Monday, September 15, 2008
(Almost) Betting the Farm
by Tom Bozzo
In alarm-clock land, NPR seemed to be in "Don't Panic!" mode as the news of course led with the Lehman story but they didn't mention, e.g., European markets being down 4-5% as of this (Monday early AM CDT) writing. Then David Wessel of the W$J was asked if this was the wildest time ever, and he lifted my spirits by answering that he was not alive in 1929.
We ran the nightmare scenario courtesy of Nouriel Roubini here at AB over the weekend. Our own Ken has an excellent follow-up explaining why we really should be glad that his Old Firm was bailed out as in that case a broader financial 'contagion' was 99 and 44/100 percent likely; if the financial world was Smart then the Lehman failure ought to be priced in. It's the 'if they were smart' part that's worrisome in a 'how do you think we got into this fine mess' way.
Suzanne showed this morning that she's been the spouse of an economist maybe a little too long, as she asked, "Would I be doing my part to help the situation if I went shopping today?"
In alarm-clock land, NPR seemed to be in "Don't Panic!" mode as the news of course led with the Lehman story but they didn't mention, e.g., European markets being down 4-5% as of this (Monday early AM CDT) writing. Then David Wessel of the W$J was asked if this was the wildest time ever, and he lifted my spirits by answering that he was not alive in 1929.
We ran the nightmare scenario courtesy of Nouriel Roubini here at AB over the weekend. Our own Ken has an excellent follow-up explaining why we really should be glad that his Old Firm was bailed out as in that case a broader financial 'contagion' was 99 and 44/100 percent likely; if the financial world was Smart then the Lehman failure ought to be priced in. It's the 'if they were smart' part that's worrisome in a 'how do you think we got into this fine mess' way.
Labels: Crisis Management, Econoblogs, Moral Hazard
Monday, April 07, 2008
There is a G-d?
by Ken Houghton
Economists Question: Identify the "moral hazard," if any, in the linked story. Explain how it could have been quantified, mitigated, or defined by one or both of the parties.
If you do not believe there is "moral hazard" in the above case, but still believe in "moral hazard" for residential transactions, please define the differences so as to explain the differences between the two scenarios.
And maybe Alanis Morissette portrayed her accurately, judging by the current contretemps at the Mortgage Bankers Association (h/t Dealbreaker).
Economists Question: Identify the "moral hazard," if any, in the linked story. Explain how it could have been quantified, mitigated, or defined by one or both of the parties.
If you do not believe there is "moral hazard" in the above case, but still believe in "moral hazard" for residential transactions, please define the differences so as to explain the differences between the two scenarios.
Labels: Housing Bubble, humor, Moral Hazard, mortgage
Thursday, April 03, 2008
In the Meantime, We are Reminded what the phrase "Representative Government" Means
by Ken Houghton
And I start fearing for the democratic process, because seeing Christopher Cox explaining financial markets as if he knows anything about them other than how to provide patronage is scary.
So it is reassuring to see this piece on Political Radar, as a reminder of that vox populi does, occasionally, work:
In the world of economists, this will probably be seen as an inefficient solution, encouraging the (mythical) Moral Hazard.
But in the real world, Congress has ready access to Wall Street bailout advocates. It's only on vacation that they speak with the people who elect them.
It appears that Gore Vidal is correct that the Congressional offices and buildings should never have been fitted with air conditioning: not because of the mischief-making, but rather because it reduces the chance of their getting actual voter input.
I'm watching (mercifully, with the sound off) Christopher Cox (R-CA; patronage job as SEC Chairman), if CNBC is correct, blatantly lie to Congress (CNBC Chyron: "What happened to Bear Stearns was unprecedented" Let's see: a major financial player with large bets in a specific market sector gets caught ignoring the rule "The market can stay irrational longer than you can stay liquid." Where have we heard that before?) and figuring that Yves or Steve Randy Waldman will take care of it so I don't have to.
And I start fearing for the democratic process, because seeing Christopher Cox explaining financial markets as if he knows anything about them other than how to provide patronage is scary.
So it is reassuring to see this piece on Political Radar, as a reminder of that vox populi does, occasionally, work:
In the Senate this week, a bipartisan bill to help stem the tide of foreclosures nationwide is sliding through the senate like water on Teflon.
A similar bill fell prey to partisan bickering at the end of February when Republicans blocked it after Democrats refused to allow unrelated amendments.
What happened between then and now to end the partisanship? Vacation. That's what. Because while most people take vacation to forget about their jobs, in Congress they take vacation to go talk to their bosses, the people.
"I suspect the other major event was the fact we went home for a couple of weeks. Nothing like going home, Mr.. president, to get a message," said Sen. Chris Dodd, the chairman of the Senate Banking Committee, who engineered the bipartisan bill in a marathon 20 hour bipartisan brainstorming session with Sen. Richard Shelby, R-Ala....
"But they asked the legitimate question, if it was good enough for people to get together to solve a problem on Wall Street, what about the problem on my street? What are you doing here to see to it I can stay in my home? That our neighborhood will not collapse? That our taxes and properties and neighborhoods will not further deteriorate? I suspect more than anything else, going homemade a big difference and -- going home made a big difference."
In the world of economists, this will probably be seen as an inefficient solution, encouraging the (mythical) Moral Hazard.
But in the real world, Congress has ready access to Wall Street bailout advocates. It's only on vacation that they speak with the people who elect them.
It appears that Gore Vidal is correct that the Congressional offices and buildings should never have been fitted with air conditioning: not because of the mischief-making, but rather because it reduces the chance of their getting actual voter input.
