Majikthise

Dispatch from the real economy

The drugstore has locked down the deodorant.

Addendum: You can tell a lot about a neighborhood by what gets locked up to prevent shoplifting. Here in New York, supermarkets in poorer neighborhoods tend to put baby formula behind glass. Swankier places will keep it behind the counter at the pharmacy, or sometimes even out on the shelf.

Yuppie liquor stores keep all but their most expensive bottles out on the shelves to encourage customers to facilitate impulse buys. By contrast, liquor stores in rougher neighborhoods may keep the bulk of their inventory behind plexiglass. Liquor stores are an extreme example because they've got to worry about robberies as well as shoplifting, but it's the same merchandising principle at work. It's a tradeoff between accessibility and security.

Small, expensive items like razor blades and batteries are likely to be secured no matter where you go. But it's a bad sign that deodorant shoplifting has become enough of a problem to justify the expense of the giant plastic case and extra hassle for the employees.

Who's making it to Making it in America?

The Institute for America's Future and the Alliance for American Manufacturing are co-sponsoring a one-day conference on alternatives to the bubble economy on Thursday, Oct 29. 

Making it In America is a symposium on how the U.S. might move from a speculation and service economy to a more just and sustainable alternative. Featured speakers include AFL-CIO President Rich Trumka, Sen. Sherrod Brown (D-OH), US Steelworkers President Lou Gerard, Prof. Suzanne Berger of MIT, and Kate Gordon of the Apollo Alliance. Registration is free.

As part of their outreach, they're covering the travel expenses of several out-of-town bloggers to attend the conference and write about it. I'll be one of them. 

AIG counterparty obligations may not be enforceable, but we're paying them anyway

Olga Pierce has a nice piece in ProPublica explaining why AIG is still paying its counterparties in full.

I submit that the short answer is money laundering. Paying the holders of credit default swaps in full is a convenient method of funnelling money to the banks without congressional oversight. The government has already paid out $52 billion this way. Much of that money is going to the same banks that are getting bailed out by TARP.  Congress can impose conditions on TARP money, but payouts from credit default swaps count as ordinary revenue, even if that money ultimately came from TARP.

The government now owns 80% of AIG, but the feds are refusing to exert meaningful influence over the management of the company. As Pierce explains, Tim Geithner could informally pressure AIG to take a haircut on these. That is, to renegotiate the contracts and take a loss. Given that the payout is holding steady at 100%, it's fair to assume that Geithner's not trying too hard.

One excuse for not making AIG and its counterparties renegotiate is that the counterparties would sue the federal government. The really amazing part of Pierce's story is that most of the counterparties probably lack the grounds to sue:

IMF: Toxic debt could reach $4 trillion

The International Monetary Fund is set to release a major assessment of the global economy at the end of the month and the results won't be pretty. The IMF estimates that the deepening recession could create up to $4 trillion in bad debts as more cash strapped people default on their mortgages, credit cards, and other obligations.

So far, the banks have only admitted to holding $1.29 trillion in bad debts:

Toxic debts racked up by banks and insurers could spiral to $4 trillion (£2.7 trillion), new forecasts from the International Monetary Fund (IMF) are set to suggest.

The IMF said in January that it expected the deterioration in US-originated assets to reach $2.2 trillion by the end of next year, but it is understood to be looking at raising that to $3.1 trillion in its next assessment of the global economy, due to be published on April 21. In addition, it is likely to boost that total by $900 billion for toxic assets originated in Europe and Asia. [Times]

(HT: Calculated Risk)

The best way to rob a bank is to own one (Bill Moyers and William K. Black)

Bill Moyers interviews William K. Black, a former bank regulator who helped save our asses during the savings and loan mess. Black argues that the financial collapse should be regarded as the result of systematic fraud, i.e., that the results of the profligate lending practices of the housing bubble were so profitable at the outset and so unsustainable as to constitute fraud, criminal betrayal of trust for financial gain.

It's a great piece of TV journalism. Watch it.

Here's a particularly topical snippet, not directly related to the fraud allegations, but worth highlighting all the same:

BILL MOYERS: But I can point you to statements by Larry Summers, who was then Bill Clinton's Secretary of the Treasury, or the other Clinton Secretary of the Treasury, Rubin. I can point you to suspects in both parties, right?

