Archive for November, 2008|Monthly archive page
From a quarter millennium ago:
“that they deceived every man into his own ruin; and ruined the nation, to enrich the directors and themselves: They sold their own stock, and that of the directors, under false and fictitious names, contrary to the obligation of their bond to the City, which obliges them to declare the name of the seller to the buyer, as well as the name of the buyer to the seller; for they knew that no man would have been willing to buy, had he known that the brokers and directors were in haste to sell. Thus they used false dice, and blinded men’s eyes, to pick their pockets. “And surely, Mr. Ketch,” says the counsellor, “if he who picks a man’s pocket is to be hanged, the rogues that pick the pockets of the whole country, ought to be hanged, drawn, and quartered.”
Skilled physicists do not know how to take nothing and turn it into matter and antimatter, but finance behaves as if it had the capacity to do something similar. Imagine a simple market economy about to create a bubble. I want to tell the story of this bubble, only to put the current, crazy stimulus package into perspective.
Somebody says to me they have a piece of paper worth $1 million. I can buy for half the price. I borrow the money to cover most of the cost. People are willing to lend me the money confident in the belief that my paper will increase in value. Other people are engaging in the same transaction, spreading confidence that these papers are now increasing in value, say to $600,000.
The seller of the paper now has a half-million dollars, having given up nothing but blank piece of paper. I have a capital gain of hundred thousand dollars. My lenders have a credit with a half-million dollars. We are all better off, even though nothing has been produced.
Feeling secure in the increasing value of our paper, I along with the other “investors” now start consuming more, spreading prosperity for the economy. Virtually everybody is enjoying the benefit of the bubble. Within a short period of time, people throughout the economy making decisions based on the increasing appearance of health and the economy.
At some point, people realize that this paper is nothing more than a blank sheet of writing paper. The bubble may have stimulated some investment that is capable of producing real economic benefits, but mostly it has induced people to consume and commit themselves to pay back debts. Read more »
Here is a graphic from the Wall Street Journal regarding the size of the stimulus package.
I hope to comment on it more tomorrow.
For an administration based on an ideology of untrammeled capitalism and which demands that all socially useful programs meet cost-benefit calculations heavily tilted toward inaction, the government seems to be getting little bang for its buck. Here is a Bloomberg estimate of a commitment of $7.7 trillion. Yes, the government can recoup some of this money, but probably not a lot.
Pittman, Mark and Bob Ivry. 2008. “U.S. Pledges Top $7.7 Trillion to Ease Frozen Credit.” Bloomberg.com (24 November).
“The U.S. government is prepared to provide more than $7.76 trillion on behalf of American taxpayers after guaranteeing $306 billion of Citigroup Inc. debt yesterday. The pledges, amounting to half the value of everything produced in the nation last year, are intended to rescue the financial system after the credit markets seized up 15 months ago. The unprecedented pledge of funds includes $3.18 trillion already tapped by financial institutions in the biggest response to an economic emergency since the New Deal of the 1930s, according to data compiled by Bloomberg. The commitment dwarfs the plan approved by lawmakers, the Treasury Department’s $700 billion Troubled Asset Relief Program. Federal Reserve lending last week was 1,900 times the weekly average for the three years before the crisis.” Read more »
Here Greenspan describes the new technologies that have revolutionized banks’ “basic business … to measure, manage, and accept risk … permitting … the unbundling of risks, improvements in the measurement of risk, and revamping of risk management process.”
“There are some who would argue that the role of the bank supervisor is to minimize or even eliminate bank failure; but this view is mistaken in my judgment. The willingness to take risk is essential to the growth of the free market economy …. [i]f all savers and their financial intermediaries invested in only risk-free assets, the potential for business growth would never be realized.”
Greenspan, Alan. 1994. The New Risk Management Tools in Banking: Address to the Garn Institute of Finance, University of Utah, November 30, 1994.
I have posted my talk for the San Francisco Peace & Freedom Party on the economic crisis at
The above link is a “call for papers” for an excellent journal that is soliciting articles from economics students. Students, give it a try!
“Tangible assets, which don’t include goodwill or intangibles, are 55 times the bank’s tangible equity …. Citi’s leverage worries some investors. Furthermore, possibly making matters worse are proposed accounting-rule changes that, if adopted, will prompt banks in 2010 to bring some off-balance-sheet assets back onto their books.
Tangible assets rise to nearly 59 times tangible equity if Citi has to bring about $120 billion in credit-card assets back onto its books in 2010, as is likely. Citi also may have to consolidate some of the roughly $670 billion in mortgage assets currently held by off-balance-sheet vehicles.
If the bank had to consolidate just 20% of these mortgage assets, tangible assets would rise to about 63 times tangible equity.
Reilly, David. 2008. “Job Losses Won’t Cut It for Citigroup.” Wall Street Journal (18 November): p. C 10.
PS: Dan Becker also told me that he just testified before Congress in the automobile hearings, shocking the politicians are telling them that there are now more unemployed automobile workers than employed.
The automobile industry is on the ropes, dying a death of 1000 cuts, most of them self-inflicted. Virtually everybody knows about the stubborn reliance on SUVs and other gas hogs, as well as the foray into non-automobile finance. I heard an interview with Dan Becker, the director of the Safe Climate Campaign, described another angle that in my ignorance I had not heard before.
I contacted Dan for some more information. What follows are my rough notes from my phone conversation regarding The Partnership for New Generation of Vehicles:
Vice President Al Gore told the Big Three that he wanted them to develop a sedan-size car that could get 80 miles a gallon. What is surprising is that they complied. Each one produced a prototype — a single prototype and then left the project to die. What was striking about Dan’s presentation was that the prototypes seem to have been relatively solid.
Word of Detroit’s success helped to spark Japanese interest in developing something similar. Coming from an island far from its oil supplies, MITI was interested in transportation alternatives. Of course, California’s requirement for zero emission vehicles (which my neighbor was instrumental in squashing) also played a role in interesting the Japanese, but the Gore angle and the successful prototypes were new to me.