Les Jones

Doris “Tanta” Dungey and the Calculated Risk blog

Wednesday, December 3rd, 2008 | Economics | Permalink | No Comments |

I always feel a little regret when I discover a writer or artist after their death, and this is one of those unfortunate cases. The New York Times has an obituary for Doris Dungey, who blogged at Calculated Risk under the pseudonym Tanta. Her co-bloggers are assembling an index of all of her posts on the mortgage industry for which she once worked.

This is my least favorite way to discover a writer, but I’m glad I discovered her writing all the same. She covers a difficult topic with humor and a sense of humanity. Rest in peace.

Here are a couple of her articles I enjoyed:
- Tanta makes a confession
- Reverse mortgages: an UberNerditorial
- A walk down the subprime memory lane (emphasis mine):

One unforeseen difficulty was that it became possible for certain participants who had always lived in the prime world to compare the profit margins on good old Fannie Mae fixed rates (maybe 50 bps if you were good at it) to those subprime deals (easily 150-200 bps if you were fair-to-middlin’ fastidious). Increased subprime lending could even improve those prime margins: as more and more of your weakest loans fell out of the bottom tier of your GSE loans [Government-Sanctioned Entity, such as Fannie Mae and Freddie Mac -LJ] and into the top tier of your subprime loans, you got paid better by the GSEs in the form of improved guarantee fees (since your average credit quality was so much better) and by your subprime investors (since your average credit quality was so much better). There was, in short, a moral hazard in play: in the shift from non-price to price rationing, more borrowers got mortgages, but it wasn’t always clear that they got the cheapest mortgage they should have gotten.

Those of us who were there at the time that the story about how “subprime is a way of serving the poor” got written do, then, tend to be somewhat more skeptical of this claim than others. The fact that many participants did not start out with the intention of preying on borrowers doesn’t change the fact that predation became widespread, or that a form of lending that had once been reserved for people with a lot of equity became associated just a few years later almost exclusively with people who had no money at all.

We can certainly debate the extent to which price-rationed lending provides true benefit to the historically credit-constrained. I’m game. I just think that market participants with short institutional memories are a menace. To all of us.

AP tries to lay mortgage mess at Bush’s feet

Wednesday, December 3rd, 2008 | Economics | Permalink | No Comments |

AP - They warned us, but US eased loan rules:

The Bush administration backed off proposed crackdowns on no-money-down, interest-only mortgages years before the economy collapsed, buckling to pressure from some of the same banks that have now failed. It ignored remarkably prescient warnings that foretold the financial meltdown, according to an Associated Press review of regulatory documents.

The AP article fails to mention that as early as 2003 the Bush administration and Congressional Republicans were pushing for tighter regulations and oversight of Fannie Mae and Freddie Mac. From the December 2, 2003 New York Times:

The Bush administration today recommended the most significant regulatory overhaul in the housing finance industry since the savings and loan crisis a decade ago.

Under the plan, disclosed at a Congressional hearing today, a new agency would be created within the Treasury Department to assume supervision of Fannie Mae and Freddie Mac, the government-sponsored companies that are the two largest players in the mortgage lending industry.

The new agency would have the authority, which now rests with Congress, to set one of the two capital-reserve requirements for the companies. It would exercise authority over any new lines of business. And it would determine whether the two are adequately managing the risks of their ballooning portfolios.

The move was opposed by construction lobbyists and by Congressional Democrats. Democrats quoted by the NYT spun the Bush administration’s tightened regulation of Fannie Mae and Freddie Mac as a backdoor attempt by the evil Republicans to keep poor people from getting mortgages:

Significant details must still be worked out before Congress can approve a bill. Among the groups denouncing the proposal today were the National Association of Home Builders and Congressional Democrats who fear that tighter regulation of the companies could sharply reduce their commitment to financing low-income and affordable housing.

”These two entities — Fannie Mae and Freddie Mac — are not facing any kind of financial crisis,” said Representative Barney Frank of Massachusetts, the ranking Democrat on the Financial Services Committee. ”The more people exaggerate these problems, the more pressure there is on these companies, the less we will see in terms of affordable housing.”

Representative Melvin L. Watt, Democrat of North Carolina, agreed. ”I don’t see much other than a shell game going on here, moving something from one agency to another and in the process weakening the bargaining power of poorer families and their ability to get affordable housing,” Mr. Watt said.

It was recently revealed that Senator Frank was dating an executive at Fannie Mae from 1991 to 1998. Meanwhile it was Republican Senators Charles Hagel and John McCain who introduced the Federal Housing Enterprise Regulatory Reform Act of 2005.