WILLIAM K. BLACK: There were two really big things, under the Clinton administration. One, they got rid of the law that came out of the real-world disasters of the Great Depression. We learned a lot of things in the Great Depression. And one is we had to separate what's called commercial banking from investment banking. That's the Glass-Steagall law. But we thought we were much smarter, supposedly. So we got rid of that law, and that was bipartisan. And the other thing is we passed a law, because there was a very good regulator, Brooksley Born, that everybody should know about and probably doesn't. She tried to do the right thing to regulate one of these exotic derivatives that you're talking about. We call them C.D.F.S. And Summers, Rubin, and Phil Gramm came together to say not only will we block this particular regulation. We will pass a law that says you can't regulate. And it's this type of derivative that is most involved in the AIG scandal. AIG all by itself, cost the same as the entire Savings and Loan debacle.

Watch the clip.

Zombie banks could pillage treasury under Geithner plan

You thought Bernie Madoff's $50 billion Ponzi scheme was impressive? Well, economist Jeffrey Sachs explains how the Geithner bailout plan could fraudulently transfer trillions of dollars from taxpayers to bankers if the banks game the system with front companies.

The Geithner plan is supposed to encourage private investors to buy up the toxic assets, thereby creating a market where none existed. In order to do that, the government will loan the private investors the overwhelming majority of the money they need to buy this crap. The private investors will only have to come up with a fraction of the cost of the assets out of their own pockets.

Sachs' worry is that there is nothing to stop the banks that are holding the toxic assets from creating straw companies to buy up their own bad assets with our money.

The plan was supposed to create an incentive for banks to price their toxic assets fairly in order to appeal to private investors who were highly motivated to scour the refuse pile for the hidden gems that Tim Geithner believes are hidden in the detritus. If a bank prices its toxic assets ridiculously high, the argument goes, private investors will find a competing bank that's charging a more reasonable price for its dreck.

This public-private partnership strategy is supposed to be better than having the government buy up the toxic assets at some arbitrary price. Maybe it is. A direct buy is a bad option too, because a) nobody knows what a fair price is, and b) the banks are guaranteed to overprice their assets and gouge the government.

Sachs asks us to consider the following scenario: A toxic asset on Citibank's balance sheet has a face value of $1 million, but it's actually worth nothing. (In real life it would have some value, but we're simplifying.)

Suppose Citibank creates what we'd normally call a front company, a legal fiction to disguise who's really doing business with whom. Let's call it the Citibank Public-Private Investment Fund (CPPIF). 

Under the Geithner plan, there's nothing to stop CPPIF from buying the asset at Citibank's ridiculously inflated asking price of $1 million. The government lends CPPIF a total of $925,000 and Citibank kicks another $75,000 to make a cool million.

What happens next? Citibank gets $1 million dollars for a worthless piece of paper. CPPIF now owes the government $925,000, but if it quietly goes bankrupt, so what? Citibank made $925,000 on the deal (the $1 million it got for the toxic asset, minus the $75,000 it fronted to CPPIF to buy it).

If this plan is going forward, Congress better be drafting legislation to stop banks from buying up their own overvalued assets with our money through front companies. But if Congress is going to start regulating what kinds of companies bailed-out banks can invest in, why not just nationalize the banks already?

Should we trust Citigroup with "significant judgment" on accounting?

The Financial Accounting Standards Board agreed to relax accounting rules for the benefit of troubled financial institutions like Citigroup:

April 2 (Bloomberg) -- The Financial Accounting Standards Board, pressured by U.S. lawmakers and financial companies, voted to relax fair-value rules that Citigroup Inc. and Wells Fargo & Co. say don’t work when markets are inactive.

The changes to so-called mark-to-market accounting allow companies to use “significant” judgment when gauging the price of some investments on their books, including mortgage-backed securities. Analysts say the measure may reduce banks’ writedowns and boost their first-quarter net income by 20 percent or more. FASB voted on the rules at a meeting today in Norwalk, Connecticut. [Bloomberg]

The article continues...

Fair-value requires companies to set values on most securities each quarter based on market prices. Wells Fargo and other banks argue the rule doesn’t make sense when trading has dried up because it forces companies to write down assets to fire-sale prices.

