentially insurance against default on assets tied to corporate debt and mortgage securities. Weakness at AIG could force financial institutions in the U.S., Europe and Asia that bought these swaps to take write-downs or losses.
AIG's millions of insurance policyholders appear to be considerably less at risk. That's because of how the company is structured and regulated. Its insurance policies are issued by separate subsidiaries of AIG, highly regulated units that have assets available to pay claims. In the U.S., those assets can't be shifted out of the subsidiaries without regulatory approval, and insurance is also regulated strictly abroad.
Tuesday afternoon, after the market closed, AIG put out a statement saying its basic insurance and retirement services businesses are 'fully capable of meeting their obligations to policyholders.' AIG said it was trying to 'increase short-term liquidity in the parent company,' but said that didn't 'include any effort to reduce the capital of any of its subsidiaries or to tap into Asian operations for liquidity.' Asia is one of AIG's largest markets.
In short, this move is not aimed at protecting AIG's policyholders, but rather at protecting the financial institutions that purchased AIG's credit-default swaps.
Moral hazard, anyone?
UPDATE: The WSJ's Real Time Economics discusses the "rarely used legal authority under Section 13(3) of the Federal Reserve Act to lend to 'any individual, partnership or corporation' in 'unusual and exigent circumstance' provided the borrower 'is unable to secure adequate credit accommodations from other banking institutions.'" So the titular question of this post appears to be the right one. Larry Ribstein takes up the question: "But is this really 9/11? One might say that it’s more like Pee Wee Herman: a bunch of grownup companies living in a child's world in which real estate prices always go up. When they go down, should we prop up the stage set anyway?"
Permalink | Finance | Comments (4) | TrackBack (0) | Bookmark
Wall Street's big, bad day has lots of legal and public policy implications. In case you haven't seen them:
- What was it like lawyering these deals?
- Matt Bodie concocts a relevant fable - and we think the Fed could have bailed out his Lemon family.
- This blog has repeatedly noted the lack of clear authority for the government to act as it has had to. John Carney celebrates this incoherence - you get necessary bailouts, and forestall moral hazard too. Hmm. We'll take it under advisement.
- Speaking of Carney, and Dealbreaker, here's how all over Lehman they were (and they're already breaking stuff on AIG). It's a nice summary, too.
- The government is scotching Frannie's golden parachutes, and why not, since the executives hardly facilitated the conservatorship?
- Daniel Gross's taxonomy of bailouts, if you haven't seen it.
- Michael Lewis: good stuff on why Bear was treated differently, and what lessons Asia will be taking from the news.
Permalink | Finance | Comments (1) | TrackBack (0) | Bookmark
Today I get to present my latest paper, Private Debt and Corporate Governance, at Larry Ribstein's Corporate Colloquium, which is part of the Program on Business Law and Policy at Illinois. It's almost (but not quite) ready for public consumption yet, so no link to SSRN today. But here's the abstract:
The influence of private lenders pervades public companies. From the first day of a lending arrangement, loan covenants and built-in contingency provisions affect managerial decision making. Conventional corporate governance analysis has been slow to notice or incorporate this lender influence. The few prior accounts of creditors’ influence over managers have emphasized the drastic actions creditors take when a firm is in serious trouble, overlooking the more routine influence private lenders enjoy even absent financial distress. In this Essay, I explain the regularity of lender influence on managerial decision making, showing that even routine lender influence may rival the influence of boards of directors. Corporate governance includes more than corporate law, and I argue for a broader conception of corporate governance that incorporates recent learning on lender influence.
While lenders of course intervene when their borrowers encounter distress, recent empirical work demonstrates lender influence at much earlier points in the debtor-creditor relationship, against the conventional wisdom. In addition to the effects of initial loan terms, a subsequent covenant violation may trigger active lender intervention. This scenario is commonplace, however, and rarely portends financial distress. Lenders may pursue a range of responses. Waiving the violation is the most common response; imposition of additional constraints on managerial discretion is also common. Calling the loan is quite rare. Initial covenants and subsequent violations effectively reallocate control from managers to lenders, in a fluid process that commences with the inception of the lending arrangement. This pervasiveness of lender influence has important implications for corporate governance policy making and future research.
