Rawk Break

I need one.

Hot Snakes live, 2004: 10th Planet – I Hate The Kids – Gar Forgets His Insulin. This guy has the rest of the Hot Snakes concert uploaded, plus some live Shellac. He wins at the internet.

“I Hate The Kids” starts in at 3m25s. I remember when Ed, who, god bless him, introduced me to the brilliance of John Reis and Rick Froberg, pointed out that when Froberg screams “the older you get, the less you’re worth / you’ve got to hit the market full force!” going into the chorus, you can picture the executives from Interscope talking to the members of Drives Like Jehu in 1994, saying “Well, this whole indie rock thing is getting pretty old pretty quickly; how well positioned are you to hit the market?”

That makes how pissed off they sound even better.

Kneel!

Hahaha How brilliant is this? (h/t – Szymon Błaszczyk)

I remember having a gchat discussion with a friend, who is also a liberal lapsed Catholic, about how creeped out we are by Pope Benedict. I grew up in a Polish neighborhood of Chicago, so I was very used to seeing paintings and mementos of John Paul II and his visit to Chi-town (right around the time I was born). The way my parents explained the events of the 1980s to me as I was growing up, it was like John Paul II and Ronald Reagan merged into a single Voltron-like being and destroyed the Soviet Union. I believed it.

But Benedict creeps me out. The best I could come up with is that when I see him, I kind of expect him to yell “Kneel Before Ratzinger!” just like General Zod did in that Superman movie.

As a joke, I typed ‘Kneel Before Ratzinger!’ into google. And on the first page, I got this – “The Theology of Kneeling [by] Cardinal Ratzinger.” It opens – “There are groups, of no small influence, who are trying to talk us out of kneeling.”

I had to walk away from the computer I was so freaked out. I feel terrible for those trying to influence the Catholic Church to reform on issues related to condoms and gay marriage. Ratzinger has no time for the non-kneelers! Even the phrasing – “of no small influence” – is the phrasing you use to deal with an existential threat. No way is he making room for those interests.

The New Financial Industrial Firm

Below, in the usury post, there was a quote “And this addicted the financial sector to very, very, very high rates of return compared to what investors were used to getting in the real economy, the manufacturing sector, General Motors, which would give piddling five, six, seven percent returns. So the capital in this country began to shift in the financial sector. That’s why the financial sector began to bloat up.”

I don’t want to comment at length on that, but did you see the Giant Pool of Money episode of This American Life? It is really good, and I’ve blogged about it before. During it, we meet a mortgage dealer named Glen. Read about meeting Glen here from the transcript:

Usury

It’s there from The Code of Hammurabi to the Bible to Adam Smith: Usury. (You would think that is enough of a cultural tradition for conservatives to want to, ya know, conserve.) Tom Geoghegan has an interesting meme that the abandonment of usury laws in the late 1970s has lead to our current crisis. (h/t Freddie):

You know, if you are Mr. Potter in It’s a Wonderful Life and can only get six percent, seven percent on your loan, you want the loan to be repaid. Moral character is important. You want to scrutinize everybody very carefully. But if you’re able to charge 30 percent or, in a payday lender case, 200 or 300 percent, you don’t care so much if the loan—in fact, you actually want the loan not to be repaid. You want people to go into debt. You want to accumulate this interest. And this addicted the financial sector to very, very, very high rates of return compared to what investors were used to getting in the real economy, the manufacturing sector, General Motors, which would give piddling five, six, seven percent returns.
So the capital in this country began to shift in the financial sector. That’s why the financial sector began to bloat up. That’s why we ended up, by 2006, having a third of all profits going into the banks and the financial firms and not into the real economy.

When I first read this, I thought it was a small piece, but the more I think about it, the more I think he’s onto a big part. As he points out, not only do the absolute levels of debt change post usury, but the way we, and especially the creditors, think of debt changes. It’s not something to be paid off is an obvious first problem; the second is that it is something now profitable to trick people into.

But what is most disturbing is when the creditors get to the mindset that debt is something to be maximized and optimized before it defaults, you get all the effort, hard work and energy going into making it just that. I’ve seen pages of equations and computer code by quants dedicated to trying to figure out how to optimize a crack addict’s NINJA loan in a 360 dimensional hilbert space. Not to optimize it so that it gets paid off, increasing the joy and utility of all, but how to squeeze as much juice out of it before the expected default probability spins out of control, leaving the bank with the home it had started with (that was worth a fortune, because home prices keep rising!). I’d rather have all the brainpower shooting to get loans to people who deserve them or figuring out how to help distressed people wind down their loans instead of getting loans to those we can most roll before leaving them bankrupt, and if usury laws are the sharpest blunt tool in the shed, I’d be open to considering them.

