Wednesday, August 27, 2014

House of Debt by Atif Mian and Amir Sufi – Book Review

Many causes have been cited for the financial crisis and the ensuing “Great Recession.” In a new and important book, two economists, Atif Mian and Amir Sufi, make a convincing argument that the major cause was a pull-back in consumption by highly-indebted households when the housing market tanked. The authors marshal data to make their case about credit scores, indebtedness, and economic fallout for different types of neighborhoods.
The argument the authors make is for the most part impressive and persuasive. That mortgage lenders were making imprudent loans and did not care because of the insatiable appetite of Wall Street for product to package into collateralized mortgage obligations (“CMOs”), some of whose tranches were ridiculously rated AAA, is beyond dispute. It also stands to reason that, when the housing market crashed and joblessness increased, the most affected households would have relatively high marginal propensities to consume. Consequently, the effect of the bursting of the housing bubble was direr for aggregate demand and the economy than the previous bursting of the tech stock bubble. Stock market investors, in general, had lower marginal propensities to consume than over-indebted homeowners faced with possible foreclosure.

The policy implications and conclusions that the authors draw from their work are somewhat more controversial. Lawrence Summers, in his generally quite positive Financial Times review of the book, is somewhat defensive concerning the authors’ arguments about what the Obama Administration should have done. The authors argue that more should have been done to help struggling homeowners and that the banks got off too lightly. Summers, while admitting that the Administration should have done more in this respect, argues that the authors ignore the political realities faced by the Administration. For example, it would have been difficult, probably impossible, for the Administration to have gotten the Congress to pass legislation to give bankruptcy judges “cram-down” authority with respect to mortgage debt, that is, the ability to force creditors to accept a reduction in principal or interest rate on the debt rather than proceeding to foreclosure. Summers, does, though agree that would have been good policy if it could have been achieved.     
Summers also argues that during the crisis that policymakers had to be concerned about the stability of the financial system and could not just drain funds from banks in order to help homeowners. Obviously, it is easier to identify a limited number of banks and other financial intermediaries and stabilize them than to set up a program on the fly to help out millions of homeowners. The authors, though, do have a point. The banks and other financial intermediaries and much of their management weathered this crisis too well with government help and forbearance. If the objective was to get the economy moving again and reduce unemployment, doing more to help those with a high marginal propensity to consume would have been better policy. We can argue, though, endlessly, about fairness and who was most at fault.
As far as one of the book’s main point is concerned, a housing bubble fueled by excessive debt is the primary cause of the financial crisis and the Great Recession when the bubble burst. The debt exacerbated the problem of getting the economy growing at a desirable rate. What the authors’ do not discuss, though, is that there were failures leading up to the crisis at multiple levels.

The financial regulators, for one, could have been tougher. The regulators were not blind to the fact that inappropriate and risky mortgage loans were being made. They had authority, even before Dodd-Frank, to do something about this. For example, they could have ordered certain banks to stop engaging in certain activities because they were unsafe and unsound banking practices. The SEC could have required better disclosures and sales practices in connection with CMOs. Why did they not do this?
The banking regulators and the SEC should also have been able to see, if they had looked, that an enormous amount of risk was being laid off by their regulatees and was concentrated at AIG in the form of credit default swaps. The regulators should have been awake to the dangers this posed and put a stop to it continuing.

The rating agencies, as is well known, failed in properly accessing the risk of CMOs. They put a priority in their short-term business interests at the expense of their reputations, as did the sellers of CMOs.
In other words, if there had been more proactive and responsible behavior prior to the crisis erupting, the housing bubble and its aftermath would have been less severe. The authors do not discuss these multiple failures of financial institutions and their regulators.

I have some other quibbles with the book. First, it would have been helpful to discuss more thoroughly the motivations of the mortgage borrowers rather than just the lenders. For example, the stagnation of incomes and growing income inequality could have been more explored. A likely explanation for why homeowners (as the commonplace jargon of the day termed it) took equity out of their homes through borrowing is that in many cases the motivation was an attempt to maintain or improve living standards when that could not be accomplished via the job market. Growing inequality, of course, has been analyzed in the recent, very long book by Thomas Piketty, Capital in the Twenty-First Century, but discussing it more specifically in relation to the housing bubble fueled by excessive debt would have been helpful.
Second, if the authors want to bring in actors such as the central bank of Thailand into the story, they should have explained more their role. For example, how were central banks in Asia able to pile up dollar reserves after that region’s financial crisis and what does the data, if available, show about their investments in securities other than Treasuries? Were they reaching for yield in buying supposedly AAA mortgage related securities, if that is what they did? What were they hearing from the investment banks advising them and selling them product? Was the Federal Reserve concerned?

