So on top of the financial crisis in general, the bank stress tests in particular, the ensuing recession, the reaching out in foreign policy, the push for healthcare reform, the changes in taxation policy, the regulation of carbon dioxide, the implosion of the US car industry and an influenza pandemic, Obama now gets to deal with a retiring supreme court judge. And he’s now in day 103 or something.
Is America recapitalising all the non-American banks?
The recent naming of the AIG counterparties [press release, NY Times coverage] reminded me of something and this post by Brad Setser has inspired me to write on it.
Back in January, I wrote a post that contained some mistakes. I argued that part of the reason that the M1 money multiplier in America fell below unity was because foreign banks with branches in America and American banks with branches in other countries were taking deposits from other countries and placing them in (excess) reserve at the Federal Reserve.
My first mistake was in believing that that was the only reason why the multiplier fell below one. Of course, even if the United States were in a state of autarky it could still fall below one as all it requires is that banks withdraw from investments outside the standard definitions of money and place the proceeds in their reserve account at the Fed.
And that was certainly happening, because by paying interest on excess reserves, the Fed placed a floor under the risk-adjusted return that banks would insist on receiving for any investment. Any position with a risk-free-equivalent yield that was less than what the Fed was paying was very rapidly unwound.
Nevertheless, I believe that my idea still applies in part. By paying interest on excess reserves, the Fed (surely?) also placed a floor under the risk-adjusted returns for anybody with access to a US depository institution, including foreign branches of US banks and foreign banks with branches in America. The only difference is that those groups would also have had exchange-rate risk to incorporate. But since the US dollar enjoys reserve currency status, it may have seemed a safe bet to assume that the USD would not fall while the money was in America at the Fed because of the global flight to quality.
The obvious question is to then ask how much money held in (excess) reserve at the Fed originated from outside of America. Over 2008:Q4, the relevant movements were: [1]
- the m1 money stock rose roughly US$190 billion
- the monetary base rose a little over US$756 billion
- currency rose slightly more than US$42
- excess reserves rose just over $707 billion
Remember that, roughly speaking, the definitions are:
- monetary base = currency + required reserves + excess reserves
- m1 = currency + demand deposits
So we can infer that next to the $707 billion increase in excess reserves, demand deposits only increased by $148 billion and required reserves by $7 billion.
In a second mistake in my January post, I thought that it was the difference in growth between m1 and the monetary base that needed explaining. That was silly. Strictly speaking it is the entirety of the excess reserve growth that we want to explain. How much was from US banks unwinding domestic positions and how much was from foreigners?
Which is where we get to Brad’s post. In looking at the latest Flow of Funds data from the Federal Reserve, he noted with some puzzlement that over 2008:Q4 for the entire US banking system (see page 69 of the full pdf):
- liabilities to domestic banks (floats and discrepancies in interbank transactions) went from $-50.9 billion to $-293.4 billion.
- liabilities to foreign banks went from $-48.1 billion to $289.5 billion
I’m not sure about the first of those, but on the second that represents a net loan of $337.6 billion from foreign banks to US banks over that last quarter.
Could that be foreign banks indirectly making use of the Fed’s interest payments on excess reserves?
No matter what the extent of foreign banks putting money in reserve with the Fed, that process – together with the US government-backed settlements of AIGs foolish CDS contracts – amounts to America (partially) recapitalising not just its own, but the banking systems of the rest of the world too.
[1] M1 averaged 1435.1 in September and 1624.7 in December. Monetary base averaged 936.138 in September and 1692.511 in December. Currency averaged 776.7 in September and 819.0 in December. Excess reserves averaged 60.051 in September and 767.412 in December. Remember that the monthly figures released by the Federal Reserve are dated at the 1st of the month but are actually an average for the whole of the month.