Labels: Democracy, High Finance, Moral Hazard, Regulation, The Old Firm
Monday, March 31, 2008
The WSJ discovers Moral Hazard, and it involves choosing to sleep under bridges
by Ken Houghton
And this is not only A Good Thing, it's a Standard, if unadvertised, Business Practice:
Strangely, all of the evidence comes from people with a clear principal-agent problem:
There's no data, apparently, so there's really no economic solution. So why is the WSJ discussing it?
Because some people are at least "haggling over the price":
There's a doctoral thesis in this. However...
(more in next post)
First, there's was Buyer's Remorse. Now, the WSJ gives us Buyer's Revenge:
Mr. Buompensiero, a gray-bearded inspector for REO Asset Services-1st Realty Group, rang the bell. When no one answered, he taped a letter to the door offering the occupants $1,000 to move out. The catch: They won't get a cent if they trash the house before they leave.
"If it was me, I'd take the money," Mr. Buompensiero said as he drove away. Either way, they're "going to get thrown out in a couple of weeks."
And this is not only A Good Thing, it's a Standard, if unadvertised, Business Practice:
No one tracks how frequently such payoffs are made. In Las Vegas, agents hired by the banks to handle foreclosed properties say the "cash for keys" approach, as it's known in the industry, is a regular part of the job. After all, formal eviction proceedings can take months and cost potentially much more than a payoff.
Strangely, all of the evidence comes from people with a clear principal-agent problem:
About 95% of the auctioned properties, however, go unsold and revert to banks eager to get the properties off their books. Some owners just walk away peacefully. But agents say a significant number take what they can carry and take revenge on the rest.
There's no data, apparently, so there's really no economic solution. So why is the WSJ discussing it?
Because some people are at least "haggling over the price":
The owner, a 43-year-old man with two children who spoke on the condition that his name not be used, says he bought the property in 1993 for $140,000. Three years ago, he says he had the house appraised for $440,000 and took out a $207,000 home-equity loan to pay off credit-card bills and buy his wife a new van. His initial payments were an affordable $1,800 a month.
He fell behind, however, after he went through a divorce and his landscaping business faltered, just as his interest rate was rising. The man worked out a payment plan with the bank and borrowed heavily from his father, but, including penalties, his monthly payments rose to $4,000, he says. After two months, he says, he ran out of money, and the bank foreclosed.
He called Mr. Carver after receiving the cash-for-keys note, but was left cold by the bank's initial $500 offer to leave the house soon, intact and broom-swept. "If I stay here it will cost them a lot more money," both men remember the former owner saying....
Mr. Carver consulted with the bank and upped the offer to $2,800.
"Better than nothing," the owner responded.
Last week, Mr. Carver went to the house, found it clean and whole, and handed the man a check. "Everybody walks away somewhat happy," Mr. Carver said. "I guess."
There's a doctoral thesis in this. However...
(more in next post)
Labels: Housing Bubble, Moral Hazard, mortgage
Tuesday, March 25, 2008
The Price Increase: a BS violation, but maybe with a purpose
by Ken HoughtonBailout Stock Offer Increase. And I think I have a theory that makes as much sense as any other.
As Carney notes, many of us who said nothing at the $2 level are screaming Bailout at the four-fold increase.* (Tom and cactus, as I noted yesterday, were ahead of the curve—I still think they were wrong, but let's go with prescient.) And, to give him credit, he also notes that this (1) may have been necessary for the market and (2) the shareholders could still make a lot of trouble (if they're asstupidstubborn as Yves, for one, believes they are).
Let us think for a minute about Black-Scholes. One of the key elements of the model is that square root of time thing: the longer you have to expiry, the higher the time value of the option.**
JPMC just went from having a lock-in until March of 2009 to needing things to be done on 8 April 2008. And they're paying more.
But, to reference another former firm,*** there was a period of time—around mid-2000, iirc—where Carly Fiorina (whose leadership and management skills are legendary) got it into her head to buy the consulting arm of PwC for about $18 billion. And negotiations went on and on. Others from the HP side talked it down to about $11 billion, and then HP decided that the employee turnover rate (the best of the Big Five, but still twice what HP was used to seeing) was too high. So the deal was called off.
For the six or seven months of that roundelay, though, the senior partners of PwC did virtually no Business Development. (Exceptions noted, but they were exceptions.) They were, as it were, counting their money.
So by the time the deal fell apart, the pipeline was dry. And along came a recession, and then 11 Sep 2001, and finally the business was sold to IBM in mid-to-late 2002 for, iirc, $3 billion.**** (HP went out and found a company with a low turnover ratio—Compaq—and the synergies created there made it a powerhouse that has only added to Ms. Fiorina's reputation.*****)
Now, I'm not saying that the time spent on the failed HP merger drained between 75 and 83% of the value of the company—but there's a reasonable argument that the market did, and it is certainly true that distracted partners don't generate the revenue stream that dedicated ones do.******
Now think about that in the context of an investment bank, where the cash flows are larger, quicker, and more fleeting. A business idea that is six months old still has value. A trading algorithm that gets delayed six months is likely to lead to losses.
So I suspect believe that Jamie Dimon has just played the last trump: "You want another $1 billion for the equity holders? All right, but you've got to finalize the agreement on this deal in the next two weeks, or I'm taking your building. And, by the way, if the deal fails, the market has already smelled blood twice. So Bring It On, if you want. But be careful what you wish for; you may get it."
Whether he finished with "Do you feel lucky, punk?" is left as an exercise to the reader. But with the value of the assets declining daily, Dimon probably realised that Black-Scholes wasn't the model to use for valuation.
It's still a bailout, but it appear to have a working logic to it.