Anyway, I couldn’t help but think of usury laws as I read this interest New York magazine piece about the guy who created the Mortgage Security software that helped blow up Wall Street. Notice this part:

I quickly learned how fishy this world could be. A client I knew who specialized in auto loans invited me up to his desk to show me how to structure subprime debt. Eager to please, I promised I could enhance my software to model his deals in less than a month. But when I glanced at the takeout in the deal, I couldn’t believe my eyes. Normally, in a prime-mortgage deal, an investment bank makes only a tiny margin. But this deal had two whole percentage points of juice! Looking at the underlying loans, I was shocked.

“Who’s paying 16 percent for a car loan?” I asked. The current loan rate was then around 8 percent.

“Oh, people who have defaulted on loans in the past. That’s why they’re called subprime,” he informed me. I had known this guy off and on for years. He was an intelligent, articulate, pleasant fellow. He and his wife came to my house for dinner. He had the comfortable manner of someone who had been to good schools—he was not one of the “dudes” trying to jam bonds into a Palm Beach widow’s account. (Those guys were also my clients.)

“But if they defaulted on loans at 8, how can they ever pay back a loan at 16 percent?” I asked.

“It doesn’t matter,” he confided. “As long as they pay for a while. With all that excess spread, we can make a ton. If they pay for three years, they will cure their credit and re-fi at a lower rate.”

That never happened.

We should be working hard now to make sure that “as long as they pay for a while” is no longer a guiding ideology for our nation’s consumer debt policy.

Warming

On Global Warming, from the Sunday’s nytimes:

Beyond the specific points of factual dispute, Dyson has said that it all boils down to “a deeper disagreement about values” between those who think “nature knows best” and that “any gross human disruption of the natural environment is evil,” and “humanists,” like himself, who contend that protecting the existing biosphere is not as important as fighting more repugnant evils like war, poverty and unemployment…

Dyson has always been strongly opposed to the idea that there is any such thing as an optimal ecosystem — “life is always changing” — and he abhors the notion that men and women are something apart from nature, that “we must apologize for being human.” Humans, he says, have a duty to restructure nature for their survival…

That said, Dyson sees coal as the interim kindling of progress. In “roughly 50 years,” he predicts, solar energy will become cheap and abundant, and “there are many good reasons for preferring it to coal.”

I’m sure Ed could rock the weird logical error that we can either worry about global warming or worry about poverty and unemployment but not both. But I worry about global warming for two simple reasons that have nothing to do with the philosophy of Man and Nature, and that aren’t assuaged away by the promise of the always forthcoming technological utopia. I think those issues can be interesting, since I think when God told Man that he had dominion over the Earth he meant it as like a shepherd over his flock instead of a conqueror over his enemies. But when I put on my harshest neoliberal glasses, and see Nature as nothing other than materials to be consumed, I still have two worries:

1) Externalities When I drive my SUV to the McDonalds to purchase many large cheeseburgers, the costs from global warming primarily fall on two groups of people – Africans, and your grandchildren. They aren’t borne by me. To the extent that they are, they fall more on everyone else, since there are way more of you, and your grandchildren, than there are of me and mine.

There is a free-rider problem that worries me about the production of carbon more generally and the creation and use of energy saving technologies. I see no reason to assume solar energy will be cheap; and if it is just a little more expensive than coal, since the hidden costs of carbon are borne by everyone else (and not priced at all), people will prefer to use the cheaper one.

I used to drive a Prius, and I always wondered if I was making the environment worse. Picture someone else – he’s worried about the environment, and wants to get an additional 5mpg to his car. However he sees someone drive by with a energy-efficient car, and thinks “well, he’s got my 5mpg. He’s probably got 10mpg more than normal. Perhaps I should go and get 5mpg less, since that driver has my moral obligations covered.” Now picture 100 people doing that mental calculation. That’s the free-rider problem, and I could easily see it with any future wonder energy source.

My old car! I miss it.

2) Tail Risk The worry about tail risks and tipping points is a very complicated one. But here’s an interesting question – do you ever think we over-estimate it? Consider that we are coming directly from an era where the smartest physics minds concluded that giving $600,000 mortgages to NINJA crack addicts might cause some problems here or there, but that the tail risk of the whole thing spinning out of control was negligible. How much do we just want to assume that the environment tipping over into a new worse equilibrium is a just something to shrug at?

