Friday Highlights

Good morning. Short list.

  1. On the extinction of religion, bad maths?
  2. Unhappy with Mr Obama. I was reading some of one of the accounts of the financial banking rebuild. “Ad hoc” is a way of life with this admin … and a fundamental problem.
  3. Hiding your message.
  4. Somebody thinks Florida might be more corrupt than Illinois? Please.
  5. Talking personhood, esp. personhood as rooted in a particular consciousness. This is a notion of personhood rejected by Eastern Christianity, which seats personhood in relationships … or so Met. Zizioulas argues (and I think he’s right). 
  6. Watching the educational beauty pageant.
  7. Well, I’m not very happy with any of those three, after all, government can accidentally do good things and very occaisonally it intentionally manages to do so. 
  8. Looking back at the Obama legacy.
  9. Offered as a kernel to trigger discussion.
  10. Airplane ettiquette.

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37 comments

  1. # On the extinction of religion, bad maths?

    Yeah I saw the headlines for that, but I didn’t even bother clicking as it didn’t pass the smell test.

    Unhappy with Mr Obama. I was reading some of one of the accounts of the financial banking rebuild. “Ad hoc” is a way of life with this admin … and a fundamental problem.

    So how does this “loyal opposition” dialectic work, anyway? Am I supposed to defend Obama no matter what?

    Well, I’m not very happy with any of those three

    The first two seem to be believed by both Republicans and Democrats and are obviously true, while the third is obviously false. (It takes but a single counterexample.)

    Looking back at the Obama legacy.

    Utterly moronic.

  2. Boonton says:

    Just as a matter of common sense, ad hoc solutions would seem to be a normal thing to expect with exceptional problems. The collapse of the financial system was hardly an example of an ‘expected problem’ (although plenty of people think so in retrospect). I’m unclear how the Obama response to it was more ad hoc, than, say TARP which was a creation of the Bush administration or the Federal Reserve (run by Republican appointed Bernake). If anything it seems the Obama admin. was the least ad hoc of all the major decision makers in terms of the financial collapse.

  3. Mark says:

    Boonton,
    That’s not the argument in the book (The New Financial Deal by Mr Skeel. The charge is that ad hoc decisions bypassing standards in place for bankruptcy surrounding the Lehman collapse and the prior ?? (I’m not recalling now) rescue led to a problems and the Dodd-Frank enshrines ad-hoc responses to crises and by replacing set regulations and guidelines that are understood with ad hoc decisions by regulators the Dodd-Frank has made the markets less not more stable. Your defense of Obama as moving away from ad hoc-ery is not supported against the explanations by Mr Skeel which directly contradict your statement.

  4. Boonton says:

    We’ll have to explore Skeel’s argument in more detail but from what I’m saying I think your argument is that basically ad hoc bailouts rather than simple bankruptcy created a new ‘deal’ where financial firms believe they can bypass bankruptcy by generating a crises.

    Lehman’s collapse would be ‘old deal’ since the Fed and gov’t both decided that ‘nature should take its course’ rather than risk moral hazard. They were shocked, though, when they saw that simply letting the firm go down wouldn’t just hurt shareholders and those with a direct stake (like people the firm owed money too) but the entire financial system itself.

    The problem is that it isn’t so easy to purposefully manufacture crises and unless you can do it on a grand scale no one will bail you out just to save the system. Anyway in terms of ad hocery, well sorry but Bush and the Federal Reserve beat out Obama. As for financial markets being more unstable today, well what exactly does that mean and how do you measure it?

  5. Mark says:

    Boonton,
    The earlier bailout of X (Goldman-Sachs) signaled to Lehman that they too would be bailed out, and if I recall there were additional signals which lead the leaders in charge of Lehmann to not seriously prepare for bankruptcy or other solutions. Lehman’s collapse was caused by ad hoc-ery. The Fed and banking leaders in place since then, drawing on mistaken lessons from the banking crises, e.g., that the Lehman collapse precipitated and signaled a important part of the collapse. They took these lessons and have now made ad hoc solutions the institutional pro forma, replacing regulatory methods with judgement calls. Since a bank cannot predict when or if it will be rescued, it is this lack of predictability makes the market less not more stable.

    The “New Deal” is not one in which firms can bypass bankruptcy by generating a crisis, but that the regulators, because they give little indication of how they will move (as they have fewer published guidelines) … generate uncertainty. Uncertainty is not a recipe for good market behavior and inhibits growth.

  6. Boonton says:

    Goldman was bailed out in Dec of 2008 under the regime of Bush-Bernake, not Obama. Whatever the ‘signal’ that sent to Lehmann that didn’t alter the problem that Lehmann’s damage had already been done years before.

    More importantly your timeline is messed up. Lehmann filed for bankruptcy on Sep 16, AIG was rescued on Sep 17. Goldman wasn’t bailed out so much as they converted themselves into a bank holding company that offered greater gov’t protection but higher regulation on Sep. 22 and Warren Buffett invested $5B in them on the 23rd.

