Sunday morning humor

Go see Razib's post on some funny investing books and their raving reviews. Among them:

"Dow 30,000 by 2008" Why It's Different This Time
Why the Real Estate Boom Will Not Bus - And How You Can Profit from It: How to Build Wealth in Today's Expanding Real Estate Market
The Rules for Growing Rich: Making Money in the New Information Economy (written of course at the peak of the dot.com bubble)

I guess every genius is misunderstood in its own time.

Quote of the Day: Economy

So here’s what I’m wondering: will it, in fact, even be possible to pull the economy out of its nosedive before unemployment goes into double digits? I’m starting to wonder. -Paul Krugman

The root cause of the financial crisis

al-Qaeda leader Ayman al-Zawahiri has the answer:

The American economy was afflicted by a downturn and loss of investor confidence in the market following the events of Sept. 11," he said.... Zawahri then called on the American people to "embrace Islam to live a life free of greed, exploitation and forbidden wealth.

I think al-Qaeda is getting desperate or its some form of twisted humor, I'm not sure which.

Hat tip: Steve Benen

Something to keep in mind when you see huge bailout numbers

From Kevin Drum:

Can we please stop this? Calling this a "$326 billion" bailout is crazy. It's a $20 billion capital injection plus a bunch of asset guarantees with a maximum cost of $250 billion and a probable cost in the low billions. (Possibly zero, in fact.) The capital will probably be repaid eventually, but even if it isn't it's highly unlikely that Uncle Sam is on the hook for more than $30-40 billion.

This stuff has gotten completely out of hand, with "estimates" of the bailout these days ranging from $3 trillion to $7 trillion even though the vast bulk of this sum comes in the form of loan guarantees, lending facilities, and capital injections. The government will almost certainly end up spending a lot of money rescuing the financial system (I wouldn't be surprised if the final tab comes to $1 trillion over five years, maybe $2 trillion at the outside), but it's not $7 trillion or anything close to it. People really need to stop throwing around these numbers as if the bailout is comparable to World War II or something. That's not reality based, folks.

More on the bailout

If the U.S. were to take another equity stake, Treasury Secretary Henry Paulson wanted it to be small, since otherwise the government would end up owning Citigroup. The officials worried that appearing to nationalize the company would further roil markets. -WSJ

This focus on the short term impacts is purely insane. Everyone know the crisis is severe, everyone know that Citi was in deep trouble and nobody feel safer now after the bailout. Au contraire, I think nationalizing would have sent exactly the right message: whatever the costs, we won't let the economy fail, but if you made a stupid decision we might not reward you for it. Here's Felix Salmon's comment:

Color me unconvinced. If there's one thing we've learned during this crisis, it's that just-enough is never enough.

Now is not the time to worry about optics: how it would look to nationalize Citi, or to squeeze out Pandit. Paulson would have done well to call up Gordon Brown for advice: if you're putting in the kind of money which gives the government a majority stake, then so be it. And the owner naturally has the right to choose the CEO.

What's more, I can't think of anybody whose confidence in Citi has been shored up by the weekend's cash injections, especially since the mechanism -- weird second-loss asset guarantees on a small part of Citi's balance sheet -- is so opaque. If it was short sellers who "led the way in driving down Citigroup's stock last week", I don't for a minute believe that they will have decided that Citi is now untouchably secure. No bank with as little tangible common equity as Citigroup counts as secure -- and its official communications are also helping to reinforce the sense of panic.

Why everyone but Midwesterners hate the Big 3

Still, I wonder if there aren't also some other factors at work in the relatively hostile reaction to the Detroit Three. Most Americans simply no longer identify with the domestic auto industry (or with the states of Michigan and Ohio). To the Southerners who now make up the core constituency of the Republican Party, it's a bunch of coddled, unionized workers trying to get handouts that the South's auto industry (Toyota, Hyundai, Nissan, Mercedes, BMW ...) doesn't need. To the coastal urbanites and suburbanites who now make up the core constituency of the Democratic Party, it's an industry that makes crappy big cars and fights against higher fuel efficiency standards. And to the business press it's the worst thing of all: a trio of companies that are neither exciting nor financially successful. -Justin Fox

But then again, Obama's support was very high in the Midwest. If he did nothing about the Big 3, he would almost certainly have to find a way to win in 2012 without Indiana, Michigan and Ohio. That alone will make sure that there is a form of bailout for the Big 3.

Moral hazard and bailout

Um . . . yeah. Look, I think these concerns about moral hazard can be overrated. Looking back on Lehman Brothers, plunging the entire world economy into a downward spiral just to teach a lesson to some uppity investment bankers doesn’t look so smart. But Paulson is proceeding as if this isn’t a concern at all. Or, rather, as if the health and welfare of wall street managers and shareholders is his primary responsibility. Sending such a giant pile of money over to Citigroup without removing the management, without clawing back the fortunes the management earned creating the mess, without adequately diluting the ownership stake of the bailed-out shareholders, and without taking any control on the board of directors is ridiculous. -Matthew Yglesias

This is exactly my position. Totally avoiding moral hazard should not be the main priority right now. Priority should be on preventing further collapse of the economy, which is why the Lehman Brothers decision, although great from a moral hazard perspective, was stupid. But as said above, bailing out should not be focused on executives or shareholders who made idiotic decisions. The bailout should look disadvantageous, but necessary given the circumstances to these groups, with the overall objective being an attempt to stabilize the market. The Citigroup bailout is ridiculous in that it is much more beneficial than necessary to executives and shareholders. There will be winners and losers in this recession and the government should try to ensure, when possible, that those who made the bad decisions be punished by the market. If the government doesn't, the cost will fall back to the taxpayers. Or as Chomsky (I think) said: "Privatize the gains, socialize the costs".