More on Northern Ireland vs. Israel/Palestine
After my last post on this, I’ve been listening to the responses of Sinn Fein to the recent murder of two guys in the British Army by the “Real IRA” and, believe it or not, thinking about the parallels with Islam. There’s nothing particularly original in my thoughts, but I thought I’d put them up here anyway.
a) I think that many beliefs – and often more importantly, many practices that are based on beliefs – change only very slowly over time. Often, the practices retain importance even when the beliefs they’re based on have long since evaporated.
b) What’s more, beliefs – and practices – change much more across generations than within them, so that once you reach your first full set of beliefs at around the age of 20, they’ll change extremely slowly, if at all, over the rest of your life. Real change comes when children choose to differ from their parents. This sort of thing is not particular to ideas of religion or morality. There’s been some recent work showing that people’s attitudes to risk-taking are essentially shaped when they’re young.
c) When somebody makes the discrete choice to turn to violence, it’s common to conclude that they are an inherently violent person (or, in the case of the radical Islamist stuff, operating under inherently violent beliefs). Contrary to this, I suspect that the violence emerges at a point of inflection (a “tipping point”) in how they cope with perceived opposition to their beliefs. It doesn’t matter if their beliefs are constant but their perception of society’s opposition to them is changing, or if their beliefs are changing and their perception of society is constant. At some point, the distance between their private beliefs and their perception of what the world is imposing on them becomes great enough for them to break from their previous behaviour and move to something disjointedly different. Violence from radical Muslims is one example, but so is violence from Republicans in Northern Ireland, or violence from working-class gangs in Northern England in the early ’80s.
d) There is an important difference between the distance between two two sets of beliefs and the level of opposition between them. Opposition might be more likely to increase when the beliefs are a long way apart, but it doesn’t necessarily have to. It is the sense of opposition that leads to the disjoint jump into violence.
e) Therefore, what brings about peace in the long term is long periods of calm. Calm with grumbling, certainly, but calm. The newly migrant family might stick out like a sore thumb, but so long as they are tolerated and they tolerate their new home, then their children (or their grandchildren) will eventually conform to the society they find themselves in.
I think the greatest victory in Northern Ireland was in convincing people to put down their guns for a while. The details of any particular agreement are less important, because the real details will emerge from the ground up as the people who had previously been spitting in each other’s faces find themselves (awkwardly, painfully) interacting with each other instead. Yes, the details of the agreement are what helped put the guns down in the first place, but that was all.
I read somewhere that before the recent crap in Gaza, Hamas had offered Israel a 30-year truce. Not a peace agreement. Not an acknowledgement of Israel’s right to exist. Just a truce. If it’s true, I think Israel made a mistake in not accepting it.
More on fiscal multipliers
In my previous piece on this, I highlighted that the fiscal multiplier will be different for different ways of “spending” the money (I put spending in quotes because there is also the possibility of simply offering tax cuts). Via Menzie Chinn, I see that the Congressional Budget Office has put out estimates of the fiscal multiplier for different forms of fiscal stimulus:
That’s table 5 from this document.
One of the challenges in negotiation for Israel/Palestine
There’s a perennial idea of proposing Northern Ireland as a model of how progress might be achieved in the fighting between Israelis and Palestinians. After reading this recent posting by Megan McArdle, one of the difficulties in such an idea becomes plain.
In Northern Ireland, both sides had moral, if not logistical, support from larger powers that were themselves allies. So while the nationalists found it difficult to trust the British government, they would generally trust the US government, who in turn trusted the British government, while the same chain applied in reverse for the loyalists.
By contrast, while Israel receives moral and logistical support from the USA, none of America’s close allies really comes close to giving the Palestinian cause at large, let alone Hamas in particular, the sort of tacit support that America gave the Irish nationalists.
The (latest) bailout of Bank of America
Bank of America is being handed a butt-load of cash:
Bank of America will on Friday receive $20bn in fresh capital from the US government and a guarantee on most of a further $118bn of potential losses on toxic assets.
The emergency bail-out will help to cushion the blow from a deteriorating balance sheet at Merrill Lynch, the brokerage BoA acquired earlier this month.
[…]
The package is on top of the $25bn BoA received from Tarp funds last October, and underscores the depth of the financial difficulties affecting the world’s leading banks.