    Lehmann didn’t fail because it expected lots of bailouts, lots of bailouts happened because Lehmann failed more or less before all the others and they demonstrated how bad it was. By the start of Oct Congress was voting on TARP (which I recall you supporting, quiping that you’d like to see it ‘paid for’ by offshore drilling).

    Post the Fall of 2008 you basically get the opposite of ad hoc rescues. The Fed dropped rates to zero, almost all the TARP money that would be spent had been spent. Aside from the auto bailouts (which are chump change relative to the tens to hundreds of billions thrown around on Wall Street), there were basically no more bailouts under Obama. There was the idea of using the TARP funds to buy ‘toxic assets’ from the bank balance sheets but the program never got off the ground. Of the $700B, only 440B was spent at the program’s max and that peak happened only 3 months into Obama’s term (see http://stimulus.org/?filter0=80&filter1=&filter2=&filter3=).

    Post TARP you basically had regulation modified for the crises. Banks were ‘stress tested’ and required to raise additional capital (which basically means get more money from shareholders, less from depositors/lenders) so they could asorb any additional losses without either bankruptcy or bailouts. The efforts to deal with the crises moved from financial repair by bailout to stimulus who benefited almost entirely non-Wall Streeters (although it is interesting how history seems to have been retconned to merge the stimulus bill with TARP and blur the two).

    I suppose Lehmann could have done some things to minimize the damage to stakeholders by ‘preparing for bankruptcy’. But why would it have? First many companies don’t get into bankruptcy because of their concern about the well being of their stakeholders. Second, “let us fail and you go down too” is a threat that works well when you’re seeking a partner to keep you out of bankruptcy and Lehmann was desperately so seeking, I believe they might have even rejected one offer because it came with the condition that their famously arrogant CEO would be fired as part of the deal.

    As for how regulators will ‘move’…… I’m not seeing it. “Published guidelines” only lower uncertainity to the degree that you can trust that they won’t be pushed to the breaking point. More importantly you didn’t answer my question. How is the market more voltile? How is that measured? How do you measure this supposed ‘uncertainity’ that is plaguing the financial markets today? Or is it just a subjective assertion designed to be immune to objective testing?

  7. Mark says:

    Boonton,
    The problem with the timeline is that I don’t remember what I read 3 months ago in great detail. After class today (10-2) I’ll pull it up and some of the details more correct.

    I’m unconcerned with partisan blame. Whether Bush or Obama regulators initiated what is not the question. The point is Dodd-Frank is badly flawed and the reason, in part, is a misunderstanding of the banks involvements in the crash.

    Oh, was the earlier bailout (6 months earlier) that sent the wrong signals not Goldman but AIG. I think that’s it.

    So, was or was not the Lehman collapse a catalyst for the financial collapse?

  8. Mark says:

    Boonton,
    And the point (of the book) isn’t about the collapse but Dodd-Frank, although the narratives of the collapse … being misunderstood by a number of principles … caused us to have a badly flawed bill/law.

  9. Boonton says:

    So, was or was not the Lehman collapse a catalyst for the financial collapse?

    I believe it was.

    Oh, was the earlier bailout (6 months earlier) that sent the wrong signals not Goldman but AIG. I think that’s it

    No it all happened more or less at once. The subprime issue was festering for a while, mostly with concern about ‘resets’ that were going to hit people with adjustable rate mortgages who couldn’t refinance out of them after people began to tighten up credit (ironically this itself didn’t become a problem because rates dropped dramatically which helped people with adjustable mortgages….provided they didn’t loose their jobs or didn’t discover they were deep under water those loans stayed good). There was no dramatic bailout 6 months before. LTCM want down the tubes in 1998 and received a ‘pseudo-bailout’ where Greenspan got several big Wall Street firms together and pushed them to take over the fund but didn’t put any actual Federal money behind it. In terms of 2007-08, ‘signals’ meant nothing. The firms that were flying towards bankruptcy and failure were already too far along.

    More important to keep in mind is that firms technically didn’t get bailed out. If you owned Lehman Bros stock, if you owned Fannie Mae, AIG, GM etc. you lose most or all of your money. The ‘bailouts’ were not so much towards saving those who got themselves in bankruptcy, it was to keep those failures from infecting everything else.

    And the point (of the book) isn’t about the collapse but Dodd-Frank, although the narratives of the collapse

    OK but then we aren’t really talking about ad-hocism here are we? Dodd-Frank is it’s own bill which we can talk about but that’s a different environment today than it was at 2008-9.

  10. Mark says:

    Boonton,
    OK. I’ve pulled up my kindle (app on PC, which means I’ve booted to windows). The PC version is better for quick scrolling around than the hardware kindle.

    Anyhow, it was the Bear Stearns bailout which convinced Lehman that they could expect a bailout too (not AIG or Goldman). That was 6 months or so earlier.

    The Lehman myth:

    Prior to the shock of Lehman’s bankrupcty filing in the early-morning hours of Sept. 15, 2008, the Panic of 2008 — then generally known as the subprime crises — was more or less manageable. Federal regulators had started off on the right foot by bailing out Bear Stearns and midwifing its sale to JP Morgan-Chase in March 2008. They were also wise to bail out AIG six months later, although they botched the execution. Lehman was the big exception — an exception that showed once and for all that bankruptcy is not adequate to handle the collapse of a major financial institution. The Lehman bankruptcy unleashed a tidal wave of consequences which nearly brought down the American economy, as well as many economies elsewhere in the world. This, in condensed form, is the Lehman myth.”