Arggggg maties! Pirates flair new opportunities

From the Globe and Mail:

The Somali pirates, renegade Somalis known for hijacking ships for ransom in the Gulf of Aden, are negotiating a purchase of Citigroup.

The pirates would buy Citigroup with new debt and their existing cash stockpiles, earned most recently from hijacking numerous ships, including most recently a $200 million Saudi Arabian oil tanker. The Somali pirates are offering up to $0.10 per share for Citigroup, pirate spokesman Sugule Ali said earlier today. The negotiations have entered the final stage, Ali said.

"You may not like our price, but we are not in the business of paying for things. Be happy we are in the mood to
offer the shareholders anything," said Ali.

The pirates will finance part of the purchase by selling new Pirate Ransom Backed Securities. The PRBS's are backed by the cash flows from future ransom payments from hijackings in the Gulf of Aden. Moody's and S&P have already issued their top investment grade ratings for the PRBS's.

Via Andrew Sullivan

Quote of the Day

The honor goes to Paul Krugman:

The answer is, eliminate the capital gains tax. Now, what was the question?

(...)

This brings back a memory: on Sept. 13, 2001, I got frantic calls from staffers on Capitol Hill. They informed me that Republican leaders in the House were trying to use the terrorist attack to ram through, you guessed it, a cut in the capital gains tax.

Citigroup bailout reaction

Here is Paul Krugman on the Citigroup bailout:

A bailout was necessary — but this bailout is an outrage: a lousy deal for the taxpayers, no accountability for management, and just to make things perfect, quite possibly inadequate, so that Citi will be back for more.

Amazing how much damage the lame ducks can do in the time remaining.

The incompetence of the Bush administration never ceases to amaze me. Their irrational blindness to the weaknesses of their pet ideology is slowly wavering but clearly not fast enough to make a difference. Hopefully the next bailouts will look more like the Swedish model.

Greenspan's mistake

It seems to me, after reading Applebaum and Nakashima's excellent article in the Washington Post on the failure of regulation that allowed the disaster of the subprime mortgage market, that the main mistake that was made and that led to the current crisis was to assume that companies act according to their own interests, as Greenspan famously admitted recently.

The problems lie in that executives' interests are not necessarily synonymous with the ones of the company; their salaries and promotions are tied almost exclusively to short term metrics, mostly profit. The problem is the divergence between executives massive incentives to increase short term profits and the almost total lack of punishment for long term problems; which creates a personal moral hazard and to the distorted behavior of firms. The "irrational" behavior at the firm level is explained by rational behavior at the individual level. A step in the good direction would be to diminish rewards for short term profits and increase incentives to promote the long term interests of the company. I don't have all the answers, but increasing by law the power of shareholders would be a good start.

Additionally, a healthy skepticism about firms ability to act according to their self-interests would lead to an increased respect for the benefits of regulation, as Spanish and us Canadians can attest.

Quote of the Day

The rebellion by American youth against the money culture never happened. Why bother to overturn your parents’ world when you can buy it, slice it up into tranches, and sell off the pieces? -Michael Lewis

Though love

Here is an excerpt of Peter Morici's address to the Senate hearing on the auto industry bailout:

If Chapter 11 is put off to the -- if Chapter 11 is put off, the industry will continue to shrink. And inevitably, when it happens, and we go through the process, fewer jobs will be saved, because fewer jobs will be there to be saved. Sooner or later, this industry has to go through the ultimate reorganization that brings its cost structure absolutely in line with its competition. It may not be fair, it may not be what we would want to see, but it is inevitable.

In my mind, Chapter 11 is viable. The assets of these companies are needed by the domestic automobile market. They make over 40 percent, near 50 percent, depending on which estimate you use, of the cars driven in America. They can't go out of business completely.

Let's not build a Maginot line

Interesting post at Yglesias on how understanding the exact causes of the present crisis is not necessary vital to prevent a future problem.

The basic reason is that we can be pretty sure that no matter what we do, we don’t need to worry about this exact thing happening all over again. Investors will be extremely reluctant to get involved in the exact kinds of products that recently crashed, everyone will worry that the first sign of housing price increases is a bubble, and regulators will be keenly aware of everyone’s pet theory of what went wrong. But the crux of the matter is that though the phenomenon of financial crises repeat over time, but no individual crisis repeats itself. The trick, if you can pull it off, isn’t to prevent a repeat of the current crisis, but to prevent (or mitigate) the next crisis which is something else entirely.