The full draft will be posted soon.
Permalink | Corporate Governance| Finance | Comments (0) | TrackBack (0) | Bookmark
Some interesting findings on CEO hirings and firings from a recent Economist piece:
1. Importance of finance. One-fifth of US CEOs in 2005 were formerly CFOs, almost twice the percentage from a decade prior. Increased focus on financial reporting and SOX compliance has likely augmented the CFO's overall importance within companies.
2. Build or buy? Both in Europe and the US (among the FTSEurofirst 300 and the S&P 500), "lifers" make it to the executive suite more quickly on average than "hoppers," defined as those who jump through 4 or more companies. Lifers make it in 22 (US) or 24 (EU) years on average, while hoppers take at least 26 years. Information asymmetry probably explains this difference.
3. Women at the top. Eleven percent of US CEOs were women in 2001. In the early 1980s, by contrast, there were none.
4. Time to the top. The average climb to the top took 28 years in 1980. By 2001, it took only 24. The average CEO had fewer jobs on the way up (five instead of six) and spent less time at each intermediate job (only four years) than before.
5. Naked capitalism. In a set of surprising (to me) results, EU capitalism appears to be a bit more rough-and-tumble than in the US, at least as regards CEO tenure. EU CEOs have much shorter tenures than in the US and have a tougher time staying there. They're also much less likely to be lifers in Europe (18% versus 26% in the US). Average CEO tenure over the past decade was just over 9 years in the US, but under 7 years in Europe. European CEO firings accounted for 37% of turnover, but only 27% in the US. European CEOs are also younger on average than in the US--54 versus 56 years of age.
Permalink | Business Organizations| Comparative Law| Corporate Governance| Finance| Globalization/Trade | Comments (2) | TrackBack (0) | Bookmark
Is something fishy is going on with dollar Libor (London interbank offered rate)? Libor is supposed to approximate the average rate that banks lend unsecured funds to one another. To calculate the dollar Libor rate, the British Bankers’ Association (the BBA), has a panel of 16 banks report their borrowing costs. Some believe that these banks may be submitting artificially low borrowing costs in order to avoid appearing cash strapped. Amid this criticism, the BBA announced today that it “will be strengthening the oversight of BBA Libor. The details will be published in due course.” The BBA, however, did not change the make-up of the 16 bank panel.
Does this mean legal trouble for the many, many contracts that rely on Libor as a financial benchmark? Well for past payments or obligations, it probably will have little effect. In my experience, most contracts rely on Libor as quoted by a particular source, at a particular time. For example:
"LIBOR Rate" means … the rate offered from time to time for U.S. Dollar deposits for the Interest Period selected, as quoted by Telerate News Services as of 11:00 A.M. London setting time … on the first Eurodollar business day of the Interest Period, provided, that if two or more of such offered rates appear on Telerate …, the "LIBOR Rate" shall be the highest of the two quoted.
To me this suggests that the parties decided that, rather than debate about what rate or rate quote might best reflect current conditions, they would instead rely on a particular source’s quote even if that quote might later turn out to be “wrong.” Of course, those hurt by low Libor rates are likely to put pressure on the BBA to ensure that going forward banks are accurately reporting their borrowing cost. Those hurt may even turn to tort law seeking redress from BBA or banks on the panel. More long-term, if people lose confidence in the reliability of Libor, future contracts will simply rely on another benchmark.
Permalink | Finance | Comments (1) | TrackBack (0) | Bookmark
Last Friday and Saturday I attended the Teaching Consumer Law Conference hosted by the University of Houston Law Center. There were a number of terrific presentations, but Christopher Peterson’s presentation on Mortgage Electronic Registration System, Inc. (MERS) really caught my attention.