Third, while the recommendation for a different kind of mortgage products for which borrowers give up a small portion of their potential capital gains in order to get an automatic principal reduction when housing prices fall makes sense, there is no discussion of how to make this a reality. Unless faced with the necessity for creative financial products because of economic conditions, Americans can often be quite conservative. This is not easy to overcome.
As an aside, I had experience while working at Treasury, to research this conservatism. Inflation-indexed bonds were a hot topic that it was my job to research. One of the reasons proponents of Treasury issuing inflation-indexed bonds was that these securities could act as a catalyst for other inflation-indexed products, such as inflation-indexed annuities and mortgages. In fact, inflation-indexed mortgages had been attempted prior to Treasury issuing inflation-indexed bonds. They were called price-level adjusted mortgages (“PLAMs”). PLAMs made a lot of sense, since it is an answer to the problem that the inflation component of interest rates in a conventional mortgage is front-loaded. For young people buying their first house, it makes sense to take out a mortgage with lower initial nominal payments which then grow with the rate of inflation. Their nominal incomes presumably will increase with the rate of inflation, if not more as they progress in their careers. However, the product was not successful and now, I assume, there is still no interest in an environment where inflation is currently relatively low.

Finally, a certain sloppiness appears in a few places. At one point, for example, the authors write: “When the banking system is under severe threat, the price for commercial paper may be much higher than the price for Treasury bills.” They actually mean “yield” rather than price. At another point, they oversimplify the way stocks are priced in a discussion of an experiment conducted by Vernon Smith. They state, and give a numerical example without any caveat, that “at any point in time, [the stock price] should equal the expected future dividends from the stock.” They should have mentioned somewhere that these expected future dividends should be discounted by an appropriate interest rate in order to determine their present value. Finally, in a discussion of money market mutual funds, the authors argue that investors know because of government actions in 2008 that there is an implicit government guarantee of these funds that makes them attractive. While this is true, it is a little behind market developments. Money market mutual funds currently have very low yields and it is easy to find bank deposits, which carry an explicit government insurance for up to $250,000, that yield more than money market mutual funds.
The authors are convincing that excessive mortgage debt was at the root of the problem and that the failure of the federal government to take significant actions to ameliorate this lengthened the recession and contributed to the slow growth we continue to experience. The authors are also correct about the limits of monetary policy action, when substantial increases in the monetary base do not lead to substantial increases in the money supply. They are somewhat less convincing in their criticism of fiscal stimulus, especially since the government could, if there were the political will, spend money in areas likely to increase employment, such as infrastructure spending. That does not appear likely at the moment though, but their preferred solution of giving mortgage relief to distressed homeowners is even less likely.

The book is well worth reading, because it gives a different perspective on what happened and why we are continuing to feel the aftermath of the 2008 financial crisis and Great Recession. It is an important book. One hopes, though, that the authors take a broader perspective on economic problems and policy recommendations in their next book.

Tuesday, August 26, 2014

Some Interesting Articles on the Web (August 26, 2014)

“Citibank fears losing local banking licence.” Buenos Aires Herald article.

“Argentina aims to skirt U.S. court, bring debt under national law.” Reuters article.

“Escalating to Nowhere?” Anna Gelpern post on Credit Slips.

“Argentina's debt saga: The local loop.” Article on The Economist website by H.C.
“Argentina and the Swap Puzzle.” Anna Gelpern post on Credit Slips.

“Hedge Funds Sue to Get Argentine Bond Payment in London.” New York Times Deal Book article.

“Argentine Default Bad Test Case for Sovereign Debt Negotiations.” Article on Foreign Policy website by Jamila Trindle.
“Argentina's Last Bond Exchange Went So Well It's Doing Another.” Matt Levine article for Bloomberg View.

“ISDA sets Argentina CDS auction date after yen bond inclusion.” Reuters article.

“Sovereign Chicken.” Mark Weidemaier post on Credit Slips.

“Europe’s Greater Depression is worse than the 1930s.” Article by Matt O'Brien for the Washington Post Wonkblog.”
“Worse than the 1930s: Europe’s recession is really a depression.” Another article by Matt O’Brien for Wonkblog.

“Enough Hate for Everyone: Muslims and Jews Are Targets of Bigotry in Europe.” New York Times op-ed by Kenan Malik.

“Balanced-budget fundamentalism.” Simon Wren-Lewis blog post.

“The Euro Catastrophe.” Paul Krugman blog post.
“An Interesting Ad-Lib from ECB Head Mario Draghi’s Jackson Hole Speech: Morning Comment.” Brad DeLong blog post.