    I’m guessing that the details above about the myth are the variant to which you ascribe. Mr Skeel makes a good case that this is indeed myth, not fact.

    Lehman’s collapse (if single handedly triggering the crises) should leave evidence, such as a stock market reaction supporting the claim of its importance. Such data is lacking. In fact the reaction of the market was greater for AIG than Lehman. Another investigator (Taylor quoted) looked at an index known as the LIBOR-OIS spread, he indicates this is an indicator of market stress. There is a small bubble which corrects after the Lehman/AIG events, but it gets bad … when TARP was announced. Taylor’s conclusion was that the unpredictability of the government response was the principle cause of the severe deepening of the crises (not Lehman).

    The other half of the myth (that bankruptcy could not handle the Lehman collapse) is also shown to be mythic.

    Skeel suggests that the real pivot point of the crises was when the government decided to bail out Bear Stearns instead letting it fail and file for bankruptcy … and points out lots of following problems and irregularities surrounding the subsequent Chrysler/GM bailouts.

    The problem with Dodd-Frank, in part, is that they take the wrong lessons from the crises and attempt to patch them based on that (incorrect) information.

  11. Boonton says:

    I forgot about Bear Sterns, you may want to review it on Wikipedia.

    First the gov’t did not formally bail out Bear Sterns. Sterns sold itself to JP Morgan for $2 (later raised to $10) a share in March of 2008. In July of 2007 the stock was trading at $172 so this was a massive loss to share holders. From the POV of bankruptcy, a shareholder was only modestly better off after this ‘bailout’. The gov’t did give JP Morgon a line of credit and did faciliate the sale but at the end of the day this wasn’t a bailout in the sense that GM was a bailout.

    Second, let’s just note for the record we are getting more and more away from the Obama administration here. “Ad hoc” charges here belong to the Federal Reserve if anyone….

    Third, from a game theory POV I’m not sure Bear really sets the stage for ensuring players that a bailout is in the works. Both Bear and LTCM were highly specific types of events and getting the ‘bailout’ to happen was iffy (major players dropped in and out until the last minute). If you were running, say, Lehmann Bros the lesson isn’t clearly “don’t worry the gov’t will bail you out”. More importantly, in both cases if you were running Lehmann Bros you’d probably look at who was running LTCM and Bear and what happened to them post-bailout. They basically got forced out and lost their jobs. The type of ‘bailout’ this type wants is basically to play the casino games on credit. Imagine a casino where you just blew $1M and the casino lets you play on credit for $500K. You’re betting that you’ll win big and come back. The type of bailout these people want is, in order of preference:

    a. A big loan. They keep control of the company and hopefully paying off the loan is no big deal after they win big again. If they don’t, well it’s just another thing to add to the pile of debts in bankruptcy court.

    b. A partner. They give up a chunck of their ownership, maybe have to take a ‘boss’ or two in exchange for an ‘angel’ who will come in with fresh funds. Warren Buffett, I believe, almost did this with LTCM but the firm balked when he told them the management team would have to leave if they wanted him in.

    It seems to me that the incentives in this game then are to make your failure an even bigger risk rather than saying since the gov’t is not consistent in bailouts or rejects bailouts you better play it safe. The mindset of these types of firms is to NOT play it safe to begin with. It’s easy to earn safe returns on a pile of cash, just buy paper or buy stocks if you don’t need the liquidity for a period of years. It’s a special type of risk taker that promises to give people who give up millions or billions both returns and liquidity. They will always drive right up to the edge of the cliff…

    Anyway, I’m not really clear that even if Bear had gone bankrupt, Lehmann would have been willing or able to reform itself in 6-9 months so that it would either not fail or fail in a less destructive manner. More likely than not, Lehmann would have viewed a Bear failure with a sense of delight that they had less competition now and could try to double down on their bets. The book I read about Lehmann’s collapse (“A Coll. Failure of Common Sense”) seems to confirm the view that Lehmann’s CEO was a horribly arrogant and short sighted type who cared nothing for so-called ‘stakeholders’ in his enterprise.

  12. Boonton says:

    Let’s also note that this isn’t very ‘ad hocish’ in the history of Wall Street. Wall Street can be thought of as a group of greedy people playing for big money. It’s also a story of ‘market makers’ who literally hold themselves responsible for an orderly, functioning market. This means that when you want to sell you can sell, when you want to buy you can buy (not, though, that the thing you brought in the past will sell today for a higher price). Stock markets, for example, have formal ‘market makers’ whose duty is to not only trade for their own profit but ‘make the market’ in their assigned stocks. When everyone sells they buy and vice versa. The market never is supposed to shut down because everyone sells at once and with no buyers no transactions can happen.