By letting banks use internal models instead of market prices and allowing them to take into account the cash flow of securities, FASB’s changes could raise bank industry earnings by 20 percent, according to Robert Willens, a former managing director at Lehman Brothers Holdings Inc. who runs his own tax and accounting advisory firm in New York.

Companies weighed down by mortgage-backed securities, such as New York-based Citigroup, could cut their losses by 50 percent to 70 percent, said Richard Dietrich, an accounting professor at Ohio State University in Columbus. [Bloomberg]

After all that's happened why on earth should we trust Citigroup's internal models to value anything, especially when Citigroup stands to massively reduce its losses by its choice of model?

How does allowing the banks to make self-serving guesses about what their worthless assets might be someday be worth help anything? The market will know the banks are viewing their toxic portfolios through rose colored glasses and discount accordingly. 

How Iceland went mad (...or not)

Michael Lewis has an amazing story in Vanity Fair about how the tiny country of Iceland essentially turned itself into a hedge fund, with disastrous results:

Iceland’s de facto bankruptcy—its currency (the krona) is kaput, its debt is 850 percent of G.D.P., its people are hoarding food and cash and blowing up their new Range Rovers for the insurance—resulted from a stunning collective madness. What led a tiny fishing nation, population 300,000, to decide, around 2003, to re-invent itself as a global financial power? In Reykjavík, where men are men, and the women seem to have completely given up on them, the author follows the peculiarly Icelandic logic behind the meltdown.

Highly recommended and very funny.

Update: Gregory A. Burris offers a pointed rebuttal to Lewis in Counterpunch. Thanks to commenter Hildur for recommending the piece It's a useful counterweight.

However, unlike Burris, I didn't think Lewis was scapegoating Iceland for the global financial crisis. In fact, Lewis stressed repeatedly that Iceland was just a bit player in a much larger and more nefarious economic system. Iceland is a tiny country that turned itself into a hedge fund. Compared to AIG, the entire Icelandic debacle is scarcely background noise. Iceland didn't break capitalism. Capitalism broke Iceland.

I thought Lewis was saying that Iceland the nation is an example of the devastation that unregulated global capitalism can wreak on an entire society. Big countries like the U.S. and the China are rich enough to weather the demise of many banks and hedge funds, whereas smaller countries like Iceland can be totally wiped out by much smaller failures. For me, the key point was that global capitalism is a lot more diverse than it used to be: The players aren't just the biggest companies in the richest countries in the world, and the regulatory framework must take that into account. We can't afford to let booms and busts destroy nation states.

Update 2: Jonas Moody of New York Magazine fact-checks Lewis's account and finds it wanting--nobody's hoarding food, or blowing up Range Rovers en masse. Lewis understated the number of surnames in Iceland and overstated both impact of elf mythology on daily life and the ease with which cults can obtain federal subsidies.  However, Vanity Fair stands by Lewis's source's assertion that Icelanders are hoarding foreign currency. Converting krona into foreign cash would certainly have been a smart move for those who realized that the banking system was unsound and the Icelandic currency was on the brink of collapse. (Thanks, HG.)

So far, the critiques of Lewis's article have centered on his snarkily hyperbolic Icelandic travellogue, as opposed to the financial details that are the meat of the story. The author consistently exaggerates for effect, sometimes to the deteriment of his overall credibility. But Lewis's hokey speculations about Icelanders as the risk-taking sons and daughters of fishers and smelters aside, I'd be curious to know what people think about his economic arguments.

Jim Cramer's confession could end his career

Henry Blodget at Slate explains what Jim Cramer was actually confessing to in those clips from The Street.com that Jon Stewart showed played on the Daily Show.

Blodget suggests that many of the trading strategies that Cramer confesses to having engaged in as a hedge fund manager, and recommends to his viewers, may constitute illegal market manipulation.

One particularly ironic detail. In the video, Cramer advocates spreading lies to reporters to move the price of a stock, including a specific CNBC reporter. Remember, Cramer wanted to go on the Daily Show to defend CNBC from Jon Stewart's previous ribbing.

via Naked Capitalism.

Does the president normally assert that T-bills are sound?

Just curious.

I'm guessing that the president is volunteering because China asked. Has this ever happened before?