At this point, BofA has received US$45 billion in hard cash and – more importantly, to my mind – a guarantee against US$118 billion of CDOs and related assets that they hold, many of them from their takeover of Merrill Lynch.
I don’t really want to get into whether bailouts in general are worthwhile, or if this one in particular is worthwhile. What I want to rant about is the nature of this bailout and in particular, that guarantee. It’s been done in a manner highly similar to the one given to Citigroup last year, so my criticism applies to that one as well.
Here is the joint Press Release from the US Federal Reserve, the US Treasury Department and the FDIC.
Here [pdf] is the term sheet for the deal with Bank of America.
The guarantee is against a pool of assets broken down as:
- US$37 billion worth of cash assets
- US$81 billion worth of derivatives (i.e. CDOs and other “troubled” assets)
Profits and losses for the pool will be treated as a whole. The fact that one third of the pool is cash (and cash equivalents) will have been insisted upon by the US government because they will almost surely generate at least a minor profit that will offset losses in the derivatives.
In the event of losses on the pool as a whole, BofA will take the first US$10 billion of losses; the US Government will take the next US$10 billion of losses; and any losses beyond that will be split 90/10: the US government will take 90% of them. That gives a theoretical maximum that the US government might be liable for as 10 + 90%*(118-20) = US$98.2 billion. In all likelihood, though, the cash assets will hold or increase their value, so the maximum that the US government can realistically be imagined to be liable for is 10 + 90%*(81-20) = US$64.9 billion.
But kicker is this: There was no easy way for them to arrive at that number of $81 billion. The market for cash is massively liquid (prices are available because trades are occurring), so it is easy to value the cash assets. The market for CDOs, on the other hand, is (at least for the moment and for many of them, forever) gone. Unless I’m mistaken, there are no prices available to use in valuing them. Even if there were still a market, CDOs were always traded over-the- counter, meaning that details of prices and volumes were secret.
Instead, the figure of US$81 billion is “based on valuations agreed between [BoA] and the US [Government]” (that’s from the term sheet).
I want to see details of how they valued them.
When TARP was first envisaged and it was suggested that a reverse auction might take place, the rationale was for “price discovery” to take place. The idea – which is still a good one, even if reverse auctions are a bad way to achieve it – is that since nobody knows what the CDOs are really worth, confusion and fear reign and the market drys up. Since nobody can properly value banks’ assets, nobody can tell whether those banks are solvent or not.
The generalised inability to value CDOs remains, and will continue to remain, a core issue in the financial crisis.
Suppose that the true value of BoA’s CDOs is US$51 billion. At some point, we will collectively realise that fact. The market will become (at least semi-)liquid again and the prices will, at least approximately, reflect that value. But since the BoA and US government had agreed that they were worth US$81 billion, it will technically look like a $30 billion loss and so will trigger the US government handing $19 billion (= 10 + 90%*(30-20)) to BoA and unlike the $45 billion in direct capital injection, the government will get nothing in return for that money.
Therefore, BofA had an enormous incentive to game the US government. No matter what they privately believed that their CDOs were worth, they would want to convince the Treasury that they were actually worth much more.
The US government isn’t entirely stupid, mind you. That’s why the first $10 billion in losses accrue to BoA. That means that for the money-for-nothing situation to occur, the agreed-upon valuation would need to be out by over $10 billion. On other hand, that means that instead of telling a little white lie, BoA has an incentive to tell a huge whopper of a bald-faced lie in convincing the Treasury.
That is why I want to see details on how they valued them.
Felix Salmon thinks that both Citigroup and Bank of America should be nationalised:
[N]either institution is capable of surviving in its present form much longer. [Hank Paulson and Tim Geithner] should embrace the inevitable and just nationalize the two banks.
…
[T]his isn’t a bank run: Citi and BofA aren’t suffering from liquidity problems. They have all the liquidity they need, thanks to the Fed. The problem is one of solvency: the equity markets simply don’t believe that the banks’ assets are worth more than their liabilities.