    The failure of huge firms, then, has always been a problem on Wall Street not because they mean people will loose money (people loose fortunes every day), but because they can destory the market. If people can’t get out of the market when they want to they won’t get in and if they don’t get in people like Grekko Gordon won’t get pension funds, 401K’s, and others to give him millions to play with. On Wall Street the failure of huge firms that threaten the market itself has always been ‘midwifed’ by major power players like JP Morgan himself over a hundred years ago. Bankruptcy was ‘allowed’ by the elites when it wouldn’t disrupt the integrity of the market itself, when it wasn’t it was avoided by finding major players to ‘take over’ the things so the failing firm could be ‘unwound’.

    The NY Federal Reserve Bank acts then rather consistently with how things were done in the past rather than inventing a new regime ad hoc. While a Lehmann may not have expected a gov’t ‘bailout’ if Bear had been allowed to fail it was reasonable for it to have expected some type of bailout if they could establish that they were ‘too big to fail’

  13. Mark says:

    Boonton,
    It seems you’ve sidestepped my prior comment. You offered that you found Lehman’s collapse to be a critical element of the crises. I’ve mentioned counter arguments that this is false (the absence of market change/signals surrounding the Lehman announcement). On what basis do you find their collapse critical?

    The reason Skeel talks about Lehman at all is that the “lessons learned” from Lehman a crucial to understand the logic and reasons for Dodd-Frank (which if you’re keeping track is not further and further way from the Obama admin). If the lesson’s learned and what is being countered is not are based in myth, that should give you pause, right?

  14. Mark says:

    Boonton,
    I think the claim is that much more, not less, uncertainty is begin put into the regulatory system by Dodd-Frank which is less conducive for a business to anticipate, hence is a market destabilizing force. Seeing that the reason for Dodd-Frank is to seek more stability, that would seem obviously wrong.

  15. Boonton says:

    I believe Lehman was not perceived as critical before the collapse because the market itself didn’t realize how interconnected it was. When Lehman did collapse, though, the issue was revealed as it started pulling down other ships that were not expected to be so dependent on Lehman. When that lesson was learned, the question/panic that came next was who else was everyone so connected too and just how healthy were those companies? If a relatively small player like Lehman could pull down so much what about other people like Morgan, Bank of America, etc.

    OK if you want to shift gears and talk specifics about Dodd-Frank then do so, but the bailouts and ad hoc policies were mostly a product of the pre-Obama era. You cited first AIG as an example of a ad hoc policy and then when corrected cited Bear Sterns.

  16. Boonton says:

    uncertainty is begin put into the regulatory system by Dodd-Frank which is less conducive for a business to anticipate, hence is a market destabilizing force

    Well the pre-Dodd era was marked by ad hoc bail outs by the Fed and/or radical federal intervention in the financial markets. The intervention itself had a great deal of uncertainity. First TARP was authorized for $700B, but it only spent about $441B. It was supposed to buy ‘toxic assets’ from banks with private funds joining in but then it started buying shares of stock, car loan and mortgage backed securities etc.

    So while there may be uncertainity in how Dodd-Frank is implemented or in the way various regulators use the discretion the law gives them, I think you have a hard case to say that uncertainity has really increased. If it had, why was Wall Street so against the bill? After all more uncertainity multiplies the chances for possible profits to those ready to exploit them.

    In terms of the market being ‘destablized’, well what exactly does that mean and how do you measure it?

  17. Mark says:

    Boonton,

    In terms of the market being ‘destablized’, well what exactly does that mean and how do you measure it?

    As noted in my earlier comment, an investigator (Taylor) looked at the LIBOR-OIS spread in the months around the Lehman failure and found little change. To help you out … I’ll search for you here.

  18. Boonton says:

    http://www.igier.unibocconi.it/folder.php?vedi=4688&tbn=albero&id_folder=183 has a nice graph of the LIBOR-OIS spread with major events marked out helpfully.
    It seems pretty clear Lehman (mental note, only one ‘n’) sparked a pretty sharp spike in the spread and TARP’s approval marked a sharp decline with it now being exceptionally low.

    What does seem consistent is when you get a spread beyond 2 the normal cultural mechanisms of the market seem to break down. The ‘let the markets decide’ stance of many politicians as well as Wall Street types who pride themselves on playing a ‘rough game’ in the market suddenly collapse and demand help. Above 3 and you get even leading Republicans running for high office charging that voting against something like TARP is unAmerican.

    Looking at the ‘months around’ the Lehman failure might be the problem here. Lehman drove the spread into a place where it cannot exist very long without capitalism collapsing….so to speak. Even being in that zone for less than a month coupled with massive injections of money creation in amounts of hundreds of billions to trillions of dollars was barely enough to return to ‘normal’ with lots and lots of collapsed wreckage laying about.

    It may be helpful to think about this metric a bit more. LIBOR is a loan you make to a bank while OIS is a swap. OIS carries no risk of default while LIBOR does. Imagine an alternative universe where the gov’t let everything collapse. You may still get your spread back under 1 but you do so after 90% of the banks and financial firms in the world are wiped out. The few that are remaining behind have little chance of default hence merit a very low spread. In other words this metric doesn’t necessarily mean that lower is better.

  19. Mark says:

    Boonton,
    (Your link didn’t work “MySQL error” is what I got).