Timeline shows Bush, McCain warning Dems of financial mess

Vallejo, California declares bankruptcy

Tuesday, December 2nd, 2008 | Economics | Permalink | No Comments |

Governing - Vallejo’s Fiscal Freefall:

Reasonable people can — and do — disagree about how Vallejo found itself in bankruptcy. There’s no doubt, however, that many of the city’s problems stem from its inability to recover from the 1996 closure of the Mare Island Naval Shipyard, once the city’s largest employer. The city also lost hundreds of thousands dollars per year in sales tax revenue after the closure of a Wal-Mart.

But the largest share of the blame in Vallejo has centered on public-safety salaries and benefits, which make up about 75 percent of the city’s general fund budget. Base pay for firefighters is more than $80,000 per year and employees can retire at age 50 with a pension equal to 90 percent of their salary, the result of a retroactive pension increase several years ago.

With the downturn in the housing market hammering revenues, Vallejo is asking the bankruptcy judge to void the collective-bargaining agreements that led to those salary and benefit arrangements. And the possibility of hard-fought union contracts going up in smoke has struck fear in the heart of labor groups

Previously:

- How irrational are California public pensions?
- State pension funds heading for insolvency
- How irrational were California real estate prices?
- California attempts to build world’s most *optimistic* commuter rail

Auto sales worst in 25 years; worst since WWII adjusted for population

Monday, December 1st, 2008 | Economics | Permalink | No Comments |

CNN - Detroit’s auto bubble pain:

Another sign of just how out of whack the market got by the middle of the decade was that there were far more many vehicles on the road than actual registered drivers. This has long been the case, due mainly to the number of cars and trucks owned by businesses. But that gap grew much wider during the boom years. In 1998, there were about 12 million more vehicles than drivers in 1998. By 2006, the difference grew to 34 million.

That kind of imbalance couldn’t be maintained, even before the economy fell off a cliff. To that end, U.S. sales slowed to 16.1 million in 2007 and have plunged this year thanks to high gas prices earlier in the year and then the credit crunch.

Sales are now at their worst levels in 25 years, with a seasonally-adjusted annual rate of only 10.5 million vehicles in October. And when adjusted for population, GM said October was the worst month for the industry since the end of World War II.

The article blames easy credit for creating an auto sales bubble, with carmakers foreign and domestic ramping up production to meet newfound demand caused by refinancing and low-interest loans.

How irrational are California public pensions?

Monday, December 1st, 2008 | Economics | Permalink | No Comments |

How irrational are California public pensions? This irrational:

The California state government provides a “defined benefit” pension plan to each of its employees. Such “defined benefit” pension plans are far more generous than any 401(k) or defined contribution pension plan available from any other employer in the state! In fact, the plan is so generous that it makes the average state employee a millionaire after only 22 years of work!

Is the state’s pension plan overly generous? The Sacramento Bee and Governor Arnold Schwarzenegger have been whining about it lately — are they jealous? The state’s own Legislative Analyst has determined that California’s pension plan provides nearly twice the benefit of the next highest state.

Other comparisons are in order. The vast majority of American corporations have now eliminated “defined benefit” pension plans — only 6% of Americans in the private sector have access to such plans. American companies have terminated over 17,000 such plans in the last 20 years. IBM, one of the bluest of the blue chip companies, terminated its “defined benefit” pension plan in 2005. Hewlett Packard, a major California employer, followed by terminating its plan later that same year.

I’m picking on California because that’s just how I roll, but closer to home Knox County adopted a defined benefit pension for the sheriff’s department in 2007. What’s even more amazing is that the plan was retroactive for previous years of service. For retiring sheriff Tim Hutchison the new plan, enacted a few months before he left office, meant his pension jumped from $20,000 per year to $80,000 per year for the rest of his life. The new pension plan will cost Knox taxpayers $100 million over 20 years.

Previously:
- State pension funds heading for insolvency
- How irrational were California real estate prices?
- California attempts to build world’s most *optimistic* commuter rail

State pension funds heading for insolvency

Wednesday, November 26th, 2008 | Economics, Social Security | Permalink | No Comments |

Analyst: State of New Jersey Is Insolvent. And most state pension funds and therefore states will be insolvent if something doesn’t change. The analyst’s recommendations:

States have to dramatically raise taxes to pay for unrealistic promises

A voluntary reduction in pension promises will be negotiated

Cities, municipalities, and states declare bankruptcy or find other ways to default on promises made

Choice number one will lead to a taxpayer revolt, and choice number three will have every school district and government employee hopping mad. Yet, to expect number two to happen voluntarily is highly unlikely. The most likely thing that will happen is governors like Corzine will put the problem off, just as Schwarzenegger has done in California, and in fact every governor in every state has done.