“What France Needs From Europe.” Bloomberg View editorial.

“By Any Means Necessary.” Linda Greenhouse on the legal attacks on the Affordable Care Act.

Thursday, August 21, 2014

Argentina Debt Crisis: Some Observations

The spectacle of the fight between the government of Argentina and the bond holdouts, led by Paul Singer of Elliot Management has been fascinating to watch. It does, however, point out weaknesses in the international financial system, is detrimental to the economy and, therefore, the people of Argentina, and highlights a problem with credit default swaps.
Some observations:

·       The Obama Administration should not have effectively blocked the IMF from submitting briefs to U.S. courts, including the Supreme Court, outlining its views of the dangers Judge Griesa rulings pose to future needed restructurings of sovereign debt. The Administration submitted an amicus brief to the Supreme Court; it is a mystery why it did not permit the IMF to submit its views. 

·       The failure of Argentina and the holdouts to reach an agreement and their subsequent actions indicates that this is about more than just money. Argentina is investigating Elliot Management for insider trading in connection with credit default swaps on Argentine government debt; Elliot Management has court permission to investigate certain entities incorporated in Nevada. The amount of money that could possibly belong to Argentina located in Nevada appears to be quite small in relation to the amount in dispute, if it exists at all. The real purpose seems to be to find financial fraud committed by high-level Argentine government officials, perhaps including that of President Cristina Fernandez de Kirchner. I do not know whether there is any potentially illegal activity for either side to discover, but that they are investigating shows how difficult it will be to reach a compromise. Each side seems to want humiliation and capitulation of the other side. Ego, pride, politics, and contempt for and antipathy towards the other side are playing a large role. 

·       Argentina’s recent announcement that it plans to offer existing bond holders the ability to swap their bonds for ones issued under Argentine law with a different trustee than the Bank of New York Mellon has caused lawyers watching this to question the government’s tactics. (For example, see Anna Gelpern’s posts on this, here and here.) This does not bode well, though, for a compromise. The next President of Argentina may be handed this mess. 

·       There needs to be serious consideration given to finding a different way to settle credit default swaps. Elliot Management is a member of the ISDA Determinations Committee for the Americas, and, even though it has a clear conflict of interest whether or not any funds it manages hold credit default swaps on Argentine government debt, it has not recused itself from voting on issues pertaining to Argentina. I wrote about this in a previous post.

Sunday, August 17, 2014

Some Interesting Articles on the Web (August 17, 2014)

“Acceleration threatens to make Argentina holdout crisis messier.” Reuters article by David Scigliuzzo.

“Last Tango in Buenos Aires.” Article by Rana Foroohar of Time Magazine.

“Hedge Fund Targets Nevada Firms in Argentine Debt Dispute.” Wall Street Journal article by Taos Turner and Santiago PĂ©rez.
“Argentina Defaulted on Bonds No One Can Even Find.” Bloomberg View article by Matt Levine.

“Holders of Argentina eurobonds plan to appeal U.S. court ruling.” Reuters article by Joseph Ax and Daniel Bases.
“Paul Singer's Next Trick Could Make the Argentine Government Way Angrier than the Time He Took its Boat.” Linette Lopez writing for Business Insider website.

“Yen bonds create Argentina CDS auction uncertainty.” Reuters article by  Helen Bartholomew.
“Argentina says will use anti-terror law against U.S. printing firm.” Reuters article.

“The Argentina Rescue Mission Has Failed.” Linette Lopez writing for Business Insider website.
Social Security:

“The case of the missing Social Security data.” A blog post for Market Watch by Alicia Munnell. She criticizes the Social Security trustees’ latest annual report for eliminating a table showing income replacement rates. Currently the director of the Center for Retirement Research at Boston College, Ms. Munnell worked as an Assistant Secretary for Economic Policy at Treasury during the Clinton Administration. The Clinton Administration considered her for a position on the Federal Reserve Board. It was widely thought at the time by those following these sorts of developments that Chairman Greenspan opposed her being on the Board and was successful in keeping her off.
“Turning the tables.” The Buttonwood columnist for The Economist discusses Alicia Munnell’s criticism of the Social Security trustees’ annual report.

“Social Security Could Decide Who Controls Congress.” Amy Weiss-Meyer writing for the New Republic.

“When She Talks, Banks Shudder.” Binyamin Appelbaum article in The New York Times about Anat R. Admati, who teaches finance at Stanford.
“Krugman lunches with Obama.” Dylan Byers writing for Politico. “Others in attendance: Anat Admati of Stanford University, Alan Blinder of Princeton University, Erik Brynjolfsson of the Massachusetts Institute of Technology, and Roland Fryer and Claudia Goldin of Harvard University.”