*Yes, I said four- not five-, fold. Round figures, the swap went from 0.05 JPMC shares per BSC share to 0.21 shares, which is just over a four-fold increase (ca. 320%). The rest of the appreciation came from the rise in JPMC's stock.
**It's also one of the reasons no one would ever use the standard model to price a long-dated option. But that's a sidebar, not relevant to the example at hand.
***I've got a million of them. Well, sometimes it feels that way.
****None of these numbers or dates is necessarily accurate, but I believe they're close. You can look them up.
*****This you can definitely look up.
******It was legend at Bear that one of the then-current Compensation Committee members had maneuvered his nearest rival out of the job when the latter was tending to his cancer-stricken wife. But again I digress.
I've been trying to figure out the
As Carney notes, many of us who said nothing at the $2 level are screaming Bailout at the four-fold increase.* (Tom and cactus, as I noted yesterday, were ahead of the curve—I still think they were wrong, but let's go with prescient.) And, to give him credit, he also notes that this (1) may have been necessary for the market and (2) the shareholders could still make a lot of trouble (if they're as
Let us think for a minute about Black-Scholes. One of the key elements of the model is that square root of time thing: the longer you have to expiry, the higher the time value of the option.**
JPMC just went from having a lock-in until March of 2009 to needing things to be done on 8 April 2008. And they're paying more.
But, to reference another former firm,*** there was a period of time—around mid-2000, iirc—where Carly Fiorina (whose leadership and management skills are legendary) got it into her head to buy the consulting arm of PwC for about $18 billion. And negotiations went on and on. Others from the HP side talked it down to about $11 billion, and then HP decided that the employee turnover rate (the best of the Big Five, but still twice what HP was used to seeing) was too high. So the deal was called off.
For the six or seven months of that roundelay, though, the senior partners of PwC did virtually no Business Development. (Exceptions noted, but they were exceptions.) They were, as it were, counting their money.
So by the time the deal fell apart, the pipeline was dry. And along came a recession, and then 11 Sep 2001, and finally the business was sold to IBM in mid-to-late 2002 for, iirc, $3 billion.**** (HP went out and found a company with a low turnover ratio—Compaq—and the synergies created there made it a powerhouse that has only added to Ms. Fiorina's reputation.*****)
Now, I'm not saying that the time spent on the failed HP merger drained between 75 and 83% of the value of the company—but there's a reasonable argument that the market did, and it is certainly true that distracted partners don't generate the revenue stream that dedicated ones do.******
Now think about that in the context of an investment bank, where the cash flows are larger, quicker, and more fleeting. A business idea that is six months old still has value. A trading algorithm that gets delayed six months is likely to lead to losses.
So I suspect believe that Jamie Dimon has just played the last trump: "You want another $1 billion for the equity holders? All right, but you've got to finalize the agreement on this deal in the next two weeks, or I'm taking your building. And, by the way, if the deal fails, the market has already smelled blood twice. So Bring It On, if you want. But be careful what you wish for; you may get it."
Whether he finished with "Do you feel lucky, punk?" is left as an exercise to the reader. But with the value of the assets declining daily, Dimon probably realised that Black-Scholes wasn't the model to use for valuation.
It's still a bailout, but it appear to have a working logic to it.
*Yes, I said four- not five-, fold. Round figures, the swap went from 0.05 JPMC shares per BSC share to 0.21 shares, which is just over a four-fold increase (ca. 320%). The rest of the appreciation came from the rise in JPMC's stock.
**It's also one of the reasons no one would ever use the standard model to price a long-dated option. But that's a sidebar, not relevant to the example at hand.
***I've got a million of them. Well, sometimes it feels that way.
****None of these numbers or dates is necessarily accurate, but I believe they're close. You can look them up.
*****This you can definitely look up.
******It was legend at Bear that one of the then-current Compensation Committee members had maneuvered his nearest rival out of the job when the latter was tending to his cancer-stricken wife. But again I digress.
Labels: financetheory, High Finance, Moral Hazard, The Old Firm
The Moral Hazard Contagion Spreads
by Ken Houghton
Yes, the plural of anecdote is not data, but the timing here is not coincident.
More later.
UPDATE: I see cactus at AngryBear is thinking the same way, though rather more like an economist than a taxpayer.
Tanta notes that Wells Fargo is begging, which they weren't doing when the BSC price was $2/share.
Yes, the plural of anecdote is not data, but the timing here is not coincident.
More later.
UPDATE: I see cactus at AngryBear is thinking the same way, though rather more like an economist than a taxpayer.
Labels: bankruptcy, High Finance, Moral Hazard, The Old Firm
Monday, March 24, 2008
A Buyout is a Buyout, No Matter How Small
by Ken Houghton
UPDATE II (via Dr. Black): There is a reason to renegotiate the contract from the JPMC side, but it should hardly be worth 4x the price of the firm, unless the stuff really is pure shite. Which would make this a true textbook case of Moral Hazard. Anyone taking bets whether Mankiw or Varian or any of the other intro or intermediate texts ever cites it? UPDATE V: John Carney gives the lie to that claim.
UPDATE III: The pity party thrown last week by the WSJ for Bear's senior, er, management appears to have omitted some data:
UPDATE IV: And it becomes official:
The Old Firm is projected to open trading today between 9.87 and 9.88 per share. Since its current takeover offer is slightly over $2/share ($2.41 last I looked, based on the then-current JPMChase price), and it was around $6.39 Thursday night, there is clearly a different type of Resurrection on the market's mind.
If the market turns out to be correct, then[It was; see Updates above] I will change my mind and agree with Tom and Cactus that the actions last weekend were a bail-out, even if the Fed didn't intend them to be.