Pension problems are rampant. Most states were way underfunded even before this 45% selloff in the stock market. I selected New Jersey to look at because they have disclosed the numbers as well as the future assumptions.

The point of pension crisis has now arrived. Yet few even recognize it and fewer still want to propose doing anything about it.

Just as long-term healthcare benefits and pensions for the autoworkers union broke Detroit the public service employees unions are liable to break cities and states.

This, by the way, is also where Medicare is headed. Social Security with its fixed payout could still be saved, but Medicare is almost certainly hopeless in its current form. The system will break once the boomers retire - their retirement will reduce the money going into the system and their declining health will increase the money going out of the system.

The system only really works when the population is steady or growing. Throw in a shrinking working population or a growing retirement population due to greater longevity and the ratio of workers to retirees becomes unsustainable.

Hat tip to Instapundit.

Inflation-adjusted U.S. house prices 1975-2008

Tuesday, November 25th, 2008 | Economics | Permalink | 21 Comments |

Source. The graph shows the bubble taking off in 1998 and the market peaking in 2005-06. That latter date is generally considered the market peak by many sources.

Note that this graph completely contradicts the chirpy real estate agent advice that “home values always go up!” Home values tend to hold their value relative to inflation, which is no small feat. Your home also gives you a place to keep your stuff dry, which is something you can’t say about T-bills and mutual funds. However, significant appreciation relative to inflation was seen almost entirely in the housing bubble era.

We’re now in an era in which home prices are depreciating. Based on the graph above prices may have to decline an additional inflation-adjusted 15-25% to be back within historical norms.

LATER: Here’s a longer-term graph from the same source:

Welcome, Instapundit readers! Here are some previous posts on the financial crisis you may find intriguing.

- Is green energy the next market bubble?
- How irrational were California real estate prices?
- Chicago business school profs on the Paulson bailout
- What caused the global housing bubble?
- Intelligent software didn’t avert the current financial crisis
- Anna Schwartz on the financial crisis
- “Economics in One Lesson” on government loans and government-backed credit

Bob Corker on the bailout

Monday, November 24th, 2008 | Economics | Permalink | 3 Comments |

Via Michael Silence:

U.S. Sen. Bob Corker, R-TN, in a press release: “I am glad that President-elect Obama has rolled out his economic team and would encourage them not to take this administration’s bait by coming to the rescue of the U. S. automakers without making them take the painful steps necessary to ensure their viability which probably include Chapter 11 bankruptcy, reorganization and consolidation,” said Corker. “Unfortunately, the Bush administration has made it clear they are willing to throw money at any problem as long as future generations are left paying it back.”

Yep. And that 700 billion dollar bailout is now 7.7 trillion dollars. (UPDATE: Before the day was even over that number had swelled to 8.5 trillion. I can’t blog as fast as the government spends.)

Thing is, Corker was for the bailout before he was against it. I can’t tell if he’s had a change of heart or is just playing both sides.

Richard Gross drinks Obama-Aid

Sunday, November 23rd, 2008 | Economics | Permalink | 1 Comment |

Writing in Slate, Richard Gross says to stop worrying your pretty little head about talk of another Great Depression. I think he’s right, if for the wrong reasons, but understates the economic danger over the next few years.

What’s remarkable about his piece is the closing paragraph:

A final difference: After the 1929 crash, the nation had to wait more than three years for a president who simply wasn’t up to the job to leave the scene. This time, we’ve got to wait only two more months.

Gross is drinking the Obamessiah Kool-Aid. There’s nothing particularly noteworthy about Obama’s career that would suggest he is somehow especially qualified to lead us through this financial crisis. Obama comes to the presidency with the least qualifications of anyone in modern history. He’s been in the Senate just four years and has never been a chief executive. He makes for an odd object of blind faith.

Second, Gross enshrines Franklin Roosevelt. Did FDR save us from the longest-lasting recession in U.S. history, or did his actions turn an ordinary recession into The Great Depression? A recent study comes to the latter conclusion - FDR’s policies prolonged Depression by 7 years, UCLA economists calculate.

The third assumption is so subtle it’s scarcely noticeable. Gross assumes that recessions end because presidents take action. It’s more likely that recessions correct themselves regardless of what the government does. That’s assuming of course that the government’s actions don’t make the situation worse, as FDR’s did during the Great Depresison or as Richard Nixon’s wage and price controls did in the 1970s.

