Today's Opinion Picks October 29, 2009

Comment:

There are ten picks today.

1) Delamaide, for Marketwatch, writes on that new theme of too big to resolve. Are there no answers?

2) Bloomberg news reports that Kenneth Rogoff and Niall Ferguson are concerned about debt levels and say this crisis is far from over.

3) Edward Harrison, on Naked Capitalism, discusses GMAC, moral hazard, and bailouts.

4) Gillian Tett's latest, from FT, suggests that perhaps the western world's central banks can adopt some strategies other than interest rate lever controls, like Asian governments are restricting lending and using other prudent measures.

5) Karl Denninger points out the "good" in the too-big-to-fail legislation proposal. Watch these points carefully as they continue to be debated.

6) On The Big Picture blog, Josh Rosner takes a negative view of the evaluation process of the too-big-to-fail House bill.

7) Also, from The Big Picture blog, Barry Ritholz does a nice summary of the GDP report break-down.

8) From the WSJ blog, this is what Joshua Shapiro sees hampering future GDP.

9) From Washington's blog, more on the too-big-to-fail subject. His case is that bailouts for these entities will be permanent.

10) Vince Farrell, for CNBC, comments on the government debt sales and the ending of the Fed purchase program.


--Kalpa



Too-big-to-fail measures too late?
By Darrell Delamaide

Congress is now turning its attention to legislation that seeks to eliminate the "too-big-to-fail" problem. But these measures may be too late to succeed. And that's because the bailout itself has produced behemoths of such market dominance that it's scarcely imaginable they could ever be dismantled even with the new "resolution authority" sought by the government.....Chase is swollen now through its acquisition of Washington Mutual - thanks to the FDIC, and the trading activities of Bear Stearns. Bank of America grew bigger through its acquisition of Merrill Lynch, which was so encouraged by the Federal Reserve, and Countrywide.

Consumers in America who do not currently have a credit card, car loan or mortgage from one of these two institutions are probably in the minority. In the meantime, Goldman Sachs has lost most of its competitors, with Bear Stearns and Lehman Brothers gone, and Merrill absorbed into the bureaucratic machinery of BofA -- leaving Goldman as one of only two traditional investment banks.

The biggest failure the FDIC has had to deal with in the current crisis was Washington Mutual, with some $300 billion in assets, and the agency quickly found a home for it with Chase. But if Chase, with its $2 trillion in assets, is in jeopardy, where will you find a home for it, or even its bigger pieces, given that other banks are likely to be stressed at the same time?......Central bankers are already calling for a more radical restructuring of the industry to solve the problem -- specifically a renewed separation of investment and commercial banking as we had until a decade ago with the Glass-Steagall Act. Former Fed Chairman Paul Volcker and Bank of England Governor Mervyn King were on the front pages of newspapers recently saying that such a separation is the only way to avoid a repeat of the financial crisis.

King, in particular, didn't mince any words, "The belief that appropriate regulation can ensure that speculative activities do not result in failures is a delusion," he said in a speech in Edinburgh.....But nobody thinks an Obama administration with economic policy set by White House adviser Larry Summers and Treasury Secretary Timothy Geithner is going to tell JP Morgan Chase CEO Jamie Dimon that he has to carve up his lovely money machine into smaller bits and pieces.....

Rogoff, Ferguson Say Global Financial Crisis Is Not Yet Over

The global financial crisis hasn’t ended, said Harvard University professors Kenneth Rogoff and Niall Ferguson, who challenged assertions made by Group of 20 leaders at their meeting in Pittsburgh last month. “The G-20 is right that it’s over for all the banks they guaranteed,” Rogoff, 56, a former chief economist at the International Monetary Fund, said yesterday in an interview with Bloomberg Radio. Even so, as a consequence of bailouts and stimulus measures, “the financial crisis may eventually morph into a government-debt crisis.”

....“Crises last longer than most people think,” said Ferguson, author of The Ascent of Money: A Financial History of the World. “Most crises, major financial crises worthy of the name depression or indeed recession, last significantly longer than a day and they can be measured more in the thousands of days. I think it would be very unwise to say it’s over.”...

GMAC has been nationalized
By Edward Harrison

And you thought the bailouts were over and market discipline might be restored. Not a chance – the bailouts will continue, come hell or high water. The latest demonstration of this is GMAC, where the government will now be majority owner. GMAC has officially been nationalized. Now the government is running auto financing in addition to running the companies making the cars.

Below is a quote from the Financial Times. Notice the parts I have bolded.

GMAC, the car financing company, is set to receive up to $5.6bn in a new capital injection from the Treasury, filling a hole identified in the “stress tests” earlier this year and paving the way for the government to become the majority shareholder.