Until then, the severance offer* alone strongly suggests that most of the employees will vote their shares in favor of the takeover.
*Three weeks per year of service for the first five years, two weeks for each year after that, and last year's bonus paid for this year. This is only slightly worse** than what the people who were severed in November got.
**November was three weeks per year, regardless of service time.
UPDATE: Well, that was quick. A Bailout is a Bailout, No Matter How Small.
UPDATE II (via Dr. Black): There is a reason to renegotiate the contract from the JPMC side, but it should hardly be worth 4x the price of the firm, unless the stuff really is pure shite. Which would make this a true textbook case of Moral Hazard. Anyone taking bets whether Mankiw or Varian or any of the other intro or intermediate texts ever cites it? UPDATE V: John Carney gives the lie to that claim.
UPDATE III: The pity party thrown last week by the WSJ for Bear's senior, er, management appears to have omitted some data:
Insiders at Bear sold a total of 715,000 shares last year worth more than $75 million, up from 2006 but down considerably from 2004, when sales of more than 1.5 million shares worth $147.9 million took place, the data show.
Since 2000, Cayne has sold 2.37 million shares worth about $182.7 million, while Schwartz has sold more than one million shares for roughly $67.2 million.
UPDATE IV: And it becomes official:
JPMorgan Chase & Co. (NYSE: JPM) and The Bear Stearns Companies Inc. (NYSE: BSC) announced an amended merger agreement regarding JPMorgan Chase's acquisition of Bear Stearns.
Under the revised terms, each share of Bear Stearns common stock would be exchanged for 0.21753 shares of JPMorgan Chase common stock (up from 0.05473 shares), reflecting an implied value of approximately $10 per share of Bear Stearns common stock based on the closing price of JPMorgan Chase common stock on the New York Stock Exchange on March 20, 2008.
The Old Firm is projected to open trading today between 9.87 and 9.88 per share. Since its current takeover offer is slightly over $2/share ($2.41 last I looked, based on the then-current JPMChase price), and it was around $6.39 Thursday night, there is clearly a different type of Resurrection on the market's mind.
Until then, the severance offer* alone strongly suggests that most of the employees will vote their shares in favor of the takeover.
*Three weeks per year of service for the first five years, two weeks for each year after that, and last year's bonus paid for this year. This is only slightly worse** than what the people who were severed in November got.
**November was three weeks per year, regardless of service time.
Labels: Economics, FRBOperations, Moral Hazard, teaching, The Old Firm
Wednesday, March 19, 2008
Bear Investors bet that Moral Hazard Doesn't Exist for Them
by Ken Houghton
There will be a lot of noise about this over the next few months, and someone (not me) will get a nice dissertation out of the results.
Most interesting, though, from an asymmetrical information point of view, is this one, which notes that the inept Christopher Cox-led (but I repeat myself) SEC:
The Bear speculators are treating the stock as if it were SCO, which for a few years was basically a gamble on a successful lawsuit. That effort has not been pretty.
Strangely, their greatest hope may also be their greatest weakness, renowned bridge player and former CEO Jimmy Cayne. As the New York Post notes:
The "I was for it before I was against it" strategy is not something I want to gamble $4/share on. Your taste for lawsuits may vary—just be certain they are suits in your favor, not against you.
The Wall Street Journal has several articles today on the death of The Old Firm. Most interesting is "Heard on the Street" (link requires sub), where investors appear to have decided to play a game of Chicken with both Jamie Dimon and the Federal Reserve.
There will be a lot of noise about this over the next few months, and someone (not me) will get a nice dissertation out of the results.
Most interesting, though, from an asymmetrical information point of view, is this one, which notes that the inept Christopher Cox-led (but I repeat myself) SEC:
issued a written statement suggesting it has expanded an inquiry into Bear Stearns Cos. to include what was or wasn't said in the two months leading up to the brokerage firm's unraveling.
The SEC, which is usually mum about investigations, said its enforcement division wrote a letter as J.P. Morgan Chase & Co. was negotiating to take over Bear. The letter addressed to J.P. Morgan concerned "investigations and potential future inquiries into conduct and statements by Bear Stearns before the public announcement of the transaction with J.P. Morgan."
The Bear speculators are treating the stock as if it were SCO, which for a few years was basically a gamble on a successful lawsuit. That effort has not been pretty.
Strangely, their greatest hope may also be their greatest weakness, renowned bridge player and former CEO Jimmy Cayne. As the New York Post notes:
Cayne, who is a member of Bear's board of directors and voted for the JPMorgan deal, could risk further embarrassment if he threatens to vote against the deal, sources said.
The "I was for it before I was against it" strategy is not something I want to gamble $4/share on. Your taste for lawsuits may vary—just be certain they are suits in your favor, not against you.
Labels: High Finance, Moral Hazard, The Old Firm
Sunday, March 16, 2008
Profit Sharing -- Not even at 1992 prices
by Ken Houghton
This time, for once, it appears the Fed did its job: tried to save the market, not the malfeasant firm.
But $2 a share is brutal. At that level, even Jamie Dimon and the crackManny Hanny Chemical Chase JPMChase JPMChaseBankOne takeover team might be able to make a profit on this.
It's always been especially true at BSC that the assets walk out the door at the end of the day. The question now is how many of them will bother to walk in the door on Monday.
The counterpoint, somewhat, is offered by Steven Randy Waldmann, citing the always worth reading jck of Alea, while Mish suggests that derivatives may be a major issue, which is possible but unlikely, save in the balance between long- and short-term assets.
But after Carlyle got squeezed, and now BSC has fallen, it seems fair to ask exactly what the purpose of the TSLF is.