Is green energy the next market bubble?

Thursday, November 20th, 2008 | Economics | Permalink | 2 Comments |

You may have heard of Barack Obama’s plan for renewable energy that he claims would provide 5 million jobs. It certainly came to my mind tonight while reading Eric Janszen’s article The Next Bubble: Priming the markets for tomorrow’s big crash from the March, 2008 Harper’s.

There are a number of plausible candidates for the next bubble, but only a few meet all the criteria. Health care must expand to meet the needs of the aging baby boomers, but there is as yet no enabling government legislation to make way for a health-care bubble; the same holds true of the pharmaceutical industry, which could hyperinflate only if the Food and Drug Administration was gutted of its power. A second technology boom—under the rubric “Web 2.0”—is based on improvements to existing technology rather than any new discovery. The capital-intensive biotechnology industry will not inflate, as it requires too much specialized intelligence.

There is one industry that fits the bill: alternative energy, the development of more energy-efficient products, along with viable alternatives to oil, including wind, solar, and geothermal power, along with the use of nuclear energy to produce sustainable oil substitutes, such as liquefied hydrogen from water. Indeed, the next bubble is already being branded. Wired magazine, returning to its roots in boosterism, put ethanol on the cover of its October 2007 issue, advising its readers to forget oil; NBC had a “Green Week” in November 2007, with themed shows beating away at an ecological message and Al Gore making a guest appearance on the sitcom 30 Rock. Improbably, Gore threatens to become the poster boy for the new new new economy: he has joined the legendary venture-capital firm Kleiner Perkins Caufield & Byers, which assisted at the births of Amazon.com and Google, to oversee the “climate change solutions group,” thus providing a massive dose of Nobel Prize–winning credibility that will be most useful when its first alternative-energy investments are taken public before a credulous mob. Other ventures—Lazard Capital Markets, Generation Investment Management, Nth Power, EnerTech Capital, and Battery Ventures—are funding an array of startups working on improvements to solar cells, to biofuels production, to batteries, to “energy management” software, and so on.

Total market value: Alternative energy and infrastructure. Estimated fictitious value of next bubble compared with previous bubbles

The candidates for the 2008 presidential election, notably Obama, Clinton, Romney, and McCain, now invoke “energy security” in their stump speeches and on their websites. Previously, “energy independence” was more common, and perhaps this change in terminology is a hint that a portion of the Homeland Security budget will be allocated for alternative energy, a potential boon for startups and for FIRE [the finance, insurance, and real estate industries].

More valuable than campaign rhetoric, however, is legislation. The Energy Policy Act of 2005, a massive bill known to morning commuters for extending daylight savings time, contained provisions guaranteeing loans for alternative-energy businesses, including nuclear-power technology. The bill authorizes $200 million annually for clean-coal initiatives, repeals the current 160-acre cap on coal leases, offers subsidies for wind energy and other alternative-energy producers, and promises $50 million annually, over the life of the bill, for a biomass grant program.

I should explain that Janzen is not entirely hostile to bubbles. He doesn’t love them, either, but he argues that to some degree bubbles drive modern economies and that it’s the extemes of the bubbles, the hyperinflation shown in the green part of the graphs above where the danger lies. You get a taste of that in the concluding paragraph:

The next bubble must be large enough to recover the losses from the housing bubble collapse. How bad will it be? Some rough calculations: the gross market value of all enterprises needed to develop hydroelectric power, geothermal energy, nuclear energy, wind farms, solar power, and hydrogen-powered fuel-cell technology—and the infrastructure to support it—is somewhere between $2 trillion and $4 trillion; assuming the bubble can get started, the hyperinflated fictitious value could add another $12 trillion. In a hyperinflation, infrastructure upgrades will accelerate, with plenty of opportunity for big government contractors fleeing the declining market in Iraq. Thus, we can expect to see the creation of another $8 trillion in fictitious value, which gives us an estimate of $20 trillion in speculative wealth, money that inevitably will be employed to increase share prices rather than to deliver “energy security.” When the bubble finally bursts, we will be left to mop up after yet another devastated industry. FIRE, meanwhile, will already be engineering its next opportunity. Given the current state of our economy, the only thing worse than a new bubble would be its absence.

Janzen’s article is interesting on any number of levels and helps explain a number of factors that led to the current housing and credit bubble, beginning with the end of the Bretton Woods agreement under Nixon and the reliance on fiat money: Continue reading the rest of this post ›››

Feeling sympathy for Detroit?

