Monday, March 9, 2009

Assorted links

  1. Martin Wolf has a very nice piece on the future of capitalism in the FT. He is always worth reading.
  2. Bethany McLean has a nice article on Fortress Investment Group and the problems facing hedge funds.
  3. The NYTimes has an article on the role of quants on Wall Street. Much of it is infuriating, but the end of the article (once Andrew Lo is quoted) is worth reading.
  4. Gillian Tett has a nice article on how the complexity and opacity of modern finance brought us to some of our present difficulties.

Saturday, March 7, 2009

Last Days of the Oligarchs?

That is the title of this article in the New York Times. There seems to be this conventional wisdom that the oligarchs are finished in Russia. The basic point:
Once-invincible oligarchs now look extremely vulnerable. With or without state aid, the government is likely to gain more control of their operations. If they get no help, many could go into bankruptcy, with nationalization of one form or another likely to follow. And any new bailout would probably mean larger equity stakes for the government.
And here is an interesting snippet:
In the initial collapse of the Russian stock market from May to October last year, Bloomberg News has calculated, the richest 25 people on the Forbes magazine list for Russia lost a collective $230 billion. Some of those unable to win state bailouts put up planes, yachts and mansions on the Côte d’Azur as collateral for loans, said Oleg V. Vyugin, the director of MDM Bank.
But the article does not really focus on the question of what would replace the oligarchs. And this is a key point. Putin does not believe that the state can effectively run industry. He wants private owners who are beholden to him. (Cliff Gaddy and I have been talking about this in many places, see for example, this article in The National Interest, Putin's Third Way). He is much more likely to protect them and thus tie them even closer to him than let them go. If he got rid of the oligarchs he would have to create a new group of them anyway.

Thursday, March 5, 2009

Debt Reduction

John Geanakoplos and Susan Koniak have a nice op-ed in the New York Times that proposes a solution to the mortgage crisis. The key point is to focus on reducing principal rather than interest rates on mortgages where the borrower is underwater. Some great pictures in the article on how default rates are related to the extent a borrower is underwater.

The key point, I think, is that when you have a borrower who is insolvent you solve the problem with renegotiating the principal, not reducing the interest cost. The latter may deal with liquidity, but not insolvency. For the latter you need to make the borrower have an incentive to pay off the loan. That is where principal reduction comes in. They also show what their solution is cheaper than those considered by the Obama administration.

Wednesday, March 4, 2009

The Missing Quadrant

The Obama administration has been talking about pushing the reset button on our relations with Russia. This partly reflects shock at how Russia has acted recently, and a belief that we can somehow go back to a golden age of relations in the Clinton-Yeltsin era. This is, of course, a myth. To understand why, Cliff Gaddy and I wrote a short note on this that focuses on the missing quadrant. It explains why westerners -- especially US policymakers -- seem to be caught so off guard.

To read "The Missing Quadrant" click here.

Tuesday, March 3, 2009

How to Think About Stimulus

Scott Sumner and Tyler Cowan, among many others argue that creative monetary policy is a better instrument than fiscal stimulus. They argue that policies such as paying interest on excess reserves or setting a nominal GDP target would be better remedies than fiscal stimulus. Paul Krugman and Brad DeLong argue for fiscal stimulus. Is there a way to think about the differences without resort to ideology?

It seems to me that there are two ways people think about the current crisis. One is that we suffer from a huge precautionary demand for savings. Everybody is risk averse, they all want liquidity, and nobody will spend. John Cochrane has articulated this view quite clearly here. If this is the diagnosis then paying interest on excess reserves or other creative forms of monetary policy (quantitative easing) may be sensible. This could unlock the monetary system and revive spending.

The advantage of the monetary policy approach is that it is easy to turn off. So if you believe that the recession is due to this huge risk aversion this is a big advantage. If attitudes return to normal there will be a lot of liquidity out there, but we won't have spending programs in the pipeline that are hard to turn off.

The alternative view, I think, is that the end of the bubble has led to a large destruction of wealth (or realization that it was not there). Between the collapse in housing prices and the stock market a huge share of wealth has been destroyed (more than 45% if we go by the stock market alone). So households must increase savings -- from the former level of zero -- to something like 8% of GDP (we are not there yet, but we will be). So if saving rises something else is needed to make up the gap. It is not net exports -- the currency is not depreciating, so we are not more competitive, and the rest of the world is in a bigger slump than we are. So it is either a huge increase in investment or government spending. It is hard to believe that investment is going to rise significantly when our export markets are deteriorating and when incomes are declining. So it must be the government that has to fill the gap.

Now the anti-stimulus view would be that if we unlock the monetary system banks will lend and firms will invest. The gap can be made up by investment spending rather than government spending. Perhaps that is the case. It is a logical argument. Personally, however, I do not see it. It is not the cost of capital that is hurting investment now but sour prospects.

In any event, it seems that there is a rational argument for both approaches. What is crucial is to figure out which explanation of the causes of the slump is correct.

Monday, March 2, 2009

No EU bailout for Eastern Europe

Angela Merkel rejected a EU bailout for troubled Easte European economies, see here and here.
Ms. Merkel said she couldn't see the need for a broad grant of aid to Eastern Europe. "The situation is very different" in Europe's economies. "We cannot compare Slovakia nor Slovenia with Hungary," she told reporters.

This came after the warning about a new Iron Curtain:

Hungarian Prime Minister Ferenc Gyurcsany, who proposed a bailout package of up to €190 billion ($240.84 billion), warned that without aid a "new Iron Curtain" would descend on Europe and again separate East from West.

This is a problem. If the EU cannot cooperate on helping themselves there is not much hope for the G-20 summit. It seems everybody wants to go it on their own.

More AIG bailouts

This article by Joe Nocera give the background on the huge losses AIG continues to accrue. Of course, their losses are somebody else's gain. But presumably, even though the banks bought the credit default swaps, these are not enough to cushion the banks. Perhaps it is third parties that are the beneficiaries.

Justin Fox points out that essentially:
AIG got into the business of insuring much of the world's financial system against the consequences of a global financial meltdown. It turned out to be incapable of delivering on that insurance—no private company could deliver on it, which is one reason why AIG's business of selling credit default swaps was a scam. And so government has stepped in as the ultimate insurer.

Credit default swaps that AIG sold were insurance against a financial collapse. But just as a private insurer cannot insure against a flood -- that is why the government provides flood insurance -- a private insurer cannot insure against the whole financial system collapsing. Thus, there should be no shock at taxpayers ending up liable for this mess. The crime is not the bailout, but the fact that AIG managers got rich selling insurance they could not possible back.