[...]

What you should be reading from this statement is the following:

• All the firms identified as lacking capital under the stress tests were given time to raise funds in the capital market to meet the shortfall.
• Some firms did meet the shortfall and they are now free to do as they please.
• Others have not and we the government are now going to take a more muscular approach in dealing with them.
• GMAC is the first public example of our flexing our muscles.
• But there surely are/will be other examples; some may already be happening in secret.

If the US government is going to throw its weight around to deal with financial firms short of capital, I would personally prefer they try a process which allows these firms to fail whereby equity and debt holders suffer consequences that are consistent with taking market risk. Bailing out GMAC is a moral hazard plain and simple.

Lessons learned in Singapore
By Gillian Tett

If you talk to financiers in Singapore these days, the topic of property prices keeps cropping up but, unlike in America, it is not the threat of further real estate market falls. Instead, as Wall Street worries about American house prices – exemplified by a downbeat report from Goldman Sachs this week – in Asia there is mounting concern about property booms-cum-bubbles.

.... some Asian authorities are also acting in less orthodox ways, by imposing modest credit constraints and prudential controls. In Hong Kong, for example, the authorities have recently tightened the conditions for down-payments on luxury homes. In Singapore, the government has banned some interest-only loans. Meanwhile in South Korea the government is tightening the screws on mortgages, in relation to loan-to-value conditions.

Thus far these measures are modest and it is far from clear whether they will work. However, they are likely to be closely watched by some western central banks. During most of the past two decades, European and US authorities have shied away from the idea of using prudential measures to control the credit cycle, preferring to rely exclusively on interest rate levers. However, the recent financial crisis has forced central banks to rethink this exclusive dependence on interest rate levers in terms of combating the slump.

....That, in turn, begs another question – namely, whether western central banks may also be tempted to reconsider their exclusive reliance on interest rate levers if, or when, the recovery takes hold....if asset prices start spiralling out of control in the west and, say, unemployment soars too, the problems of relying on interest rate levels alone may become more apparent.

Is This the End of 'Too Big to Fail'?
by Karl Denninger

The WSJ reports:

WASHINGTON -- A deal between the Treasury Department and a key House Democrat would give the government sweeping new powers to police the country's largest financial companies, including the ability to seize and break up failing companies and order large firms to shrink.

[...]
Let's not mince words - there is good in here. Among the good parts of this bill are that "too big to fail" will become formally invalid as public policy.

It requires the failed firm's creditors and shareholders to bear "first loss", and, if the brief is to be believed, only if they are entirely wiped out and there remains a shortfall will assessments be laid - on other large financial institutions, not the taxpayer. This should result in large amounts of "social pressure" to stop stupid actions, since the risk of them can fall on other large market participants.

It requires that securitized products retain 10% of the risk (which can be reduced to 5% but not lower by regulators) of any product so securitized, stopping the "pass it all on and watch the bomb go off on the back of the fool who you sold it to" game.

And finally, it requires approval of the Treasury Secretary for The Fed's employment of 13(3) authority - the blanket "we can lend to anyone" authority that The Fed has cited (and in my opinion both abused and exceeds the limits of) during this crisis. In addition, it prohibits "special facilities" entirely - that's a real improvement.

Left unanswered is whether there are criminal penalties imposed for violations. My expectation is that like the rest of the "toothless tiger that roared" games out of Washington DC, the critical "or else" is missing, but we'll see once the markup is complete.

I cannot endorse this as written, but I can say that it is a vast improvement over what we have now, and what has happened to date.
[...]

Congress and TBTF – Bring in the Bomb Squad
By Josh Rosner
(Joshua Rosner examines the House regulatory reform bill, which does not, in its current form, acknowledge that “Too Big to Fail” is too big to exist.)

The House draft bill written by Rep. Barney Frank – along with several former Fed attorneys and Treasury staff and consultants — ignores fundamental reality: You don’t employ a bomb squad to sit around and wait for a bomb to explode, you engage them to dismantle it as soon as they find one.

[...]
Each of the elements of this historic and flawed approach was carefully negotiated in close coordination with the most interested parties – that is, the bankers and their friends. Mock hearings will be this week and the complete bill will be marked up mid-week next week. When the hearings begin, the public should demand to know how many of these “experts” have ever taken money as consultants or employees of the “Too Big To Fail” (TBTF) banks or the Federal Reserve System. You can play along with the game show at home by watching the testifying “experts” closely. Try to keep score of how many of them identified the collapse of our credit markets in 2006 or 2007. You can go on to the bonus round and score which of these “experts” expressed a view or highlighted the risk that the Fed’s “emergency powers” would create a moral hazard and be used to bail out our banks.
[...]