Thursday, November 20th, 2008 | Economics | Permalink | No Comments |

Feeling sympathy for Detroit? Me neither. Besides bad cars and excess compensation, the list of paid holidays for United Auto Workers members is insane (hat tip to Sebastian).

At my job we get 10 paid holidays per year. UAW workers get 21, including not just Memorial Day but the Friday before, not just Good Friday before Easter but the Monday after, Election Day, and eight days from Christmas Eve through New Year’s.

Likewise the executives aren’t exactly sympathetic, doe-eyed little ragamuffins:

• Big Three CEOs Flew Private Jets to Plead for Public Funds
• GM, Ford Executives Say No To $1 Salary In Exchange For Government Aid
• Mitt Romney NY Times op-ed: Let Detroit Go Bankrupt: “The need for collaboration will mean accepting sanity in salaries and perks. At American Motors, my dad cut his pay and that of his executive team, he bought stock in the company, and he went out to factories to talk to workers directly. Get rid of the planes, the executive dining rooms — all the symbols that breed resentment among the hundreds of thousands who will also be sacrificing to keep the companies afloat.”

Word of the Day: Tranche (Investing)

Wednesday, November 19th, 2008 | Economics, Word of the Day | Permalink | 1 Comment |

You’ll be hearing the word trance more and more as the mortgage crisis plays out. As mortgages were bundled into securities, the securities were organized into tranches. Prime mortgages were mixed with high risk Alt-A and subprime mortgages to create different tranches or investment grades. From Wikipedia:

In structured finance, a tranche (misspelled as traunch or traunche) is one of a number of related securities offered as part of the same transaction. The word tranche is French for slice, section, series, or portion. In the financial sense of the word, each bond is a different slice of the deal’s risk. Transaction documentation (see indenture) usually defines the tranches as different “classes” of notes, each identified by letter (e.g. the Class A, Class B, Class C securities). The term “tranche” is used in fields of finance other than structured finance (such as in straight lending, where “multi-tranche loans” are commonplace), but the term’s use in structured finance may be singled out as particularly important. Use of “tranche” as a verb is limited almost exclusively to this field.

Tranching poses the following risks:

• Tranching can add complexity to deals. “Beyond the challenges posed by estimation of the asset pool’s loss distribution, tranching requires detailed, deal-specific documentation to ensure that the desired characteristics, such as the seniority ordering the various tranches, will be delivered under all plausible scenarios. In addition, complexity may be further increased by the need to account for the involvement of asset managers and other third parties, whose own incentives to act in the interest of some investor classes at the expense of others may need to be balanced.
• With increased complexity, less sophisticated investors have a harder time understanding them and thus are less able to make informed investment decisions. One must be very careful investing in structured products. As shown above, tranches from the same offering have different risk, reward, and/or maturity characteristics.
• Modeling the performance of tranched transactions based on historical performance may have led to the over-rating (by ratings agencies) and underestimation of risks (by end investors) of asset-backed securities with high-yield debt as their underlying assets. These factors have come to light in the subprime mortgage crisis.

Previous WOTD - Misdemeanant

Detroit bailout?

Tuesday, November 18th, 2008 | Economics | Permalink | 4 Comments |

Mich Weinsteain has a roundup of opinion. For most people, this is the most relevant fact:

The chart above shows average hourly compensation for the Big Three ($73.20) and Toyota (TM) ($48.00), compared to average hourly compensation for Management and Professional Workers ($47.57), Manufacturing/Goods Producing ($31.59) and all workers ($28.48), data available here.

Should U.S. taxpayers really be providing billions of dollars to bailout companies (GM (GM), Ford (F) and Chrysler) that compensate their workers 52.5% more than the market (assuming Toyota wages and benefits are market), 54% more than management and professional workers, 132% more than the average manufacturing wage, and 157% more than the average compensation of all American workers?

Detroit’s problem isn’t a temporary downturn in the economy. Their problem is unsustainable cost structures for their labor. If that isn’t fixed then they’re doomed to fail eventually.

How irrational were California real estate prices?

Monday, November 17th, 2008 | Economics | Permalink | 5 Comments |

How irrational were California real estate prices? This irrational - the Pasadena shack in the picture sold for $522,000 in August, 2006. The local government was happy to play along with the fantasy since it meant more property tax money for them:

That’s one of Doctor Housing Bubble’s Real Homes of Genius. If you want to know how much trouble California is in read his article, 10 Reasons Why California is Years Away from a Housing Bottom.