Unless, of course, you assume that market participants are using the three weeks (now 11 days) before it starts to kill of some competition. And no one in the financial services industry would do that, would they?
Iirc, and I probably don't, the first time I got BSC stock options was during my first go-round there. They were around $50/share, which was a minor premium when issued and a discount by the next year.
This time, for once, it appears the Fed did its job: tried to save the market, not the malfeasant firm.
But $2 a share is brutal. At that level, even Jamie Dimon and the crack
It's always been especially true at BSC that the assets walk out the door at the end of the day. The question now is how many of them will bother to walk in the door on Monday.
The counterpoint, somewhat, is offered by Steven Randy Waldmann, citing the always worth reading jck of Alea, while Mish suggests that derivatives may be a major issue, which is possible but unlikely, save in the balance between long- and short-term assets.
But after Carlyle got squeezed, and now BSC has fallen, it seems fair to ask exactly what the purpose of the TSLF is.
Unless, of course, you assume that market participants are using the three weeks (now 11 days) before it starts to kill of some competition. And no one in the financial services industry would do that, would they?
Labels: FRBOperations, High Finance, Moral Hazard, nce, The Old Firm
Monday, February 11, 2008
Tom's Favorite Homebuilder has Familial Problems
by Ken Houghton
Metropolitan Opera Broadcast buffs, such as the proprietor of this blog, can start worrying now.
Barry Rithholtz relays a story that must send shivers down NAR spines:
The daughter of Vice Chairman and co-founder Bruce Toll informed the company last month that she and her husband "did not intend to make settlement" on a $2.47 million home they had previously agreed to purchase, the company said in a regulatory filing.
Metropolitan Opera Broadcast buffs, such as the proprietor of this blog, can start worrying now.
Labels: Housing Bubble, Moral Hazard, opera
Friday, February 08, 2008
A Momentary Return to Mortgages
by Ken Houghton
Ignore that someone—most likely people who make less than $100,000 in two years—will have to make up this shortfall. Look at that middle location, and translate it into English.
Brooklyn.
And not likely the outer edges of Brooklyn, those two-fare zones where you could (a few years ago) get a house and some land for $60,000. Probably talking Park Slope and all of the other glory places that gave you "all the advantages of living in New York City."
We're talking about the people to whom many of my neighbors, and others like them, sold.
If Musical Chairs has really stopped in Brooklyn, can Sylvia Miles telling Charlie Sheen that "the market is slow" be far behind?
Forbes notes the value of the regressive "Mortgage Forgiveness Debt Relief Act":
It eliminates the tax liability for short-sellers. Before this bill, if you sold a $250,000 home for $200,000, the IRS considered the $50,000 gap earned income and taxed it as such. Not so today.
That's good news for underwater mortgage holders in expensive markets, who are more likely to see larger spreads. Los Angeles County, Calif., Kings County N.Y., and Riverside County, Calif., have the highest instances of homeowners, with more than $100,000 in negative equity. [emphases mine]
Ignore that someone—most likely people who make less than $100,000 in two years—will have to make up this shortfall. Look at that middle location, and translate it into English.
Brooklyn.
And not likely the outer edges of Brooklyn, those two-fare zones where you could (a few years ago) get a house and some land for $60,000. Probably talking Park Slope and all of the other glory places that gave you "all the advantages of living in New York City."
We're talking about the people to whom many of my neighbors, and others like them, sold.
If Musical Chairs has really stopped in Brooklyn, can Sylvia Miles telling Charlie Sheen that "the market is slow" be far behind?
Labels: Moral Hazard, mortgage
Wednesday, January 23, 2008
75 Basis Points, A Day Later
by Ken Houghton
Today, we still don't need to say anything, because Steve Randy Waldman's analysis says everything I would have yesterday, and gives it a context that will stand the test of time.
UPDATE: Felix Salmon appears to agree. So that's two people on two continents. Get thee to Interfludity!
*It will interesting to see if people who want to refinance now, solely to reduce rates or terms (i.e., even excluding MEW) will be able to do so.
We didn't discuss the interest rate cut here yesterday (though Felix Salmon understood the impact of my one related comment at MarketMovers*), partially because I assume everyone who isn't here for the Legos and kid pix and cars and religion and SFWA went to Mark Thoma's blog and found all the links they could want.
Today, we still don't need to say anything, because Steve Randy Waldman's analysis says everything I would have yesterday, and gives it a context that will stand the test of time.
UPDATE: Felix Salmon appears to agree. So that's two people on two continents. Get thee to Interfludity!
*It will interesting to see if people who want to refinance now, solely to reduce rates or terms (i.e., even excluding MEW) will be able to do so.
Labels: FRBOperations, Moral Hazard, mortgage
Wednesday, November 14, 2007
Go. Read.
by Ken Houghton
The price of freedom is eternal vigilance. Good to see someone who still believes that.
Tanta at Calculated Risk explains that one judge believes in the Rule of Law, and, in Footnote 3, understands and explains why it exists.
The price of freedom is eternal vigilance. Good to see someone who still believes that.
Labels: Calculated Risk, Moral Hazard, mortgage, subprime
Saturday, September 15, 2007
Annals of Moral Hazard (Northern Rock Edition)
by Tom Bozzo
Fast forward, and our friend Xtin was on the scene [*] of the run on England's Northern Rock, which is remarkable in part because England does have a deposit insurance system as part of the Financial Services Compensation Scheme [**]. However, the NYT account this morning leaves out a significant detail of the system in the following:
One criticism of deposit insurance is that it takes away a depositor's incentive to put money in sound banks. This is a form of "moral hazard," and a coinsurance scheme like the FSCS is a common means of dealing with it — in this case, by having the depositor share some of the risk. I would argue that this isn't an especially damning critique, since the soundness of banks isn't easily observed, and it's facially ridiculous to suggest that there aren't gains from specialization in bank regulation.