    See this. Taylor found pretty clearly that there was a one day spike around the bankruptcy but it triggered … nothing. More here.

    A quote from the second:

    But Taylor, drawing on the well-known finding of financial economists that financial markets adjust within hours or minutes to new information, shows that the Libor-OIS spread did not widen much after the Lehman bankruptcy. Instead, the big widening occurred after Bernanke’s and Paulson’s Sept. 23 testimony spooked financial markets with their warnings of grim days ahead if the bailout were not passed. This is some of the key evidence that the bailout actually worsened the problem.

  20. Mark says:

    Boonton,
    Well, it worked the third time (your link) … which doesn’t really support your Lehman theory. There is a trend before it, the event is a spike which basically retreats to the trend. The big spike is at the announcement of “we need TARP.” Lehman did not drive the spike. Sorry. That data don’t support your claim.

  21. Boonton says:

    I think the chart was the TED spread which is slightly different but basically the same idea, you can see the TED spread chart here for sure:

    http://www.bloomberg.com/apps/quote?ticker=.TEDSP:IND

    Page 10 of this has a nice chart of the LIBOR OIS spread but it cuts off after late 2008….it does appear to show that there was a huge OIS spike that returned to normal both before and after.

    http://www.ibefa.org/conferences/ahead2009/discussants/Levin.pdf

    The TED chart is really nice though, please try once more if not I’ll try to catch it and maybe email it to you or toss it up on a site…….

    I’m not saying the spike wasn’t saying ‘we need TARP’ but why did ‘we need TARP’? What are these spread’s saying? They are saying that even to loan money for a few days to the most respected and safest of banks was perceived as so risky as to demand high premiums. The money class wasn’t conducting a big shakedown for TARP, they were in panic mode.

  22. Mark says:

    Boonton,
    But Lehman was just a bump in the road, not the cause of their panic. Check stocks as well, no panic around Lehman (just a bump) … panic in the market hit when the government insisted on the necessity of TARP.

  23. Boonton says:

    No luck with the original link? Hmmm.

    Why exactly would the market panic at a proposal for the gov’t to purchase $700B in assets on the market from banks and other financial institutions? It’s not like some odd entity from another planet called ‘government’ just came down from the sky and announced TARP was the big plan. The market was panicing both because of Lehman and more importantly because Lehman signaled that the problem was worse than they had hoped. It sounds like you’re saying the miners who panic after seeing the canary die and rushed for the elevator didn’t panic because the canary died but because someone said ‘rush to the elevator’. After all, miners don’t care about a little bird! And technically that’s true, the it’s not the bird’s life that they care about but their own, if the CO was just enough to kill the bird but not the people they wouldn’t care but the bird’s death signals that the danger is at least enough to kill the bird and might be enough to kill the people.

  24. Boonton says:

    And I’m still not getting how your spread ‘over several months’ can tell us anything about Lehman? So what that spreads returned to normal post Lehman? They returned to normal after massive intervention. That doesn’t mean that Lehman’s failure was harmless to just about the entire economy except for Lehman employees and shareholders.

  25. Mark says:

    Boonton,
    The claim is (one the hand made by those believing the Lehman myth) that the Lehman collapse was a critical event. This is contradicted by the data as indicated by Skreel and Taylor for the reasons mention, i.e., the markets and stress data show only momentary signals surrounding Lehman.

    Regarding the canary … let me try a stab at the Taylor Creed variant with that analogy (with Lehman as canary … note also if you’re calling Lehman the canary, then you are rejecting the Lehman myth, which posits Lehman as a cause not an indicator). The miners are in the mine. Canaries begin dying (Bear, then Lehman and so on). Workers aren’t panic but are aware there is a problem, some are leaving some are working to seal the gas source. Then the super starts on the bullhorn hollering at 140 decibels that everyone has to be on the surface by elevator within 10 minutes or everybody will be dead. 2000 workers stampede for the elevators and panic ensues, people are trampled and the elevators overload and fail. What caused the panic? The canary or the poor reaction and supervisors handling of the situation? Note, it might really have been true that the mines needed prompt evacuation. However, that does not mean that a more measured non-panicked supervisor might have meant less aftermath. It also doesn’t a priori indicate that if the standard procedures on canary death would not have been a better response.

  26. Boonton says:

    Let’s say for the sake of argument that Lehman was just a run of the mill failure that by itself indicated nothing. Because the gov’t thought there was a major problem, it proposed to start buying $700B worth of bank assets or bank stocks. From the POV of a profit seeking investor, this would be a great time to start buying those stocks. After all, the businesses are supposedly sound to begin with and here comes nearly a trillion dollars of aid out of the blue! Yet that did not happen, why? Likewise if this is reality then it would be a time to short US gov’t debt. After all here you have the gov’t getting all panicy and borrowing nearly a trillion in less than a week for something entirely unneeded.

    Yet if you followed this strategy you would have lost a lot of money. Why did it happen like that? The coal mining analogy faulters because if the foreman sounds the bullhorn the logical thing to do is get out. There’s no reward if the emergancy is false and you stay behind. Markets are a bit different because if the herd is spooked but you aren’t you can make a lot of money being rational while everyone else panics.

    i.e., the markets and stress data show only momentary signals surrounding Lehman.