We are going to find out how pervasive and extensive this fraud network is. To paraphrase Warren Buffet, the tide is going out and we are going to see who is swimming naked. Most of these loans fall under the Alt-A category and many lenders are deluded thinking these are much better than subprime loans. They are not. How many of these loans are out in California?

Total Alt-A loans as of June 2008: 688,975
Average Balance as of June 2008: $419,790 [* See note - LLJ]
Number with a prepayment penalty: 302,909
Number with a second lien at origination: 206,216 (these are most likely worth zero)
Number with interest only payment: 252,329
Number with negative amortization: 198,385
Percent with at least one late payment in last 12 months: 27%
Percent ARM loans: 70%
*Source: New York Fed

Think about those numbers for a second. This one point is enough to quell any bottom talk. Take a look at WaMu’s Option ARM portfolio, half of which is in California and you’ll realize that we haven’t even seen the start of this mess:

The world is in for a rough ride. The country is in for a rough ride. California is in for something even worse. Go read the Doctor.

* That $419,790 average is slightly higher than Fannie Mae’s 2008 limit of $417,000 for conforming single-family first mortgages.

Another name for black markets

Thursday, November 13th, 2008 | Economics, Quotes | Permalink | No Comments |

“In societies where they tried to impose their will on the free market, or push it aside, the free market became known as the “Black Market.” The market is like water…it’ll seep in, despite your best efforts.”
 – Anonymous

About that Deutsche Bank analyst who priced GM at $0

Wednesday, November 12th, 2008 | Economics | Permalink | No Comments |

TheStreet.com - Analyst Does a U-Turn on GM:

As recently as September 2007, just over a year ago, Agent Zero/Rocket Rod saw cause for high optimism, excitement and potential for a soaring stock price in the company’s negotiation with the United Auto Workers. Here’s a quick passage from MarketWatch:

“Deutsche Bank analyst Rod Lache reiterated to clients in a note that if GM is able to reach a deal to shed billions in retiree health-care liabilities and shield itself from future health-care inflation, the stock could break into the $50 range.”

In a Forbes article from back in January of this year called “GM’s Better-Than-Expected December,” Agent Zero/Rocket Rod was quoted as saying that automakers had already priced in a recession. General Motors stock was, at the time, selling at about $24 a share; it’s now at $3.24.

Perhaps Agent Zero/Rocket Rod’s difference between $24, $50 and $0 was a rounding error. But next time you see the business media reporting earnestly about a Wall Street analyst saying one thing, do keep in mind that he might have recently said another. The business media might need the quotes and price targets too badly to mention it.

Chicago business school profs on the Paulson bailout

Wednesday, November 12th, 2008 | Economics | Permalink | No Comments |

Paulson’s Gift:

By computing the value of the preferred equity and the warrants the Government will receive in exchange for the $125bn investment we obtain an estimate between $89 and $112 bn. Hence, the equity infusion costs taxpayers between $13bn and $36bn. We also estimate the cost of the debt guarantee extended by the FDIC on all the new bank debt to be worth $99bn. This brings the total taxpayers’ cost at between $112bn and $135bn. Hence, in the banking sector the plan destroyed between $3bn and $26bn.

During the event window (Oct 10-14), however, Mitsubishi confirmed the $9bn investment in Morgan Stanley. Consequently, part of Morgan Stanley return may be attributed to this positive news. When we exclude Morgan Stanley from the calculations, we estimate the plan net benefit between $4bn and -$17. In other words, Paulson’s plan simply amounts to a redistribution of money from taxpayers to the investors in the major financial institutions. Possibly a costly redistribution, in fact, where a fraction of the money transferred was lost.

In other news, Paulson is now saying he wants to shift the bailout from bad mortgage debt to consumer credit. I wonder if the payback for taxpayers will be any better and whether Paulson will change his mind again in two weeks time. Who’s sailing this sinking ship?

Word of the Day: Cabotage (Economics)

Wednesday, November 12th, 2008 | Economics, Word of the Day | Permalink | 1 Comment |

From Merriam-Webster’s Word of the Day:

Coastlines were once so important to the French that they came up with a verb to name the act of sailing along a coast: “caboter.” That verb gave rise to the French noun “cabotage,” which named trade or transport along a coast. In the 16th century, the French legally limited their lucrative coastal trade, declaring that only French ships could trade in French ports. They called the right to conduct such trading “cabotage” too. Other nations soon embraced both the concept of trade restrictions and the French name for trading rights, and expanded the idea to inland trade as well. Later, English speakers also applied “cabotage” to the rights that allowed domestic airlines to travel within national boundaries but that prevented foreign carriers from doing so.