The problem being, as I explained above, that nobody knows what the assets are really worth and the market is simply assuming the worst as a precautionary measure.
I’m not yet convinced that they should be fully nationalised. I just don’t think that the government should put itself in a situation where it promises to give them money for nothing in the event that their private valuation turns out to be too high (i.e. the market is correct in believing that they’re worth bugger-all).
Barry Ritholtz wants to know why the heads of Citi and BoA are still there:
Like Citi, the B of A monies are a terrible deal for the taxpayer — not a lot of bang for the buck, and leaving the same people who created the mess in charge.
Organ transplant medicine understands certain truths: You do not give a healthy liver to a raging alcoholic, as they will only destroy the organ via their disease/bad judgment/lifestyle.
In this, I agree with him entirely.
The Transparent Society
During the recent US presidential election, California voted to change it’s state constitution to exclude gay couples from being married (proposition 8). Prior to the election, the Californian supreme court had overturned a regular law that banned gay marriage as being unconstitutional. Thus the (successful) move by social conservatives to change the state’s constitution.
Via Andrew Sullivan (1, 2, 3, 4) and in a demonstration of the move towards David Brin’s “Transparent Society,” I give you http://www.eightmaps.com where you can see the names, addresses, employer and amount donated of everybody that gave money to the proposition 8 campaign, all arranged on a Google Maps mash-up.
The three best things I’ve read on the US car (auto) bailout …
… are this opinion piece in the FT by Joseph Stiglitz, this brief blog entry by Matthew Yglesis and this blog entry by Robert Cringley.
Stiglitz’s piece makes, to me, a compelling argument for letting the firms go into Chapter 11 bankruptcy, albeit (given the state of the market) with government guarantees for any further financing they may need for restructuring. The following four paragraphs are among the most succinct and clearly written on the US car industry:
Wall Street’s focus on quarterly returns encouraged the short-sighted behaviour that contributed to their own demise and that of America’s manufacturing, including the automotive industry. Today, they are asking to escape accountability. We should not allow it.
[…]
The US car industry will not be shut down, but it does need to be restructured. That is what Chapter 11 of America’s bankruptcy code is supposed to do. A variant of pre-packaged bankruptcy – where all the terms are set before going before the bankruptcy court – can allow them to produce better and more environmentally sound cars. It can also address legacy retiree obligations. The companies may need additional finance. Given the state of financial markets, the US government may have to provide that at terms that give the taxpayers a full return to compensate them for the risk. Government guarantees can provide assurances, as they did two decades ago when Chrysler faced its crisis.With financial restructuring, the real assets do not disappear. Equity investors (who failed to fulfil their responsibility of oversight) lose everything; bondholders get converted into equity owners and may lose substantial amounts. Freed of the obligation to pay interest, the carmakers will be in a better position. Taxpayer dollars will go far further. Moral hazard – the undermining of incentives – will be averted: a strong message will be sent.
Some will talk of the pension funds and others that will suffer. Yes, but that is true of every investment that has diminished. The government may need to help some pension funds but it is better to do so directly, than via massive bail-outs hoping that a little of the money trickles down to the “widows and orphans”.
I would perhaps suppliment Professor Stiglitz’s words by proposing that government support to workers laid-off as part of the restructuring could be improved dramatically over the provisions currently available. They should not only include lengthening the duration of unemployment payments and paying for retraining programmes, but also payments to help with relocation if anybody is willing to (voluntarily!) move to find work. An Obama administration might also be reasonably expected to look to Michigan for skilled manual labour in it’s push for infrastructure renewal/expansion.
Yglesis’ brief note observes a vital co-ordination problem when it comes to restructuring what is genuinely a global industry:
One thing here is that as best I can tell none of the five countries — US, Japan, Germany, France, Korea — with substantial auto industries are willing to let their national favorites fail. And yet there seems to be substantial global overcapacity in car manufacturing. If a few of the existing firms are allowed to fail, then the survivors will be in good shape. But if nobody fails, then all the firms worldwide will be left suffering because of overcapacity problems, all potentially drawing bailouts and subsidies indefinitely.