I have to think a lot about tail risk at my job, and what worries me the most are those cross-interactions that kick in once the ball gets rolling. Those interactions usually either push one back to where they started, or speed one into the spiral faster. What I notice is the same thing that I noticed as the subprime, credit and greater economy collapsed – when people come back to change their original estimates, they are always worse, and worse in a way that indicates a spiraling condition.

These are the things that worry me.

Bank sizes

Lots of people are talking about how big banks should be going forward. I don’t have any expert opinion on this, but I have read this paper, Bank Consolidation and Consumer Loan Interest Rates (Kahn, Pennacchi, Sopranzetti):

The recent wave of bank mergers has raised concern with its effect on competition. This
paper examines the influence of concentration and merger activity on consumer loan interest
rates. It uses Bank Rate Monitor, Inc. survey data on loan rates quoted weekly by large
commercial banks in ten major U.S. cities during the 1989 to 1997 period. The pricing behavior
of banks is analyzed for two types of loans: new automobile loans and unsecured personal loans.

Market concentration is found to have a positive and significant impact on the level of
personal loans, but not automobile loans. Consistent with the exercise of market power, we find
that personal loan rates rise in markets following a significant merger. However, there is a
significant decrease in automobile loan rates charged by banks participating in within-market
mergers, a finding consistent with economies of scale in the origination of automobile loans.

The paper also tests for the existence of leader-follower relationships in loan pricing and
finds that it is more widespread in markets for automobile loans. Interest rates on both types of
loans respond asymmetrically to a change in equivalent maturity Treasury security rates, being
more sensitive to a rise than a fall. In addition, personal loan rates are less responsive in more
concentrated markets.

That paper is the 2000 version; the published 2005 version has a similar abstract, but is firewalled by the various econ paper sites. I don’t keep up with the literature, but these guys are good and I’m pretty sure this analysis is current in the field. The “respond asymmetrically” means that if interest rates go up, it takes longer for the rates customers see to go up compared to the opposite direction (good for banks, bad for consumers).

There’s little reason to believe from the available research that having large banks with market concentration was passing along much to the customers of those banks – and good reason to believe they were using their market power to overprice them at the margins. From the summary data, those results appear with the coefficient of asset size as well as market concentration.

Wow.

Wow. Just wow.

…During Jan/Feb AIG would call up and just ask for complete unwind prices from the credit desk in the relevant jurisdiction. These were not single deal unwinds as are typically more price transparent – these were whole portfolio unwinds. The size of these unwinds were enormous, the quotes I have heard were “we have never done as big or as profitable trades – ever”
This caused single name credit to massively underperform equities – run a chart from say last September to current of say S&P 500 and Itraxx – credit has underperformed massively. This is largely due to AIG-FP unwinds.

I can only guess/extrapolate what sort of PnL this put into the major global banks (both correlation and single names desks) during this period. Allowing for significant reserve release and trade PnL, I think for the big correlation players this could have easily been US$1-2bn per bank in this period.”…

For those to whom this is merely a lot of mumbo-jumbo, let me explain in layman’s terms:
AIG, knowing it would need to ask for much more capital from the Treasury imminently, decided to throw in the towel, and gifted major bank counter-parties with trades which were egregiously profitable to the banks, and even more egregiously money losing to the U.S. taxpayers, who had to dump more and more cash into AIG, without having the U.S. Treasury Secretary Tim Geithner disclose the real extent of this, for lack of a better word, fraudulent scam.

In simple terms think of it as an auto dealer, which knows that U.S. taxpayers will provide for an infinite amount of money to fund its ongoing sales of horrendous vehicles (think Pontiac Azteks): the company decides to sell all the cars currently in contract, to lessors at far below the amortized market value, thereby generating huge profits for these lessors, as these turn around and sell the cars at a major profit, funded exclusively by U.S. taxpayers (readers should feel free to provide more gripping allegories).

What this all means is that the statements by major banks, i.e. JPM, Citi, and BofA, regarding abnormal profitability in January and February were true, however these profits were a) one-time in nature due to wholesale unwinds of AIG portfolios, b) entirely at the expense of AIG, and thus taxpayers, c) executed with Tim Geithner’s (and thus the administration’s) full knowledge and intent, d) were basically a transfer of money from taxpayers to banks (in yet another form) using AIG as an intermediary.