About that last part. I don’t think many people realize that only U.S. airlines can fly routes inside the U.S. Foreign airlines are mostly or entirely restricted to U.S. international airports. Some countries go a step further and have a single national or nationalized airline flying within their country or even restrict what airlines can fly into their country.

Cabotage is pronounced like another French word, sabotage.

Previous WOTD - Stranger Room or Elijah Room

What caused the global housing bubble?

Monday, November 10th, 2008 | Economics | Permalink | 12 Comments |

Arnold Kling - Difficult Facts About Housing:

It is interesting to go back and read of the papers delivered at a Fed conference in Jackson Hole in 2007. Tanta was on top of them.

For example, Robert Shiller wrote,

Dramatic home price booms since the late 1990s have been in evidence in Australia, Canada, China, France, India, Ireland, Italy, Korea, Russia, Spain, the United Kingdom, and the United States, among other countries.

He has charts suggesting that the Netherlands and Norway experienced greater booms than the United States. In his book The Subprime Solution, he has a chart that shows London house prices rising faster than prices in Boston.

What makes this a difficult fact is that so many explanations of the house price boom are U.S/ specific. It is hard to argue that the Community Reinvestment Act or the repeal of Glass-Steagall are what account for the home price booms in Norway or Spain. In fact, Shiller’s view is that bubble/contagion is the only theory that can account for the multinational nature of the home price boom.

It’s an interesting point. The current mortgage meltdown and financial meltdown is more than a U.S. problem. If you try to explain it strictly in terms of U.S. policy, how do you explain the same problems happening at the same time in so many places in the world?

Intelligent software didn’t avert the current financial crisis

Friday, November 7th, 2008 | Economics, Tech | Permalink | No Comments |

Business Week - What the Market Crash Taught Me About Tech:

For years I’ve listened to software companies tell us that, with technology, our decision-making will be made easier. And we’ll be making better decisions. We’ll have better facts. We’ll be able to do better analysis—in small businesses, large enterprises, and financial-services firms.

And yet, the markets still crashed despite all this cutting-edge magical stuff. Where were the alerts? The safeguards? Those special programs and whiz-bang tools that so many tech companies promised? It didn’t do much for Bear Stearns, Merrill Lynch, and AIG. Those guys had a lot of great and expensive technology, but they still tanked.

This financial crash has taught me that even the best technology doesn’t do a very good job predicting anything—or even helping business owners and managers make decisions. At best, technology can help us do something faster. But we are a long way off from artificial intelligence. So, the next time some software sales guy tries to tell me that his business application will do anything more than increase productivity, I’ll be hard-pressed to believe it.

If that strikes your interest, read Jaron Lanier’s year 2000 piece One Half of a Manifesto about the ongoing failure of artificial intelligence to live up to its claims:

An official Turing Test is held every year, and while the substantial cash prize has not been claimed by a program as yet, it will certainly be won sometime in the coming years. My view is that this event is distracting everyone from the real Turing Tests that are already being won. Real, though miniature, Turing Tests are happening all the time, every day, whenever a person puts up with stupid computer software.

For instance, in the United States, we organize our financial lives in order to look good to the pathetically simplistic computer programs that determine our credit ratings. We borrow money when we don’t need to, for example, to feed the type of data to the programs that we know they are programmed to respond to favorably.

In doing this, we make ourselves stupid in order to make the computer software seem smart. In fact we continue to trust the credit rating software even though there has been an epidemic of personal bankruptcies during a time of very low unemployment and great prosperity.

We have caused the Turing test to be passed. There is no epistemological difference between artificial intelligence and the acceptance of badly designed computer software.

Even more bad real estate news: 1 in 5 mortgages upside down, increasing foreclosures

Thursday, November 6th, 2008 | Economics | Permalink | No Comments |

Graph via Dr. Housing Bubble.

Reuters - One in five homeowners with mortgages under water:

NEW YORK (Reuters) - Nearly one in five U.S. mortgage borrowers owe more to lenders than their homes are worth, and the rate may soon approach one in four as housing prices fall and the economy weakens, a report on Friday shows.

About 7.63 million properties, or 18 percent, had negative equity in September, and another 2.1 million will follow if home prices fall another 5 percent, according to a report by First American CoreLogic.

The data, covering 43 states and Washington, D.C., includes borrowers nationwide, even those who took out mortgages before housing prices began to soar early this decade.