Finally, Cringely’s piece investigates how a successful US car firm ought to be run by imagining that Steve Jobs (of Apple) was running it. The idea is not his. Thomas Friedman briefly mentioned in early November that …
… somebody ought to call Steve Jobs, who doesn’t need to be bribed to do innovation, and ask him if he’d like to do national service and run a car company for a year. I’d bet it wouldn’t take him much longer than that to come up with the G.M. iCar.
It was something of a trite comment, and it was picked up by many people in the IT industry who got a little over-excited when imagining the details of what functionality the iCar should have (for example). In contrast, Cringely looked at the most important thing that somebody trying to emulate Apple might bring to the car industry: it’s design and manufacturing process:
… embracing these [new technologies] requires the companies do something else that Jobs came to embrace with Apple’s products – stop building most of their own cars.
There are two aspects to this possible outsourcing issue. First is the whole concept of car companies as manufacturing their own products. There is plenty of outsourcing of car components. Most companies don’t make their own brakes, for example. Yamaha makes whole engines for Ford. Entire model lines are bought and rebadged from one maker to another. But nobody does it for everything, yet that’s what Steve Jobs would do.
All the U.S. car companies are closing plants, for example, and all are doing so because of overcapacity. But what would happen if just one of those companies — say Chrysler — decided that two years from now it would no longer actually assemble ANY of its own vehicles? Instead they’d put out an RFQ to every company in the world for 300,000 Chrysler Town & Country minivans as an example. Now THAT would be a dramatic move.
And a good one, frankly, because with a single pen stroke most of the overcapacity would be removed from the U.S. car market. Chrysler would have to shut down all those plants and lay off all those people, true, but doing it all the way all at once would change the nature of the company’s labor agreements such that there wouldn’t be a whimper. When you are eliminating 8 percent of capacity the tussle is over WHICH 8 percent. When you are eliminating ALL capacity, there is no tussle.
So Chrysler reaches out to contract manufacturers in this scenario and you know those manufacturers would fight for the work and probably give Chrysler a heck of a deal. For current models, for example, Chrysler could probably sell the tooling and maybe even the entire assembly plant for a lot more than they’d get from the real estate alone. But that particular advantage, I’d say, would be unique to the first big player to throw in the production towel.
In this scenario, Chrysler becomes a design, marketing, sales, and service organization. What’s wrong with that? They can change products more often and more completely because of their dramatically lower investment in production capital. They can pit their various suppliers against each other more effectively than could a surviving car manufacturer. It’s what Steve would do.
This is brilliant stuff.
The sky is blue …
… news at eleven.
The National Bureau of Economic Research (NBER), the official business-cycle dating body for the U.S., has declared that the United States is in a recession and that it started in December 2007.
The data were a little confusing in calling the timing. Gross Domestic Product (GDP) and Gross Domestic Income (GDI) are two sides of the same coin. Figures regarding their levels and growth rates ought to be the same and differ only because of statistical (i.e. counting) errors. From the formal release:
The committee believes that the two most reliable comprehensive estimates of aggregate domestic production are normally the quarterly estimate of real Gross Domestic Product and the quarterly estimate of real Gross Domestic Income, both produced by the Bureau of Economic Analysis. In concept, the two should be the same, because sales of products generate income for producers and workers equal to the value of the sales. However, because the measurement on the product and income sides proceeds somewhat independently, the two actual measures differ by a statistical discrepancy. The product-side estimates fell slightly in 2007Q4, rose slightly in 2008Q1, rose again in 2008Q2, and fell slightly in 2008Q3. The income-side estimates reached their peak in 2007Q3, fell slightly in 2007Q4 and 2008Q1, rose slightly in 2008Q2 to a level below its peak in 2007Q3, and fell again in 2008Q3. Thus, the currently available estimates of quarterly aggregate real domestic production do not speak clearly about the date of a peak in activity.
The brief respite in the middle of 2008 appears to be the result of the first fiscal stimulus package. Nevertheless, it seems quite clear that the overall trend has been downward.