For banks to proclaim their profitability in January and February is about as close to criminal hypocrisy as is possible. And again, the taxpayers fund this “one time profit”, which causes a market rally, thus allowing the banks to promptly turn around and start selling more expensive equity (soon coming to a prospectus near you), also funded by taxpayers’ money flows into the market.

Try reading the whole thing, though it is from the prospective of a desk trader.

If that made no sense at all to you, we bailed out AIG so they wouldn’t firesale their portfolio (this is why we also wanted to pay the bonuses – so that AIG could unwind their portfolio slowly and not firesale off). It appears they did that anyway, transferring a huge amount of money from taxpayers to banks. This mismanagement of the sale shows up as the profits the big banks made in Jan/Feb.

This makes the banks look like they are in even worse conditions than I had originally thought. This should look like obvious blips in the historical financial data stream, let’s see what we can figure out on the blogosphere. If you see any interesting follow-ups, feel free to link through. Anyone reading this good at analyzing iTraxx data?

Current Mood: Fraudulent.

Take note: livejournal isn’t just for cutters who think that Donnie Darko is the best movie ever made anymore. A wife of a senior IT executive at the financial products wing of AIG that blew up – AIGFP, has started a livejournal. (h/t – Felix Salmon, who also has the link to the husband’s blog.) It’s probably not going to stay up long, so I hope historians get a snap-shot for future generations. But here’s what it is like (underline mine):

…And my husband was hired [at AIGFP].

Thus began 15 years of being on call every hour of every day of every week of every year.

Never getting to read the boys a bedtime story without the phone ringing from Hong Kong or Tokyo or London or Paris because the mail server was down or someone couldn’t log on to their office machine from home or….

Eating at his desk with a phone to his ear – at dinner – at home…

Little did I know he was moving over and would use my husband as his chief geek and whipping boy for the next 10 years.

My husband was held accountable by Cassano for other people’s performance but never given direct authority over them, screamed at in public (as were most employees who had to encounter Joe) if any fault was found…Joe Cassano is a bully. I wanted very much to like the person who made our amazing London adventure possible but it was not going to happen.

Sent to London on a 2 to 3 year commitment, half a house left in storage in CT, we have been here ‘indefinitely’ for 11 years pushing 12. We were unable to press for anything more than the ex-pat package we were given at the beginning and lost even housing support after the first 5 years.Our housing costs rose to 5 times what we paid in Connecticut. The salary did not.

Raises were only given in the ‘bonus’. So imagine having to pay 5 times your mortgage or rent on your current salary with the promise of the rest of your compensation to come once a year, in December. How do you leave that job?

Do you leave in December and disrupt your children’s education? Well, not without a very good reason.
Do you leave at the end of the school year and essentially throw away 6 months of under compensated work? Not likely.

- Oh and, a percentage of your paycheck you will be forced to ‘re-invest’ in the company for 5 years before you will see it.

It is a very pretty velvet lined cage with a tyrant holding the key.

I had many reasons to trust that, though I was having to do most of the utility parenting and keep the world ticking over for the family while he spent all hours working, we would come out of the long hard road with money for the boys education and a retirement fund that would allow my husband to have time to do the things he loves.

Then Cassano betrayed us. The CDO business was his. The other businesses were profitable and still are. When the executive in charge of risk challenged him he was told to shut up. When it blew up Joe walked around the office, looking at people who had worked loyally for him (no choice there if you wanted to stay) and took home $1,000,000 per month, knowing that those around him were going to lose their savings and more. We have.

Ok, it was a huge blow but the government stepped in and my husband still had a job for now. But the description had changed…

And now Cuomo says that the security of our families can be purchased by returning the compensation we had been promised with his re-assurance in October. He is no better than a highwayman waiving a gun “Your money or your lives.”

Two things. Notice how she is able to see, and let’s assume she saw it early, that Cassano was a lunatic and a bully. She also catches how the pay structure has been set up to keep them trapped – to keep even the well employed people away from their families working shit jobs with terrible bosses thinking maybe they should just stick it out for one more bonus.

She’s smart enough to see that – but, as I underlined above, she made the mistake of thinking this insane person had any interest in providing the long-term for his employees. Read it again – “he treats my husband like shit, humiliates him, keeps him trapped here without enough money to transition out – but in the long run he’ll be taken care.” What kind of abuse-victim mentality is that?!? How do smart people fall for it?