Meanwhile, the anti-moral hazard design may suffer from an excess of cleverness by half or more, to the extent it induces depositors to behave as if they are uninsured and run on the bank, which works at cross purposes to rescue attempts such as the Bank of England's in this case.
[*] She snapped, at higher resolution (if you click through), a picture of the queue at one of the branches depicted in this Calculated Risk post on the story.
[**] I suppose "scheme" doesn't have the connotation of fraud or unsoundness it has in American English; we'd undoubtedly substitute the robust-sounding "System" for the trailing "S."
Some of you might remember that during the savings and loan crisis of the 1980s, there were some runs on S&Ls whose deposits were insured through weak state systems.
Fast forward, and our friend Xtin was on the scene [*] of the run on England's Northern Rock, which is remarkable in part because England does have a deposit insurance system as part of the Financial Services Compensation Scheme [**]. However, the NYT account this morning leaves out a significant detail of the system in the following:
One reason Northern Rock customers may be nervous is that there is less protection for account holders in Britain than in the United States in case a bank fails. Deposits are insured up to £31,700, or about $64,000, compared with up to $100,000 in the United States.The difference between £31,700 and $100,000 in covered deposits doesn't do much to explain the length of the lines at Northern Rock branches. The difference which might is that the FSCS only provides 100% insurance to £2,000. The next £33,000 on deposit is insured 90%, so customers with non-extravagant balances could find themselves out sums that might not be enormous, but which also might not be inconsiderable either.
One criticism of deposit insurance is that it takes away a depositor's incentive to put money in sound banks. This is a form of "moral hazard," and a coinsurance scheme like the FSCS is a common means of dealing with it — in this case, by having the depositor share some of the risk. I would argue that this isn't an especially damning critique, since the soundness of banks isn't easily observed, and it's facially ridiculous to suggest that there aren't gains from specialization in bank regulation.
Meanwhile, the anti-moral hazard design may suffer from an excess of cleverness by half or more, to the extent it induces depositors to behave as if they are uninsured and run on the bank, which works at cross purposes to rescue attempts such as the Bank of England's in this case.
[*] She snapped, at higher resolution (if you click through), a picture of the queue at one of the branches depicted in this Calculated Risk post on the story.
[**] I suppose "scheme" doesn't have the connotation of fraud or unsoundness it has in American English; we'd undoubtedly substitute the robust-sounding "System" for the trailing "S."
Labels: Economics, Housing Bubble, Moral Hazard
Friday, August 17, 2007
The Fed approaches its senses
by Ken Houghton
Of course, they're also making it easier for firms that lack proper liquidity management to survive:
This is, not to put too fine a point on it, a Monetary Policy Mistake. While providing emergency liquidity can be justified, this is simply a Revolving LoC to perpetuate poor management practices.
After 11 September 2001, the Fed made small business loans available to several NYC-area firms, loans that gave firms a chance to get their finances in order and back on their feet. But those loans were not renewable, and firms that could not adjust to the new market wound down anyway, as part of the "creative destruction" so feted by "free"-marketers. The effect of the loans was to make that destruction orderly, not to prevent it from happening.
Now, at 9:34 a.m., the immediate effect of the Discount Rate cut is that the stock market (Dow and NASDAQ) are massively up. To borrow a theme from The Sandwichman (at Max's Place), the idea that the "loan of last resort" is worth at least a 2.5% gain in the markets should in itself produce "a slight sense of unease."
One of the silliest moves during the Bush administration was 2003's policy change that left the "Discount" rate higher than Federal Funds. (Discussed here; the short version is that any "moral hazard" was always mitigated by the transparency of the act itself.) Temporarily, they have seen the error of their ways, and taken a halfway measure of action:
To promote the restoration of orderly conditions in financial markets, the Federal Reserve Board approved temporary changes to its primary credit discount window facility. The Board approved a 50 basis point reduction in the primary credit rate to 5-3/4 percent, to narrow the spread between the primary credit rate and the Federal Open Market Committee’s target federal funds rate to 50 basis points.
Of course, they're also making it easier for firms that lack proper liquidity management to survive:
Board is also announcing a change to the Reserve Banks’ usual practices to allow the provision of term financing for as long as 30 days, renewable by the borrower. [emphasis mine]
This is, not to put too fine a point on it, a Monetary Policy Mistake. While providing emergency liquidity can be justified, this is simply a Revolving LoC to perpetuate poor management practices.
After 11 September 2001, the Fed made small business loans available to several NYC-area firms, loans that gave firms a chance to get their finances in order and back on their feet. But those loans were not renewable, and firms that could not adjust to the new market wound down anyway, as part of the "creative destruction" so feted by "free"-marketers. The effect of the loans was to make that destruction orderly, not to prevent it from happening.
Now, at 9:34 a.m., the immediate effect of the Discount Rate cut is that the stock market (Dow and NASDAQ) are massively up. To borrow a theme from The Sandwichman (at Max's Place), the idea that the "loan of last resort" is worth at least a 2.5% gain in the markets should in itself produce "a slight sense of unease."
Labels: Economics, Market Failures, monetary policy, Moral Hazard
Saturday, August 11, 2007
The Standard Rule always applies
by Ken Houghton
Apparently, good credits put into bad houses find the same effect. Or, as Tanta put it:
Warren Buffet is fond of noting that when a good manager joins a bad company, it's likely that the manager's reputation, not the company's, will change. (A simplified version is here.)