The main problem was that the majority of people who were supposed to know better failed to looked critically at what became conventional wisdom. The focus should be on understanding why there was such a failure of critical thinking, not how to prevent another housing bubble.

Big 3 troubles: consumers' fault?

Here are a few arguments from Blake Hounshell at FP Passport, explaining why consumers are to blame for the current plight of the Big 3 automakers:

• The industry was in trouble before, but it's the drying up of consumer demand due to the financial crisis that is threatening to destroy it at present. Even the innovative Toyota is feeling the pain right now.
• Who bought all those "gas-guzzling S.U.V.s and trucks" Friedman is ranting about? Martians?
• I must have missed the groundswell of grassroots activism in favor of the higher taxes that would have put a floor under the price of gasoline and made for a stable environment that could make technologies like plug-in hybrids viable even when market prices for crude oil collapse.

I think Blake is missing the point here by saying that it was basically the consumer's role to ensure that the Big 3 innovate or simply realize that gas prices would increase in the long term. That responsibility falls solely on those companies. It was (and still is, despite recent fall in price) obvious that world demand for oil increases faster than the output and, especially given limited reserves, the long term trend for oil price would be up. The Big 3 totally failed to see this reality.

While gas-guzzlers might have been profitable in the short term, it was the role of the directors of the companies to realize that to be competitive in the long term they would have to invest in fuel-efficient cars, not only because of government regulations but because of long term economic trends. It is in no way the fault of consumers that they bought them for a short period, while oil prices and the economy was good; the fault lie on the total lack of vision of the upper management of those companies.

Foreign automakers managed to foresee this trend and reacted accordingly, so this was by no mean an impossible thing. Also, while you claim that Toyota is feeling the pain, which is true, there are no signs that they are close to collapse; so the current crisis can not fully explain the desperate situation at the Big 3.

Foreign companies invested in the right places while American automakers closed its eye on reality. End of the story.

Lawrence Summers?

Since I am too young to have followed politics closely in the 1990s, all I knew about Lawrence Summers was the 2005 controversy over his comments on women which made him resign from his job as Harvard's president. I still think he has been unfairly criticized for his comments on why certain jobs are disproportionately occupied by men. I think his arguments are sound hypotheses, I've defended them several times and I managed to convince everyone I talked to that they made sense; but I'll readily admit that they're easy to misinterpret (and making them probably showed poor judgment given his political aspirations).

But I have a hard time defending this:

The aside was leaked to the press and stated that, developed countries ought to export more pollution to developing countries because these countries would incur the lowest cost from the pollution in terms of lost wages of people made ill or killed by the pollution due to the fact that wages are so low in developing countries. The aside went on to state that "the economic logic behind dumping a load of toxic waste in the lowest wage country is impeccable and we should face up to that.

There's a time when an economist should realize when what might be economically optimal doesn't make sense from a moral perspective. He failed that test.

He was chief economist of the World Bank from 1991-1993. Given the disastrous results of his policies in the region, and his support of the disastrous World Bank policies of the 1990s, I have a hard time taking this man seriously. Maybe he learned from his mistakes and maybe he is the best economist for the job now, I do not know since this isn't my field. I do like his opinion that increasing wage discrepancy is a problem, but I am troubled by his "successes" and his judgment.

Here's a view on the result of his policies in Eastern Europe and Russia:

He turned to America’s great rival, the former Soviet Union, to try out his economic experiments. In 1990, Lithuania, a restive Soviet republic seeking independence, hired Summers to advise on that country’s economic transformation. Poor Lithuania had no idea what it got itself into. This was Summers’s first opportunity to tackle a country in economic crisis and put his wunderkind theories into practice. The results were literally suicidal: in 1990, when Summers first arrived, Lithuania’s suicide rate was 26.1 per 100,000 and falling. Just five years after Summers got his hands on Lithuania’s economy, life became so unbearable under the economic transition that the suicide rate nearly doubled to 45.6 per 100,000, worse than any other ex-Soviet republic in transition. In fact, it was the highest suicide rate in the world, suggesting something particularly harsh and brutal about the economic transition in that country as opposed to the others, where suffering and pain were common. Things got so bad that in 1992, after just two years of Summers-nomics, the traumatized Lithuanians voted the communist party back into power, the first East European nation to do so–even though just a year earlier Lithuanians actually died on the streets fighting communism.

Fresh off his success in Lithuania, Summers moved to the World Bank, where he was named the chief economist in 1991, the year he issued his famous let’s-pollute-Africa memo. It was also the year that Summers, and his Harvard protégé Andrei Schleifer (who worked with Summers on the Lithuania economic transformation), began their catastrophic “rescue” of Russia’s crisis-ridden economy. It’s a complicated story involving corruption, cronyism and economic devastation. But by the end of the 1990s, Russia’s GDP had collapsed by more than 60 percent, its population was suffering the worst death-to-birth ratio of any industrialized nation in the twentieth century, and the financial markets that Summers and Schleifer helped create had collapsed in what was then the world’s biggest debt default ever. The result was the rise of Vladmir Putin and a national aversion to free markets and anything associated with Western liberalism. -Mark Ames