Issues & Opinions

From Douglas McIntyre:

Stable home prices may be overrated. Every month that there is an artificial barrier that prevents real estate prices from falling faster is a month that the market does not reach rock bottom, and rock bottom prices are what eventually bring buyers into the market. Real estate prices are being destroyed by the current “hundred year storm” in the industry and buyers will find the bargains irresistable, even if mortgages rates are not at a historic low. The government can draw out that process unnecessarily instead of standing aside as it takes it natural course.

The taxpayer will write a check to Fannie Mae and Freddie Mac in the name of keeping real estate prices from falling. That taxpayer might buy a house with his check, but the government is keeping home prices too high.

Everyone (well, some people anyway, the ones who were paying attention, not including those who were playing the game) worried about the clearly-building bubble in the real estate market. Poof! Turns out it was real.

And now, those who should have taken action (Greenspan’s folksy alleged wisdom notwithstanding) are blowing as hard as they can, attempting to reflate the bubble. Marvelous.

In 2004, Stephen Roach was quoted: (Economist)

…the chief economist at Morgan Stanley, has long argued that the Fed is a “serial bubble blower”. Its cheap money is stimulating another round of irrational exuberance. America’s property market certainly looks pricey: the ratio of house prices to incomes is currently at a record high, and about a fifth above its 30-year average.

He was right then, and it’s still true today. Clearly, they’re at it again.

To avoid gloom and doom? Too late – that already occurred, and should have been left, in late 2008, to burn itself out by whatever means necessary. Stretching the pain of the adjustments over the next 30 years is not preferable to allowing the markets to have regained equilibrium on their own.

To assure affordable housing for everyone? As any economist, observer of recent history, or both should be able to point out, the fact that everyone with a pulse was allowed to purchase a home, even when many would clearly have been better served to rent or live with their parents, did nothing but goose the price of real estate to the point where it not only became unaffordable to all those this magical low price was supposed to help, it ALSO cratered the financial system.

Great work, Fed/Treasury (but I repeat myself). Give yourselves a pat on the back. And then get the hell out of the market. You’re killing us.

Bookmark to:

From the AP via James Taranto (“Close Enough for Government Work“):

—– Quote —–
“President Barack Obama’s economic recovery program saved 935 jobs at the Southwest Georgia Community Action Council, an impressive success story for the stimulus plan,” the Associated Press reports.

Hey, great news! Just one little problem: “Only 508 people work there.” The story continues:

The Georgia nonprofit’s inflated job count is among persisting errors in the government’s latest effort to measure the effect of the $787 billion stimulus plan despite White House promises last week that the new data would undergo an “extensive review” to root out errors discovered in an earlier report.

About two-thirds of the 14,506 jobs claimed to be saved under one federal office, the Administration for Children and Families at Health and Human Services, actually weren’t saved at all, according to a review of the latest data by The Associated Press. Instead, that figure includes more than 9,300 existing employees in hundreds of local agencies who received pay raises and benefits and whose jobs weren’t saved.

You read that right: Civil servants got pay raises, and the Obama administration claims credit for “saving” their jobs:

Officials defended the practice of counting raises as saved jobs.
“If I give you a raise, it is going to save a portion of your job,” HHS spokesman Luis Rosero said.

Aren’t you excited to think that these people may soon be in charge of your health care?

—– End Quote —–

One of several possibilities seems obvious here:
1. These guys are idiots
2. These guys think we’re idiots
3. Both

Bookmark to:

Moderately old, but new to me:

Bookmark to:

Where to start?

The short-selling ban that is in place from yesterday through October 2 (or later) is an abomination. Not only is it bad policy in an absolute sense, it’s made worse by the cynical hypocrisy of those who begged for it to be put into place.

It’s one thing for an amiable boob like Patrick Byrne to whine about short-sellers and how they’re killing his company. I’m willing to give Byrne some small measure of benefit of the doubt, since finance isn’t his claim to fame. But when the chairmen of the Federal Reserve and the SEC, along with the former CEO of Goldman Sachs, now Treasury Secretary, start whining out of the same hymn book, they’re not serious, not believable, and are clearly playing to the idiots in the audience.