Seven hard-hit states — Arizona, California, Florida, Georgia, Michigan, Nevada and Ohio — had 64 percent of all “underwater” borrowers, but just 41 percent of U.S. mortgages.

Foreclosure filings rose 71 percent in the third quarter to a record 765,558, according to RealtyTrac.

Last week, Wachovia Corp said borrowers with its “Pick-a-Pay” ARMs and living in or near Stockton and Merced, California, owed at least 55 percent more on their mortgages, on average, than their homes were worth. Wells Fargo & Co is buying Wachovia.

Owing more than their house than is worth is going to create economic despair for millions. No wonder consumer confidence is so low. Some homeowners will stick it out until the market recovers, but others will walk away from the moneyhole. ARM resets will only accelerate the trend. It’s going to get ugly.

Previously:
- More bad real estate news

Robert Heinlein on wealth and poverty

Saturday, November 1st, 2008 | Economics, Politics, Quotes | Permalink | 1 Comment |

“Throughout history, poverty is the normal condition of man. Advances which permit this norm to be exceeded — here and there, now and then — are the work of an extremely small minority, frequently despised, often condemned, and almost always opposed by all right-thinking people. Whenever this tiny minority is kept from creating, or (as sometimes happens) is driven out of a society, the people then slip back into abject poverty. This is known as ‘bad luck.’”
 – Robert Heinlein

Hat tip to Instapundit.

More bad real estate news

Monday, October 27th, 2008 | Economics | Permalink | 1 Comment |

Option ARMs are just now starting to reset on a large scale. The housing market will get worse before it gets better. Link.

September’s growth in home sales was apparently mostly foreclosures and short sales. The sales that aren’t foreclosures are mostly homes being sold at lower prices than before. Link.

Gold down sharply

Monday, October 27th, 2008 | Economics | Permalink | No Comments |

Last week gold prices were down as much as 30% from their 52 week high. From MarketWatch:

The reason, according to analysts at the World Gold Council, is that the latest bout of the credit crisis has been deeper and more far reaching. Funds were forced to sell desired assets such as gold to meet margin calls, while weakness in European economies lifted the U.S. dollar, which then pushed dollar-denominated gold prices lower.

“The fact that gold did not head higher during the current leg of the crisis seems to reflect a combination of the rise in the dollar, deleveraging of commodity positions, sales to meet margin calls, and the unwinding of the long gold, short dollar trade,” wrote Natalie Dempster, an analyst at the WGC, in a research report released Thursday.

I’ve watched gold’s inflation the last few years and wished I had had some, but even though it’s much cheaper now I’m still not convinced gold is priced rationally, so I’m not buying yet.

Anna Schwartz on the financial crisis

Wednesday, October 22nd, 2008 | Economics | Permalink | No Comments |

Wall Street Journal - Bernanke Is Fighting the Last War:

Most people now living have never seen a credit crunch like the one we are currently enduring. Ms. Schwartz, 92 years old, is one of the exceptions. She’s not only old enough to remember the period from 1929 to 1933, she may know more about monetary history and banking than anyone alive. She co-authored, with Milton Friedman, “A Monetary History of the United States” (1963). It’s the definitive account of how misguided monetary policy turned the stock-market crash of 1929 into the Great Depression.

In the 1930s, as Ms. Schwartz and Mr. Friedman argued in “A Monetary History,” the country and the Federal Reserve were faced with a liquidity crisis in the banking sector. As banks failed, depositors became alarmed that they’d lose their money if their bank, too, failed. So bank runs began, and these became self-reinforcing: “If the borrowers hadn’t withdrawn cash, they [the banks] would have been in good shape. But the Fed just sat by and did nothing, so bank after bank failed. And that only motivated depositors to withdraw funds from banks that were not in distress,” deepening the crisis and causing still more failures.

But “that’s not what’s going on in the market now,” Ms. Schwartz says. Today, the banks have a problem on the asset side of their ledgers — “all these exotic securities that the market does not know how to value.”

And this:

“It’s very easy when you’re a market participant,” she notes with a smile, “to claim that you shouldn’t shut down a firm that’s in really bad straits because everybody else who has lent to it will be injured. Well, if they lent to a firm that they knew was pretty rocky, that’s their responsibility. And if they have to be denied repayment of their loans, well, they wished it on themselves. The [government] doesn’t have to save them, just as it didn’t save the stockholders and the employees of Bear Stearns. Why should they be worried about the creditors? Creditors are no more worthy of being rescued than ordinary people, who are really innocent of what’s been going on.”