The committee declared December 2007 as the peak after looking at payroll (i.e. employment) data:
Payroll employment, the number of filled jobs in the economy based on the Bureau of Labor Statistics’ large survey of employers, reached a peak in December 2007 and has declined in every month since then. An alternative measure of employment, measured by the BLS’s household survey, reached a peak in November 2007, declined early in 2008, expanded temporarily in April to a level below its November 2007 peak, and has declined in every month since April 2008.
… and personal income (less transfer payments):
Our measure of real personal income less transfers peaked in December 2007, displayed a zig-zag pattern from then until June 2008 at levels slightly below the December 2007 peak, and has generally declined since June.
… and real manufacturing and wholesale-retail trade sales:
Real manufacturing and wholesale-retail trade sales reached a well-defined peak in June 2008.
… and the Federal Reserve Board’s index of industrial production:
This measure has quite restricted coverage—it includes manufacturing, mining, and utilities but excludes all services and government. Industrial production peaked in January 2008, fell through May 2008, rose slightly in June and July, and then fell substantially from July to September. It rose somewhat in October with the resumption of oil production disturbed by hurricanes in the previous month. The October value of the industrial production index remained a substantial 4.7 percent below its value in January 2008.
The only really interesting thing in all of this to me is to observe that the first fiscal stimulus and the corresponding positive growth in 2008:Q2 saved some embarrassment for the Republican Party. The negative 2008:Q3 figures were only released on the 25th of November, three weeks after the U.S. election. Had the 2008:Q2 figures been even faintly negative, there may have been considerable (and, I think, reasonable) pressure for the recession to have been formally recognised in the middle of the campaign.
Why Obama chose Hillary for State
I like both of these answers:
This is exactly the kind of detailed political question I don’t follow so let’s try some crude, fact-poor economism. Hillary Clinton commands the loyalties of significant segments of the Democratic Party. The implication is that Obama will need these segments for what he is trying to do. Since Obama already has 58 (?) Democratic Senators on his side, we should conclude that Obama will try to do lots in the first few months of his term; this is the “throw long and deep” scenario.
He can always encourage her to leave later, if the relationship does not work out. Latinos, on the other hand, are stronger as voters than as a lobby or as an organized segment of the Democratic Party. The implication is that they will get relatively little at the beginning of Obama’s term — when lobbies are needed — but successively more as the next election approaches.
Earlier this year, it seemed a good idea to plonk her on the ticket to defang the threat. That would have followed the “team of rivals” concept that Obama wanted to purloin from Lincoln. It would also have given the Clintons an independent claim on power. By winning without them and even, in some measure, despite them, Obama can now bring the Clintons into the power structure while retaining clear dominance. The State Department appointment is prestigious enough not to be condescending, yet also keeps Clinton off the Washington circuit more than any other position. She’ll be on a plane or abroad a great deal. Extra bonus: Bill will just love that. Sending his wife to the Middle East is the ex-president’s idea of a good time.
There’s also the small question of Iraq. Think of the appointment this way: “You voted for this bloody war, Hillary; you can end it.”
Withdrawing from Iraq will not be easy and it may well be gruesome. I have no confidence that the place won’t erupt into an even nastier civil war when the United States pulls out than it did when the United States didn’t fully push in. How does a president avoid the domestic blow-back of essentially cutting his losses on a doomed adventure? He uses Clinton as a protective shield from domestic critics. It’s also a rather brilliant manoeuvre against those elements on the right – from Fox News to Washington neocons – who came out in praise of Clinton in the spring when she sounded more hawkish than Obama on the Middle East. Having hailed Clinton as the Iron Lady of the Jews, the stab-in-the-back right will find it hard to pivot immediately and accuse her of treason if and when she ends the Iraq occupation.
But why did Hillary accept the job?
The best I can imagine off the top of my head is that (a) she really believes that the Obama presidency will be a successful one; and (b) a successful stint as Secretary of State after time in the Senate would look very, very good on the resume in eight years time.