    Problem, if the data showed a buildup of stress leading to Lehman then Lehman would NOT be an event. The market would have been adjusting to the slowly increasing stress levels making Lehman’s failure well anticipated. Likewise if the massive intervention ‘solved’ the problem to one degree or another what you’d expect to see is ‘momentary signals’ surrounding Lehman. Looking at the labelled TED spread, Lehman shot it up over 3 from 1. It very briefly retreated to a bit under 2.5 (still an indication of extreme uneasyness if 1 is the ‘normal’ level). Then it shot even high to just under 4 with the failure of Washington Mutual. There was then another spike that culminated with the endorsement of TARP at above a whopping 4.5 (what is left off, though, was that TARP briefly failed in the House…if TARP was the cause then why would the market spike when TARP failed? Wouldn’t its failure then be viewed as good news?). Post TARP the spread falls like a rock.

    If no intervention had happened and the data looked like this you could argue that Lehman was no big deal, but since that didn’t happen you can’t really prove it one way or the other.

  27. Mark says:

    Boonton,
    You are confusing the intervention with the announcements (Congressional testimony by Paulson and Bernanke). The latter was not TARP, when these indicators begin easing. The announcement is where the crises, as argued by these authors, really begins to occur.

    The timeline as noted, was that stress indicators looked fairly steady (historically speaking) in early Sept. At the Lehman collapse, they blipped but recovered the next day. 9 days later at the testimony they went haywire. Yet you blame Lehman. Doesn’t make sense to me.

    So then, why do you blame/cite the Lehman collapse as trigger? You need to deal with these points. There was no stock market signal around Lehman, only a brief one/two day movement which recovered. Taylor cites a metric (LIBOR-OIS spread) which he cites as relevant and for it the movement follows the timeline cited in the first paragraph in this comment.

    Looking at your graph is difficult because each tick is one month. I can’t distinguish between Sept 15 and 25 very easily. You keep citing Lehman as trigger and TARP as recovery. The authors cite an event 9 days later (Bernanke/Paulson testimony as trigger) which in the time resolution of the data you’re looking is indistinguishable. I haven’t said TARP was the cause. Ever.

  28. Boonton says:

    Bloomberg has a dynamic chart that let’s you get the figures for each day by mousing around it (unfortunately it doesn’t seem to let you zoom in on a historical week rather than just the current weeek).

    I’m not buying the argument that liquidity wasn’t the problem. If it wasn’t, then why did TARP work? Why did the spread shoot so high indicating that there was plenty of money willing to go to riskless US debt but not near riskless short term bank loans? Your quote says that spreading spreads was ‘key evidence’ that the bailout was part of the problem (and what was the bailout? It was TARP and the Fed’s easing. If not then what was it?). Why was news of a massive bailout or the need for one the cause of a massive increase in the spread? What the spread means is that you can short US Treasuries at low cost, use those funds to loan in the LIBOR market for higher returns. Why would smart money not have done that thereby lowering the spread rather than widening it?

  29. Mark says:

    Boonton,

    Why was news of a massive bailout or the need for one the cause of a massive increase in the spread?

    Didn’t you read the links? The reason it caused movement because it signaled that the government indicated there was a big problem and that they had no plan.

  30. Boonton says:

    Reading the Forbes review (having trouble loading the other one), I’m not quite sure what he’s getting at. Both demand for liquidity and ‘counterparty risk’ seem like two sides of the same coin.

    You’re a big financial firm. You’ve gathered some brillant investments that will yield 10% over 12 months but this required a massive investment, say $15 Billion. No problem. Big businesses all the time have idle cash. You sell them a service that takes that cash, let’s it sit in your hands for two weeks and then goes back to the company in time to make payroll and pay suppliers. You’ll pay them .192% interest which works out to about 5% over a year…better than a bank checking/savings/money market.

    Even better, you’ve found customers whose cash needs are staggard. Customers A have cash on the first of the month and need it two weeks later. Cutomers B get cash two weeks into the month and need it on the first of the new months. So you’re rolling over $15B every two weeks between customers A and B which allows you to make the needed $15B investment to earn 10% for a net return of 5%….which is pretty good on such a large investment. Forget about changes in interest rates, assume your math quants have worked out hedges that will preserve everyone’s interest rates regardless of how actual market rates go.

    Now stuff goes wrong all the time. Maybe a customer will want out or not have so much cash in a week. No problem, you’re a big Wall Street firm with good credit. If you had to borrow a few hundred million or even a billion for a month or two at a 10% per year rate until your sales dept. could bring in more customers you can do it. Yea it cuts into your expected profits but hey no guts no glory.

    In six months, though, two big Wall Street firms go bankrupt. Rumors are going around that there’s massive, unseen counter-party risk. Banks and firms that were thought to have hundreds of billions in high quality assets really have junk assets but no one knows where they are or how much is junk.

    Your customers start getting calls from their shareholder.