Big GDP Number: 3.5%
by Barry Ritholz

Ok, a quick review of GDP is revealing of a few things of interest. Let’s start with the data, and go on from there. BEA reports:

“Real gross domestic product — the output of goods and services produced by labor and property located in the United States — increased at an annual rate of 3.5 percent in the third quarter of 2009, (that is, from the second quarter to the third quarter), according to the “advance” estimate released by the Bureau of Economic Analysis. In the second quarter, real GDP decreased 0.7 percent.”

We get the usual disclaimers that this is an “estimate based on source data that are incomplete or subject to further revision” (Next GDP update is November 24, 2009).

Where did the growth come from?

The increase in real GDP in the third quarter primarily reflected positive contributions from personal consumption expenditures (PCE), exports, private inventory investment, federal government spending, and residential fixed investment. Imports, which are a subtraction in the calculation of GDP, increased…

Motor vehicle output added 1.66 percentage points to the third-quarter change in real GDP after adding 0.19 percentage point to the second-quarter change. Final sales of computers subtracted 0.11 percentage point from the third-quarter change in real GDP after subtracting 0.04 percentage point from the second-quarter change.

The 1st question to ask about GDP is the degree of inorganic/artificial gains. As the above paras suggest, much of the improvement is where the government is spending, incentivizing, or bailing out various sectors: Autos, Residential RE, and Fed spending. As expected, Inventory reduction helped, and unexpectedly, increasing imports hurt.

A large chunk of the gains — 1.66 percentage points — came from Car sales in the form of cash for clunkers; this will not be in the Q4 data.

Home building soared 23.5% — reflecting a combination of zero percent interest ratyes (ZIRP) and 1st time homebuyers tax credit. That was good for another 0.5 percentage points of GDP.

Well over half of the gains are therefore government related.

Also of note: Nominal GDP was below forecasts, thanks to a surprise 0.8% gain in the deflator (That also added to the REAL GDP figure). Hence, a chunk of the gains are pure inflation.

Economists React: GDP Puts Last Bit of Dirt on Great Recession’s Grave?

The most important factor limiting growth will be households continuing to struggle with ravaged balance sheets and lingering labor market weakness. Moreover, many negatives related to sour commercial real estate loans, consumer lending, commercial & industrial loans, non-subprime mortgage lending, etc. are yet to be felt as far as banks and other creditors are concerned, while soft demand and substantial spare capacity will weigh on any recovery in capital spending.
–Joshua Shapiro, MFR Inc.

Government Is Trying to Make Bailouts for the Giant Banks PERMANENT
by Washingtonblog

On September 25th, I wrote:

Paul Volcker and senior Harvard economist Jeffrey Miron both testified to Congress this week that the government is trying to make bailouts for the giant banks permanent.

Writing Wednesday in The Hill, Congressman Brad Sherman pointed out that:

In my opinion, Geithner’s proposal is “TARP on steroids.” Section 1204 of the proposal [the proposal being the "Resolution Authority for Large, Interconnected Financial Companies Act of 2009"] allows the executive branch to use taxpayer money to make loans to, or invest in, the largest financial institutions to avoid a systemic risk to the economy.

Geithner’s proposal reminds me of the Troubled Asset Relief Program (TARP), the $700 billion Wall Street bailout adopted last year, but the TARP was limited to two years, and to a maximum of $700 billion. Section 1204 is unlimited in dollar amount and is a permanent grant of power to the executive branch. TARP contained some limits on executive compensation and an array of special oversight authorities. Section 1204 contains absolutely no limits on executive compensation and no special oversight.

When I asked Geithner whether he would accept a $1 trillion limit on the new bailout authority (if the executive branch wanted to spend more, it would have to come back to Congress), he rejected a $1 trillion limit, insisting that the executive branch be able to respond without coming back to Congress.
[...]

We Spent All $300 Billion!
By: Vince Farrell

On March 18 of this year the Treasury announced they would buy $300 billion of Treasury paper to support the market. They will finish the program this week and some are worried about possible fallout in the market. Public US debt expanded by a net $719 billion the last two quarters. The government bought the above mentioned $300 billion (most of it during the two quarter span). Very active foreign buying saw total foreign holdings increase by almost $67 billion in July and August alone. It's estimated foreign buying accounted for 60% of the total needed after the US Treasury's purchase of $300 billion. Commercial banks accounted for most of the rest. A Treasury is zero risk weighted on a banks balance sheet and is very liquid. Borrowing at a near zero interest rate, and buying government bonds (that are zero risk weighted) is an easy trade for a bank to make. The question is will there be enough incremental buying to substitute for the government exiting the market.....

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