Apparently, good credits put into bad houses find the same effect. Or, as Tanta put it:
Insofar as FICOs are accurate measures of past performance, high scores indicate borrowers who have managed credit wisely in the past. Put those borrowers in unwise credit terms, and they perform just like people who have managed credit unwisely in the past. Glad we got some real-time empirical data to prove that. Sorry about your global financial crisis.
Labels: Housing Bubble, Moral Hazard, mortgage
Friday, August 10, 2007
Mark to Model -- Singular
by Ken Houghton
I have no conceptual problem with marking to model so long as (1) actual trading prices are not significantly different from the model and (2) the model used is consistent.
Apparently, the SEC is starting to share that last concern:
Note that the same method doesn't require the same price. But especially assets that are Held for Sale (HFS) are supposed to be marked with the best information available. This may not have been happening:
The first rule of reporting losses is that you can survive if you detail the entire problem upfront. If you report an $8 million loss the first day and $4 million more the next, you'll run into more problems than if you report $12 million on Day 1.
Liquidity and Transparency: they're not just for text books any more.
There has been much discussion (often heated enough to cover Tom's household energy needs) about "marking to model." (Tanta at CR has been especially good on this issue.)
I have no conceptual problem with marking to model so long as (1) actual trading prices are not significantly different from the model and (2) the model used is consistent.
Apparently, the SEC is starting to share that last concern:
U.S. regulators are scrutinizing the books of Wall Street's largest investment banks amid questions they are hiding losses from subprime mortgages, people familiar with the inquiry said.
The Securities and Exchange Commission wants to see whether firms are calculating the value of subprime-mortgage assets on their books the same way they calculate those values for their brokerage clients, such as hedge funds.
Note that the same method doesn't require the same price. But especially assets that are Held for Sale (HFS) are supposed to be marked with the best information available. This may not have been happening:
Wall Street banks are in a sensitive period as turmoil in U.S. mortgage markets generate losses for investors and push some lenders into bankruptcy. Yet few investment banks have disclosed significant subprime losses in recent periods.
The scrutiny may also help pinpoint whether hedge funds accurately report their results to investors, the Journal reported, citing an unnamed source. Regulatory checks into how firms calculate values of certain assets could boost the accuracy of performance reports to investors. [emphasis mine]
The first rule of reporting losses is that you can survive if you detail the entire problem upfront. If you report an $8 million loss the first day and $4 million more the next, you'll run into more problems than if you report $12 million on Day 1.
Liquidity and Transparency: they're not just for text books any more.
Labels: hedge funds, High Finance, Moral Hazard, Personal Finance Advice of Alan Greenspan, principal/agent problems, subprime
Sunday, August 05, 2007
Na Na Na Na/Na Na Na Na/Cramer's World
by Ken Houghton
It took less than an hour—on a Saturday morning—for dblwyo to point out the obvious: the Fed's Discount Window is always open. But the Discount window has changed since the days when it was a discount loan of Last Resort:
which means the current Discount Rate is 6.25.
In the old days (pre 9 Jan 2003), the Discount Rate was a legitimate discount (generally, iirc, about 3% below FedFunds). The alleged "incentive for institutions to borrow for the purpose of exploiting the positive spread" was more than mitigated by two things: (1) everyone knew you were doing it and (2) you had to explain to the Federal Reserve why you were doing it.
I interviewed once at a major money center bank that had, a year or so previously, been generally discussed as being on the brink of collapse. They had used the discount window six times in their worst year. So I view the talk of that "incentive" with a large barrel of salt.
What is real is that the "discount window" is now a Lender of Last Resort, with all the stigma and all of the information of the old Discount Window, and a higher interest rate.
So—as Jim Cramer should know—going to the Discount Window won't improve a financial institution's short-term cash flow problems; it will exacerbate them, both directly and indirectly. It's one of the improvements of the Federal Reserve made during the Bush Administration.
Jimmy Cayne, a major Bush supporter, undoubtedly knows that. That Jim Cramer didn't is sad.
Go read the whole thing at The Big Picture; check out the videos, listen to the remix. And mark Friday as the day that financial journalism—even in the context of Cramer's normal hyperbole—reached the level usually reserved for political reporters.
Just a brief note on this post from Barry Ritholtz and the folks at The Big Picture (h/t Dr. Black):
It took less than an hour—on a Saturday morning—for dblwyo to point out the obvious: the Fed's Discount Window is always open. But the Discount window has changed since the days when it was a discount loan of Last Resort:
The rule replaces adjustment credit, which currently is extended at a below-market rate, with a new type of discount window credit called primary credit that will be broadly similar to credit programs offered by many other major central banks. Primary credit will be available for very short terms as a backup source of liquidity to depository institutions that are in generally sound financial condition in the judgment of the lending Federal Reserve Bank. The Board expects that most depository institutions will qualify for primary credit.
Reserve Banks will extend primary credit at a rate above the federal funds rate, which should eliminate the incentive for institutions to borrow for the purpose of exploiting the positive spread of money market rates over the discount rate. The Board anticipates that the primary credit rate will be set initially at 100 basis points above the FOMC's target federal funds rate.
which means the current Discount Rate is 6.25.
In the old days (pre 9 Jan 2003), the Discount Rate was a legitimate discount (generally, iirc, about 3% below FedFunds). The alleged "incentive for institutions to borrow for the purpose of exploiting the positive spread" was more than mitigated by two things: (1) everyone knew you were doing it and (2) you had to explain to the Federal Reserve why you were doing it.
I interviewed once at a major money center bank that had, a year or so previously, been generally discussed as being on the brink of collapse. They had used the discount window six times in their worst year. So I view the talk of that "incentive" with a large barrel of salt.