    “How much is at risk in those toxic things that no one understands”
    “Why nothing, we make widgets and sell them for cash. We put the money in our bank taking it out at the end of the month for payroll and expenses”
    “Whose your bank”
    “Why Bank of America, but we have the funds earning an extra 5% in our Wall Street Firm’s “Cash Viagra Max. Tool””
    “And what does that firm do with the money?”
    “Errrr, we don’t know…..”

    Now it’s time to re-up the $15B, but $3B in customers opt not to continue. OK, go borrow it from the paper markets for a month. Wait a second, they are talking about ‘counterparty risk’. OK tap our retained earnings, no bonus’s this year but we’ll make good on our deposits….

    But now the press is reporting that people are ‘fleeing’ Wall Street firm. The fund may be ‘bankrupt’. No worries says the PR department. The exposure is only $3B which can easily be managed. But now another $4B wants out, “exposure doubles!” scream the headlines a day later. How to get out? Sell the $15B investment that’s earning 10%. Wait a second, there are no buyers! Now maybe the press is wondering if the $15B investment itself might be no good. Now the firm starts to go under entirely……

    But in the larger market two events can happen. One is that this is a $15B loss. The investment and debts owed to the customers may be sold to another Wall Street firm or the investment itself will be ‘sold for scrap’ in bankruptcy leaving the customers to collect whatever they can on the dollar. That’s ‘normal’. What also can happen is a contaigin effect. A ‘run on the bank’ so to speak although you can see here these aren’t technically banks. Customers seek safety and the safest thing around is US gov’t debt so the Treasury market booms and interest rates fall. But while rates fall, borrowing is almost impossible. Even very liquid investments like the ‘two weeks on’ type of investment I speced out above aren’t good enough. They want either cash in a safe or US Treasuries (short term, zero coupon). You have a liquidity crises but that’s also a counterparty crises. The firm I speced above was technically in good shape. It was earning 10%, borrowing at 5% all perfectly hedged against rate changes so guaranteed profit.

    The liquidity crises, though, creates a counterparty crises. If the firm normally could make up random shortfalls by borrowing a billion here or there for a month at 10% all it does is lower profit a bit. If that goes to 30%, though, now the firm may start losing money on the investment or may have to default on the withdrawl requests of some customers….which will make everyone else want out immediately. Imagine the Widget Company President screaming at the CFO….”what do you mean we can’t take it out! It’s our cash, it came in last week from our customers and we have no debt….we can’t take it out of the Wall Street firm to make payroll! Call our bank they suggested this firm and got a commission from them for it!!!! What they won’t give us a short term line of credit!!!!” Now the Widget company has a ‘counterparty crises’ with its employees and suppliers even though in the ‘real economy’ it was perfectly healthy.

  31. Boonton says:

    Still thinking about this…..let’s look at the same example but a counterparty issue.

    In the liquidity problem, the firm was ok. They were earning 10% long term, borrowing at 5% short term with the only problem some back and forth in rolling over the short term debt that could be easily handled (at a price of course) by the short term credit markets.

    In the counter party problem, let’s say the firm isn’t ok. It has a $15B investment it thinks will produce a 10% return after a year BUT now they are starting to see it’s not the case. Well the firm is no different than any other borrower in this case, they have short term debt due now but their long term asset isn’t going to pay what they thought. They either have to keep turning over the debt, slowly writing off the loss or just pay off the debt all now and take a big loss. Trouble but not fatal for the whole economy.

    Now what happens to the spreads here? If the market is getting wind of this problem, the spread will go up. Loaning ‘overnight’ with companies like this in the lake is more dangerous than loaning to the US gov’t. OK. What if, though, the Federal Reserve and various *Very Important People* start saying that there’s a massive crises and the gov’t must borrow billions to buy up ‘toxic assets’ and save firms from failure.

    It seems like Taylor’s argument is that this would cause the spread to spike even more, but it wouldn’t. If this firm could offload its bum investment on the Fed for $15B then it’s home free. It can pay off its short term debts and no one will ever know they were heading off a cliff. Onto the next big deal! The spread, then, would shrink at the announcement that such a plan might be in the making, not spike.

    In other words it’s basically the same thing. If you have a liquidity problem, you will create counter party problems. A liquidity problem can be sparked by a single or set of counter party problems. It’s a bit like asking which buffalo set off the stampede. Sure maybe you can mark the ‘first’ one to bolt but individual buffalos have ‘bolted’ without setting off a stampede. Saying the market fell into a crises because a Very Important Person testified that there was one overplays the influence VIPs have in talking the market.

  32. Mark says:

    Boonton,
    I think I read Taylor said it wasn’t a liquidity problem at heart, but a unknown toxicity problem.

    He has a book explaining his argument. Don’t depend on my poor explanations or one (linked) review. Seems to me if you want to give his argument a fair shake, you’d have to read the book.

  33. Boonton says:

    fair enough im reading all the devils are here so this is my first and probably last comment written on a kindle

  34. Mark says:

    Boonton,
    The book on it I was reading was recommended on the Volokh site, btw. That’s how I landed on that one.

  35. Mark says:

    Boonton,
    I should add that by the remarks about who Taylor is, he seems a pretty mainstream (and well regarded) economist.