MERS is a privately held company that “registers” mortgages. Ordinarily, the mortgagee (lender) must record its interest in the mortgage in the county land records. Any subsequent transfers of the mortgagee’s interest (for example, in the securitization process) must also be recorded. MERS short circuits this multiple recording process. Instead, the lender includes language in the Deed of Trust or Mortgage describing MERS as “a separate corporation that is acting solely as a nominee for Lender and Lender’s successors and assigns. MERS is the mortgagee under this Security Instrument.” MERS is recorded as the mortgagee in the county land records. Although MERS does not lend money, service the mortgage, or receive any of the payment stream from the mortgage, it remains as “nominee” through all future transfers. As a result, any subsequent transfers of interest in the mortgage are recorded only in MERS electronic system -- not in the county land records. According to MERS, it “now registers more than half the mortgage loans originated in the United States.”
Increasingly, foreclosure actions are being brought in MERS name. Professor Peterson questions whether MERS as “nominee” has standing to bring foreclosure actions. A few courts have agreed with him, but other courts conclude MERS has standing. (See here for a summary.) Professor Peterson believes that the MERS system may have other legal deficiencies. He questions whether subsequent transfers of the mortgagee interests are properly perfected if they are only recorded in the MERS system and not the county records. He also believes it may be appropriate to treat MERS as a debt collector under the Fair Debt Collection Act. I look forward to reading Professor Peterson’s completed article.
While I have not fully analyzed the legal implications of MERS’s business plan, it seems to me that MERS's innovation of electronically tracking mortgage interests was only a matter of time. It is cumbersome and costly to file and search in the paper land records in each county. States have already consolidated and digitized records for security interests in personal property. Of course, the personal property recording systems are still state government systems. In contrast, MERS is a nation-wide private company owned partly by some mortgage lenders. MERS will end up with a lot of bad publicity if a very large number of foreclosure actions are brought in its name, particularly if it appears that the MERS system was used to hide the ball from consumers.
Permalink | Businesses of Note| Conferences| Finance | Comments (2) | TrackBack (0) | Bookmark
In recent months, both BusinessWeek and Inc.com have featured articles describing the explosion of merchant cash advances as a funding source for small businesses. BusinessWeek reports that the size of the merchant cash advance industry “jumped 50% in 2007, to around $700 million.” The industry even has its own trade association, the North American Merchant Advance Association.
What are merchant cash advances? Traditionally, banks have lent money to small businesses and taken credit card receivables as collateral. As would be expected, the business pays back the loan over time with interest. In many cases, the loan agreement specifies that payments to the bank will be taken directly from the business’s credit card collections. Merchant cash advances are functionally very similar to credit card receivables lending – except that merchant cash providers are quick to point out that their agreements are not loans. According to AdvanceMe, the industry leader, a merchant cash provider “purchase[s] a portion of … future credit and debit sales at a discount.” For example, a merchant cash provider might give a business $100,000 in exchange for $130,000 of future credit card receivables. Then the merchant cash provider collects “a fixed percentage of daily credit [card] sales” until the agreement has been satisfied. Merchant cash providers claim they are supplying much needed liquidity to small businesses that have been squeezed by the credit crunch.
But the merchant cash advance industry is not without its critics. Because merchant cash advances are structured as sales and not loans, merchant cash advances need not comply with state usury law. Merchant cash advances are unquestionably more costly than traditional bank loan financing. Inc.com reports a typical 25% fee, but other press has reported more costly advances.
In addition, merchant cash advance agreements are treated differently from loans in bankruptcy proceedings. Merchant cash providers contend that they can continue to collect from credit card receipts even after a business has filed for bankruptcy (when the automatic stay protects the business from most loan collection efforts). Merchant cash advance agreements are not discharged in bankruptcy.