What is real is that the "discount window" is now a Lender of Last Resort, with all the stigma and all of the information of the old Discount Window, and a higher interest rate.
So—as Jim Cramer should know—going to the Discount Window won't improve a financial institution's short-term cash flow problems; it will exacerbate them, both directly and indirectly. It's one of the improvements of the Federal Reserve made during the Bush Administration.
Jimmy Cayne, a major Bush supporter, undoubtedly knows that. That Jim Cramer didn't is sad.
Go read the whole thing at The Big Picture; check out the videos, listen to the remix. And mark Friday as the day that financial journalism—even in the context of Cramer's normal hyperbole—reached the level usually reserved for political reporters.
Labels: High Finance, Journamalism, Moral Hazard, subprime, The Old Firm
Tuesday, July 17, 2007
All Right, I Give Up: Rating Agencies cannot find barn door to close
by Ken Houghton
However, closing the barn door after the horses escape is one thing; not knowing how to tell if the horses have escaped, or where the door is, is another.
Via Naked Capitalism, the FT discusses rating agency mis- or nonfeasance:
Anyone interviewing for a job as an MBS analyst who didn't mention most of the above would not get a second interview. Except, apparently, at Moody's.
There still should be other agents acting first. (The most reasonable argument against regulation is that, by the time regulators have the information, the problem may be being solved.) But rating agencies are at worst the last resort of the small investor.
Oh, well. So much for that theory?
I'm disinclined to blame rating agencies, who are explicitly not fiduciaries, for delays in downgrading, largely because they will not have updated information so quickly as, say, the service provider or the owner of the securities.
However, closing the barn door after the horses escape is one thing; not knowing how to tell if the horses have escaped, or where the door is, is another.
Via Naked Capitalism, the FT discusses rating agency mis- or nonfeasance:
[Josh] Rosner [a consultant at research firm Graham Fisher} points to an April report from Moody's that showed the rating agency did not consider debt-to-income ratios as a primary piece of data in their mortgage models, although this is generally considered as one of the three key predictors of mortgage default.
In the same report Moody's said it would for the first time request loan level data detailing the structure of adjustable-rate mortgages, the servicer, the month of the first interest rate adjustment and other data that would allow them to analyse risks. S&P admitted this week that it does not receive this kind of granular data on performance of individual loans within the mortgage pools backing the bonds that it rates.[emphasis mine]
Anyone interviewing for a job as an MBS analyst who didn't mention most of the above would not get a second interview. Except, apparently, at Moody's.
There still should be other agents acting first. (The most reasonable argument against regulation is that, by the time regulators have the information, the problem may be being solved.) But rating agencies are at worst the last resort of the small investor.
One revelation that analysts have described as "extraordinary" this week is that S&P has no specific estimate of how much turmoil in the housing market would be needed to force downgrades of the AAA and AA ratings that have been left untouched in this round of downgrades and constitute the bulk of the principal value of most mortgage-backed deals. Moody's also said in an interview that it had no such estimate.
Oh, well. So much for that theory?
Labels: fiduciary responsibility, Moral Hazard, mortgage, subprime
Thursday, July 05, 2007
A Post I Now Do not Have to Write
by Ken Houghton
It was going to be a discussion of price versus value, and the danger to market players and makers of having to choose between (1) still being able to "mark to model," (2) taking the exposure of marking their portfolios at one price and their custodial holdings at another, or (3) remarking everything based on the benchmark trading levels established in the collateral selloffs.
Note especially that none of the above options requires the underlying assets to be foreclosed or defaulted; the question is one of price, not value.
Fortunately, I am lazy and the reason no one wants to use option 2 or 3 is becoming clear, as noted at Mish's:
As I noted at Felix Salmon's place, it takes more than a week to hire a Jeffrey Lane.
While I desperately hope I'm wrong, it looks more and more as if any legitimate investigation of the no-longer-planned Everquest IPO would produce results to make Arthur Anderson's relationship with Enron look positively arm's-length.
I was thinking about a long response to Brad's comment when I quoted Dr. DeLong here:
The "As long as..." is there for a reason. If defaults trigger foreclosures and if dumping foreclosed houses onto the real estate market triggers a steep price decline in the underlying, we're in big trouble. If not, not, IMHO...
It was going to be a discussion of price versus value, and the danger to market players and makers of having to choose between (1) still being able to "mark to model," (2) taking the exposure of marking their portfolios at one price and their custodial holdings at another, or (3) remarking everything based on the benchmark trading levels established in the collateral selloffs.
Note especially that none of the above options requires the underlying assets to be foreclosed or defaulted; the question is one of price, not value.
Fortunately, I am lazy and the reason no one wants to use option 2 or 3 is becoming clear, as noted at Mish's:
The situation is so bleak that Bear Stearns' asset management group is suspending redemptions at the onetime $642 million fund—meaning investors have no choice but to sit on their losses. And that's got some hopping mad.
An investor in Europe, who didn't want to be identified, says he's been trying to get his money out of the hedge fund since February.
He's particularly incensed that on a June 8 conference call the fund's managers set up to discuss performance, Bear Stearns officials refused to field investors' questions. "They specifically said they weren't taking any questions," says the investor. "They didn't want to say anything."
A Bear Stearns spokesman declined to comment.
As I noted at Felix Salmon's place, it takes more than a week to hire a Jeffrey Lane.
While I desperately hope I'm wrong, it looks more and more as if any legitimate investigation of the no-longer-planned Everquest IPO would produce results to make Arthur Anderson's relationship with Enron look positively arm's-length.
Labels: corporate malfeasance, Moral Hazard, mortgage, Regulation, subprime, The Old Firm