  36. Boonton says:

    About 2/3 through All The Devil’s are Here and I have to suggest it as a good review of the financial crises. It’s not quite a ‘for dummies’ book but it takes things in very simple steps and appears pretty fair IMO to all sides. It does not seek to explain a single moment (like the Lehman failure and what the market did or didn’t think about it that week or two) but the whole thing.

    Several broad themes I’m getting:

    1. The problem was not simply ‘bad loans’. Bad loans happen all the time and whether or not they happened due to gov’t pushing housing for minorities and the poor or not shouldn’t really matter. A bank ‘forced’ to make a ‘bad loan’ would take a loss since when they go to sell that loan to the market they would fetch a lower price versus a financial institution that was lucky enough to have a ‘non-bad’ loan on the books.

    2. Derivatives were and are an issue. An analogy here is to think of the environment. When someone has ownership rights in the environment (say your front lawn), it tends to stay pretty clean. When no one does (that empty stretch of sidewalk where everyone seems to chuck their water bottles and such), it doesn’t.

    They are a real financial innovation, though and Greenspan esp. and others refused to allow them to be regulated. The problem is that while derivatives like credit swaps allow you to manage one type of risk, it seems like they cause other problems. Namely:

    a. They ‘pollute’. By ‘insuring’ against default the risks don’t disappear but are ‘spread out’ throughout the entire financial system. The bad then drives out the good. Since a ‘bad mortgage issuer’ can package his mortgages as ‘risk free’, there’s no difference between its incentives and one who is a careful issuer. By analogy, you refraining from littering doesn’t help much when everyone else does it and the system is set up to encourage littering by making it illegal to enforce any fines for littering…even making it hard for private individuals to enforce ‘no littering’ rules on their own lawns!

    b. They create a new type of risk, ‘counter party risk’. You buy a bond of a thousand mortgages but AIG, which has a AAA credit rating, sells you a ‘swap’ aganst them defaulting. You’ve eliminated one risk but you’ve replaced it with another one…namely that AIG will go under. Since the swaps are unreglated, AIG is not required to put up certain levels of ‘safe capital’ to reserve against loss nor are you able to easily guage just how much risk AIG has taken on with its ‘insurance’. This might be ok if you could properly price it but the market relied on the credit rating agencies like Moody’s & S&P for accurate credit ratings. But the ‘big three’ get paid by the company that wants to be rated, not the investor who is judging the company. Their incentive is to give everything an ‘AAA’. Even worse, the ratings of two agencies were usually expected but three ratings didn’t add much credibility. Firms learned to play the agencies against each other, if they got one good rating from one agency, they would play the remaining two rating companies against each other since they only had to give business to two, not three, rating agencies.

    3. There was the illusion that by building up diversified bundles of risky assets and slapping some type of ‘insurance’ on it, you could turn a high risk product into a AAA low risk product. Gov’t policy did play a role here because many banks, pension funds and insurance companies are obligated by regulation to only buy ‘investment grade’ securities. The ‘illusion’ was that you could have a bundle of sub-prime mortgages that had a high yield but were low grade and turn them into AAA rated securities by the right slicing and dicing coupled with the right type of swap (aka derivative).

    This actually created a perverse incentive for *worse* types of assets. The profit margin was greatest when you took a shabby set of loans (like sub-primes) and ‘transformed’ them into premium AAA securities. People with good credit scores were pushed into sub-prime loans. The most infamous type of sub-prime loan was the Alt-ARM….or the ‘name your mortgage payment’ loan where you could pay more or less ‘what you wanted’ for two years but then had to pay a high min. amount. People were terrified of these loans and no do-gooder activists or gov’t agency was pushing them (on the contrary, they were protesting them as exploting buyers), but they were pushed on people because they represented fantastic profit margins when sold to Wall Street versus more conventional 30yr fixed.

    To be blunt about it, if you thought a magical machine could turn anything into gold….what would you buy to feed into it? Silver or shit? Hmmmmmmm….

    But go back to point #2. Since the ‘shit’ wasn’t really being spun into gold but the people holding the ‘shit’ weren’t taking on the full actual costs of it the entire system was asorbing it. Hence you get to the convoluted point where PJ O’Rourk quipped that the trashy neighbor down the street somehow manages to destroy the economy of Iceland by not paying his mortgage.

    The problem, though, really wasn’t people not paying their mortgages or taking risky loans. A risky loan is fine provided the guy who owns the loan knows what he’s doing and pays the proper price for it. I think a misguided effort at reform today is trying to up the ‘requirements’ for mortgages. The fact is the innovations of secuarizing mortgages were real and do allow more people to qualify for them and own homes. That’s why they are sticking around even after the crash. The problem is when the market says everything is gold there’s no real incentive to produce real gold anywhere.

  37. Mark says:

    Boonton,
    The book I was/am reading isn’t about the crash. It’s about the Dodd-Volker(?) new regulations. It looks at the crash only to the extent of looking at the motives and themes that the new regulations were designed to prevent and noting that many of the things that the new regulations are designed to prevent were not actually relevant.

    I’d offer that you might look at Taylor’s book too about the crash. He’s well respected, and is working to dispel some of the mythology that our financial lead regulators and administrators, alas, subscribe.