Of course, some courts may be willing to look beyond the form of the merchant cash advance agreement to find that the agreement is, in substance, a loan. (Courts have long struggled to distinguish leases from loans and have generally tried to look beyond the form of the transaction to the economics of the agreement.) If this happens, usury and/or bankruptcy laws could be applied directly to merchant cash advance agreements.
It is also possible that the rapid growth of the industry will attract legislation. I tend to favor free markets and believe that heavy-handed regulation here would be a mistake. It seems to me that the case for usury laws here is weaker than for the average consumer loan because small businesses should have some financial sophistication. Regardless of what happens, it should be interesting to watch this emerging industry.
Permalink | Bankruptcy| Businesses of Note| Entrepreneurs| Finance | TrackBack (0) | Bookmark
After the SEC went after a short seller for spreading false rumors - unprecedented, apparently - it's worth looking to see if economists, the lonely defenders of the shorts, are still on board. Maybe not, at least not in every case, such as if damage to the stock price might deter the firm from useful, announced plans. Here's a blog post, here's a story, and here's the paper, written in part by, I must note, a colleague of mine.
Permalink | Finance | Comments (3) | TrackBack (0) | Bookmark
Roger Lowenstein, the NYT's ace long-form business reporter, will dig deep into credit rating agencies in next week's magazine. Probably nothing new to the Glom's readers, but Lowenstein sure knows how to break it all down:
In a practical sense, it was Moody’s and Standard & Poor’s that set the credit standards that determined which loans Wall Street could repackage and, ultimately, which borrowers would qualify. Effectively, they did the job that was expected of banks and government regulators. And today, they are a central culprit in the mortgage bust, in which the total loss has been projected at $250 billion and possibly much more.
[snip]
The Securities and Exchange Commission, faced with the question of how to measure the capital of broker-dealers, decided to penalize brokers for holding bonds that were less than investment-grade (the term applies to Moody’s 10 top grades). This prompted a question: investment grade according to whom? The S.E.C. opted to create a new category of officially designated rating agencies, and grandfathered the big three — S.&P., Moody’s and Fitch. In effect, the government outsourced its regulatory function to three for-profit companies.
[snip]
Issuers thus were forced to seek credit ratings (or else their bonds would not be marketable). The agencies — realizing they had a hot product and, what’s more, a captive market — started charging the very organizations whose bonds they were rating. This was an efficient way to do business, but it put the agencies in a conflicted position.
And so on. Of note, Lowenstein walks us through how Moody's gave a particular subprime mortgage security its investment grade, and he quotes Glom book clubber Frank Partnoy.
UPDATE: And here's SEC chair Christopher Cox's testimony before the Senate today on credit rating agencies. Here's what the SEC has in mind for the agencies:
To strengthen accountability, the new rules that the Commission will soon consider may include requirements for enhanced disclosures about ratings performance. ....To enhance transparency, the Commission may soon consider new rules that would require the disclosure of information about the assets underlying the mortgage-backed securities, CDOs, and other types of structured finance products they rate. ....The rules that the Commission will soon consider may also include provisions designed to ensure that enhanced disclosure about a firm's ratings performance affords other credit rating agencies, including newly recognized NRSROs, an opportunity to identify flaws or opportunities for improvement on their competitor's approach, or to demonstrate to investors that their credit ratings perform better.
After the jump, check out just how much downgrading of subprime products the credit rating agencies have done, according to Cox.