“Why the Public Library Beats Amazon—for Now.” Wall Street Journal article by Geoffrey A. Fowler.
“The Global Lawyer: Cleary's Litigation Slump.” Michael D. Goldhaber writing for The American Lawyer website.

“Cops Should Be Cops—Not Combat Troops.” John Cassidy article for The New Yorker website.

Tuesday, August 12, 2014

ISDA Committee Discussions on Auction Details to Settle Credit Default Swaps on Argentine Government Debt

The ISDA Determinations Committee may be having difficulty in agreeing on how to set up the auctions to settle outstanding credit default swaps on Argentine government debt. The committee met on Monday with no announcement of the auction details. It will meet again tomorrow. From the ISDA website:
“August 11, 2014: The DC met on Monday August 11, 2014 to discuss the Failure to Pay Credit Event with respect to the Argentine Republic and agreed to convene again on Wednesday August 13, 2014 to continue discussions.”

Update (August 13, 2014). The ISDA Americas Dertimnations Committee has set August 21 as the date of the auction to settle the credit default swaps. There apparently is some uncertainty relating to four yen-denominated notes. See this Reuters article and this from the ISDA website.

Sunday, August 10, 2014

Some Interesting Articles on the Web (August 10, 2014)

“Argentina: Unresolved debts.” Financial Times article by Benedict Mander, Elaine Moore and John Paul Rathbone.

“Argentina’s Griesafault.” Post at Project Syndicate by Joseph E. Stiglitz and Martin Guzman.
“Argentina files legal action against the US at The Hague over debt default.” Reuters article in The Guardian.

“Argentina CDS holders await auction detail.” International Financing Review article by Helen Bartholomew.

The CIA and the Senate Intelligence Committee Report on “Enhanced Interrogation Techniques”:
“C.I.A. Hires Yossarian to Censor Torture Report.” Andrew Rosenthal blog post for The New York Times.

“The Latest Obamacare ‘Glitch’ Isn't a Glitch At All—and It’s Democrats’ Fault.” New Republic article by Brian Beutler.

“Paying Ransoms, Europe Bankrolls Qaeda Terror.” New York Times article by Rukmini Callimachi posted on July 29.
“Inequality Is a Drag.” Paul Krugman column in The New York Times.

“No, America Is Not Turning Libertarian.” Jonathan Chait of New York magazine.
“Obama Is on a Pro-Labor Roll: The president just signed the most important workers’ rights reform of the past 20 years.” Emily Bazelon writing for Slate.

“Washington: Less Red Ink.” A 1983 Milton Friedman article in support of a balanced budget amendment. In this article, he writes that he is more concerned about the level of spending than how it is financed.
“…I have written repeatedly that while I would prefer that the budget be balanced, I would rather have government spend $500 billion and run a deficit of $100 billion than have it spend $800 billion with a balanced budget. It matters greatly how the budget is balanced, whether by cutting spending or by raising taxes.
“In my eyes, the chief merit of the amendment recommended by the Senate Judiciary Committee is precisely that it does limit spending…”
As one listens or participates in debates on “entitlements,” other government spending, and taxes, one should keep in mind what the real issue is for many people, the appropriate role and size of the federal government.

Friday, August 8, 2014

Argentina, Credit Default Swaps, and ISDA

On August 1, the International Swap and Derivatives Association (“ISDADeterminations Committee for the Americas decided that a “Failure to Pay Credit Event [had] occurred with respect to the Argentine Republic.” The vote was unanimous.
Argentina, of course, argues that it has not defaulted, having deposited the funds necessary to pay the interest on its bonds (except those bonds not exchanged in a restructuring held by the “holdouts”) with the trustee bank, the Bank of New York Mellon. It is not Argentina’s fault if BNY Mellon, obeying a federal district judge in New York, has not forwarded the funds to the owners of the bonds. This seems to be  a not entirely ridiculous argument, even if, as it appears, many lawyers specializing in this area consider it to be weak. Of course, the bondholders did not get paid.

Whether or not the ISDA committee was correct in its determination for the purpose of credit default swaps (“CDS”), the committee making the decision could hardly be called neutral and objective. Argentina’s principle legal tormentor, Elliot Management, is on the committee and it did not recuse itself. Whether or not Elliot Management holds CDS on Argentinian government bonds, it is obviously conflicted. (Reuters says according to “sources,” the holdout firms do not have positions in CDS on Argentinian government debt. Argentina is investigating.) The other members of the committee likely have positions on one side or the other in CDS on Argentinian government bonds.
The ISDA committee has yet to announce the specifics of the auction procedures to settle the CDS. These auctions are notoriously complex and few people understand them. The details are important and apparently will be decided by people who represent firms which may be participants.