Second – How perfect is it, and I’ve heard it from several people, that the argument for the bonus is “we deserve our bonus because we don’t really get paid a big salary and expect to live on our large bonus.” I retort “We’ll it is so large because you need to be compensated for the employer counterparty risk; you run the risk your employer will be gone, and the next one, be it a new bank or the USA, won’t want to honor it.”

A quick example – I can give you $1 a month each month for a year, or I can give you $20 at the end of the year. That’s a huge premium! Of course you’d take the $20. However you haven’t gotten free money – you’ve just leveraged up on your counterparty risk. You suddenly now have the risk that I won’t have the $20 a year from now or that I’ll be gone, and you’ll be out all that you deserve instead of just that last $1. If someone else is standing in my place at the end of the year, and he says “I don’t owe you $20; in fact I don’t owe you anything” that’s not highway robbery.

That AIG employees and other investment bankers don’t understand a simple idea of counterparty risk at the micro and contract level makes perfect sense to me, because the not being able to pay out the big premium is exactly what brought them down. “But we had these CDS contracts! You promised!”

If she’s looking for “current music” recommendations, here’s Yo La Tengo singing “Stockholm Syndrome.”

Banks, Secretly Terrified

Financeguy brings up a really good point. Banks are probably scared, really scared, that so many people are discussing and arguing that this Geithner Plan is a massive giveaway from taxpayers to banks – and even more scared that they are using math to do so. Not because the public has exposed the plutocrats who rule us, but because the plan is probably going to fail and the public will have no patience left – didn’t everyone prove this was gamed to win from the get-go?

5 Reasons U.S. Banks are Secretly Terrified of Geithner’s Plan…

1. It reveals this sort of, well, lie, you’ve been telling that the assets can’t be sold at a fair price simply because of a liquidity crisis.

The Geithner plan is swimming with leverage and liquidity. Private investors will have to put up less than 10 percent of the purchase price (some estimates have been as low as 3 percent). Public money is waiting to flood in to support transactions.

But that won’t be good if you have an asset on your books for $80 (when face value is $100), and the “fire sale” price that you rejected a month ago was $37, and the bid (under the Geithner plan) comes in at $41. In this case, you can hardly blame a liquidity shortage for the low offer. So that means, um, the main problem with getting $80 for your asset isn’t a broad, out-of-your-control systemic issue (liquidity and those damn credit markets) but a specific, you-screwed-up issue (you’re holding a piece of junk)….

3. You’re being screwed by the “big overpaying” fallacy making its rounds on the Net.

As if things couldn’t get worse: there is a simple mathematical model of how these bids will work, showing that (with the public ponying up most of the money) private investors will have an incentive to overbid by 30 or 40 percent because of the extensive government support. The model turns out to be wrong (see my preceding two entries), but it’s spreading like a brush fire and was started by Mr. Nobel, Paul Krugman himself. (The real overpayment incentive will be much smaller … perhaps a few percent?) [edit: Rortybomb - 12%!]

So here’s how you’re screwed: You list the asset for $80. Let’s say the bid comes in for $41. You can’t accept that price; it’s too low. Meanwhile bloggers worldwide begin to mutter, “Okay, that asset’s true value was about $30 because of the overpaying — holy criminy, these banks really are clinging to a bunch of crap.” So your asset book looks even worse to the public at large than it really is. Great.

Read the rest! I do think he’s ultimately right. My suspicion is the stress tests are coming back as disasters. People talk about how difficult it is to value these things, and they are. But it is not hard to get a ballpark, and my guess is that even with numbers that are perhaps massaged and favorable the banks have no clothes. But Obama can’t commit to nationalizing a massive part of the banking sector just yet – so he has to go through this dance.

But maybe he and I aren’t. Newest strategic data point to this: Banks are currently buying up these loans to sell to the government – which signals to me (1) There will be overpayment by the bidders and a transfer; not a few percents, which it isn’t worthwhile, but at least 12%, at which point it is a return worth grabbing hold of for them. (2) Either they are confident on their books or confident on their bidders, but increasing their supply of loans makes me think they think they can weather this. That or the ship is sinking so fast they want to grab some more money on the way down. I suppose we’ll eventually figure out…

Go Greyhound.

Do you want a quick way to know if the bar you are drinking at is a respectable establishment?

Check if the pint glasses have Greyhound Bus advertisements on them. In case you are drinking your beer late at night on a weekday and think “I need to get out of town, now. By bus.”

I also want it noted that the advertisement is not a sticker; the ad is painted on. From the bar I was in, I can only assume the marketers hit their “target market” right in the bullseye.