- As of February 2008,
Moody's had downgraded at least one tranche of 94.2% of the subprime
RMBS issues it rated in 2006, including 100% of the 2006 RMBS backed by
second-lien loans, and 76.9% of the issues rated in 2007. Overall,
Moody's has downgraded 53.7% and 39.2% of all of its 2006 and 2007
subprime tranches, respectively.1
- As of March 2008, S&P had downgraded 44.3% of the subprime
tranches it rated between the first quarter of 2005 and the third
quarter of 2007.3 This included 87.2% of securities backed by second lien mortgages.2
- As of December 2007, Fitch had downgraded approximately 34% of the subprime tranches it rated in 2006 and in the first quarter of 2007. In February 2008, Fitch placed all of the RMBS it rated in 2006 and the first quarter of 2007 backed by subprime first lien mortgages on Ratings Watch Negative.4
Permalink | Finance | Comments (2) | TrackBack (0) | Bookmark
Last Sunday's NYT reported on an idea that regulators and legislators have been kicking around to keep
people in their homes and save the housing markets--negative equity certificates. (Also see an earlier WaPo story). These certificates would be available to existing mortgage lenders willing to refinance upside-down mortgages--loans whose outstanding balance exceeds the current value of the home. Under the plan, a government-insured refinancing would reduce the outstanding mortgage balance to the current home value. The original lender, in addition to getting paid the current value of its collateral from the refinancing, would receive a negative equity certificate. This certificate would entitle the holder to any appreciation in home value realized when the the owner sells--up to the amount of the original loan. In effect, the old lender gets any prospective upside in exchange for stripping its loan down to the current market value of the home. Proponents anticipate that a trading market would develop for these certificates.
According to NYT, Treasury Secretary Henry Paulson's latest pronouncement would limit the plan to homeowners who are paying on their mortgages pre-reset, but who may be otherwise be tempted to abandon their homes once their interest rates jump.
At first blush, it seems like an interesting idea. The borrower gets to stay in her house without taking the credit hit of foreclosure. The original lender gets potential upside--which might be tradeable--without having to incur the costs of foreclosure, resale, and interim maintenance. And it's better than getting stripped down in bankruptcy--a prospective modification to the Bankruptcy Code that was (until recently) working its way through Congress--where the lender gets no upside. But several problems come to mind:
1. Valuation. How do we decide the market value of the home at refinance time? I know, we can get an appraisal! Just like the last time we got a mortgage on this house . . . .
2. Loan servicers. I thought one of the original precipitators of the mortgage meltdown was that for mortgages sold and bundled into pools for purposes of securitization, the servicers did not have clear authority to commit to workouts. So foreclosure was the only readily available option. If this is still true, then it's unclear how this latest proposal will help.
3. Homeowner incentives. With all the potential home appreciation captured in the negative equity certificate, the homeowner is basically a renter, with all that that implies. The homeowner has no more incentive to invest in maintenance than renter. In fact, the homeowner is worse off than a renter, since she can't call the landlord to fix the plumbing. Perhaps the terms of the certificate could be modified to give the homeowner some piece of the upside to counter this problem. Law scholars (e.g., Lee Fennell) have suggested the possibility of separating home-specific risk from market risk, leaving home-specific risk to the owner and selling market risk to investors. But the mechanics for implementing this idea seem pretty complicated. In any event, it's hard to figure how a simple split of the upside could be large enough to incentivize the homeowner and still small enough to be acceptable to the lender, who could own all the upside (net of attendant costs) through foreclosure.
4. Screening for sham sale. Presumably, the negative equity certificate covers only the first sale post-refinance. This would give homeowners some incentive to engage in sham sales to shed the overhang of the negative equity certificate in order to own the upside. Lenders will balk without some mechanism to police for this.
5. Tax and accounting consequences. I hesitate to offer any opinion on tax and accounting issues, except to raise the possibility that lenders may have to take a write down either when they do the refinance or sell the negative equity certificate (which might not be different from the foreclosure scenario either).
6. Irony. Let's solve a (somewhat) derivatives-driven crisis with . . . another derivative! We could bundle them, get an investment-grade rating from one of the big rating agencies, and sell NECBSs (Negative-Equity-Certificate-Backed Securities) to institutional investors!
For a thorough vetting of the proposal, check out Calculated Risk, especially the comments.