In my experience at Treasury, I found ISDA to be a very professional organization which hired good staff and had excellent (and no doubt expensive) outside counsel. I do find it strange, though, that the Treasury Department and the various financial regulators have not appeared to question the role of ISDA , which is not a self-regulatory organization overseen by federal government regulators, in  determining whether and how CDS should be settled in the event of a default. While the ISDA committee could well be correct in this case, there are likely to be other credit events in the future where the application of legal definitions is tricky and arguable.
Sometimes it is argued or implicitly assumed that the 2008 financial crisis was due to OTC derivatives. This is of course not the case; the housing bubble and the associated high levels of debt were the main cause. Most types of OTC derivatives had nothing to do with the financial crisis, whatever other problems one might see with these contracts. CDS, though, did contribute to the financial crisis. It concentrated an amount of risk which proved intolerable at one firm, AIG, and CDS were used to construct “synthetic” mortgage securities when the mortgage supply, despite the lending frenzy, was not sufficient to meet the demand for these types of securities, which had tranches that the rating agencies, to their everlasting shame, rated triple A. One would have thought that if there was one market that the regulators would want to examine closely and do something about, it would be the market for CDS. It is striking that the regulators still countenance a situation where a trade association that lobbies Congress, regulators, and whatever Administration is in power continues to make key decisions without oversight about this market through committees composed of conflicted members.   

Wednesday, August 6, 2014

Some Interesting Articles on the Web (August 6, 2014)

Middle East:
“Arab Leaders, Viewing Hamas as Worse Than Israel, Stay Silent.” David D. Kirkpatrick article in The New York Times.

“Anti-Semitism Rises in Europe Amid Israel-Gaza Conflict.” Melissa Eddy article in The New York Times.

“Palestine: The Hatred and the Hope.” David Shulman article in The New York Review of Books.
“The Liberal Zionists.” Jonathan Freedland article in The New York Review of Books.

“Liberal Zionism After Gaza.” Jonathan Freedland article in The New York Review of Books.
“Israeli Pullback Won’t Quell Questions About ‘War Crimes.’” John Cassidy writing for The New Yorker website.


“Where Do We Go Now?” Mark Weidemaier post for Credit Slips.
“The Strange But True Tale Of Argentina’s Debt Mess.” Ken Bensinger writing for BuzzFeed.

“Argentina Debt Dilemma Spotlights Knotted World of Default Swaps.” Abigail Moses writing for Bloomberg Businessweek.
“Argentina’s Default Option.” Felix Salomon article for Slate.

“Argentina launches investigation into holdouts' investments.” Reuters article by Sarah Marsh and Eliana Raszewski. According to the article, sources say the holdouts do not have positions in CDS on government debt of Argentina. Argentina is investigating.

The CIA and the Senate Intelligence Committee Report on “Enhanced Interrogation Techniques”:
“CIA admits it broke into Senate computers; senators call for spy chief’s ouster.” Article by Jonathan S. Landay and Ali Watkins for the McClatchy newspapers.

“Citing redactions, Feinstein delays release of report on CIA interrogations.” McClatchy article by Jonathan S. Landay, Michael Doyle, and David Lightman.

James Brady and Gun Control:
“Why I'm for the Brady Bill.” 1991 article for The New York Times by Ronald Reagan.

“History of gun-control legislation.” From The Washington Post (December 2012).
Chesapeake Bay:

“Distant states seek to disrupt our region’s Chesapeake Bay cleanup plan.” Robert McCartney article for The Washington Post (May 2014).
“As more male bass switch sex, a strange fish story expands.” Washington Post article by Darryl Fears.

“Ted Cruz Punks John Boehner Again, This Time on Immigration.” Jonathan Chait writing for the New York magazine website.

“ICE Said to Seek Mortgage Role Through Talks With Data Service.” Bloomberg article by Matthew Leising, Jesse Hamilton, and Jody Shenn. This might not be a really great business plan. From what I have read, records concerning mortgages and the associated promissory notes are often in sad state and there are still legal issues that are not fully resolved about MERS.
“Republican Climate Policy Keeps Getting Less Intelligent.” Jonathan Chait writing for the New York magazine website.

“Rick Scott, Meet the Politics of Climate Change.” Rebecca Leber writing for the New Republic website.
“House Intel Committee Finds No Benghazi Scandal; Will Boehner Ignore Its Findings?” Ari Rabin-Havt writing for The American Prospect magazine website.

Links to The New York Times editorials on marijuana can be found here.