Short selling, the act of selling shares you don’t own, with the expectation that you’ll be able to buy them back later at a price equal to or lower than the price at which you sold the. Simple, really. And it’s got nothing to do with wanting to harm the company whose shares you’ve sold short. It’s simply an expression of opinion that the shares are overvalued, for one reason or another.

Selling short, then spreading false rumors against a company is an offense for which one can be pursued in a court of law. Funny thing, though – not selling short, then spreading false rumors against a company is also an offense for which one can be pursued in a court of law. If you do the verbal algebra, it becomes clear that selling short has nothing to do with the illegality of false rumors. And the law recognizes this – selling short is, in anything approaching sane regulatory times, not illegal at all.

Selling short can occur for many reasons, in many different contexts. Everyone I’ve read focuses on bets that a stock might or should go down. I’ll go you one better. For instance, to take a random example, let’s just say that the Investment Banking group in Goldman Sachs’ Chicago office were doing a public offering of stock for a client.

Such offerings typically include an underwriter’s option for an additional 15% of the shares being offered as “the green shoe”, to cover overallocations. Since an investment bank typically has no interest, and certainly has no requirement, to be an owner of stock in the companies for which it provides underwriting, if an offering looks successful, and the demand is high enough to make exercising their option for the “green shoe”, the normal action an investment bank takes is to sell short a number of shares equal to the amount of the green shoe, knowing that they’ll be able to replace those shares with the additional 15% for overallocation. If the stock has run up in the aftermath of the offering, better still – they can sell stock that’s more expensive than the offering price, knowing full well that they can replace it at the offering price. But at a minimum, they already know the price at which they can buy the stock in the future, so this isn’t a bet that the stock will go down.

Treasury Secretary Hank Paulson, having been the head of investment banking for Goldman Sachs’ Midwest Region (1983-1988), then managing partner of the Chicago office, followed by co-head of IB for the entire firm, can safely be presumed to know all of this.

Neither SEC Chairman Cox and Fed Chairman Bernanke has any experience in capital markets, but neither of them can assert ignorance of the role that short selling plays in the market.

And who’s been calling loudest for limitations on short selling? The investment banks, solvent and formerly-solvent:

Lehman:

Lehman executives complain that they have been singled out by hedge fund investors that are short selling — or betting against — their stock, and Mr. Fuld has called senior executives at competitor banks demanding that their employees stop criticizing Lehman.

Morgan Stanley:

The mood was far different at Morgan Stanley, which lobbied vigorously for the ban on short selling. The bank’s shares shot up 21 percent, to $27.21, on Friday. Analysts said the reprieve might be only temporary, though, because the firm’s business model still requires a big balance sheet and core base of deposits for financing.

Goldman Sachs:

…the SEC is this afternoon holding a meeting to “determine if they need to take further steps to curtail what both Mac and [Goldman Sachs CEO Lloyd] Blankfein characterize as improper short selling that is really causing damage to the share price of Morgan Stanley and Goldman Sachs.” Blankfein also spoke with Cox to complain of short selling of their stock, as did New York senators Chuck Schumer and Hillary Clinton, according to Gasparino’s sources.

And so on. Fannie Mae, Freddie Mac, Bear Stearns, AIG, and a host of others, all now functionally dead as public companies, claimed loudly, with much gesticulation, that short sellers, not their crappy business models or abysmal risk management, were the reason for the drops in their stock prices.

New York’s AG Andrew Cuomo:

Likening such traders to “looters after a hurricane,” New York Attorney General Andrew Cuomo Thursday said his office is investigating “a significant number” of complaints about improper short selling in shares of Lehman Bros., AIG, Morgan Stanley, Goldman Sachs and other financial stocks.

Cuomo said his investigation would use the New York state Martin Act, which subjects violators to criminal as well as civil penalties, to combat the illegal practices.

“The markets need to be stabilized,” Cuomo said. “And one way to bring about such stability is to root out and deter short-selling that is based on the spread of false information.”

Sorry, Spanky – you left one class of people out: Weather forecasters before a hurricane. Deter short selling based on the spread of false information? Sure – go ahead, although there are already laws in place to do that, so knock yourself out enforcing them, with my blessing and encouragement. Disallow short selling itself, as though there’s no valid reason for a non-rumor-spreading trader to do? Utterly stupid. And impressive only to the self interested (the banks) or ill-educated (all other non-bankers who’ve complained about short selling).

Applauded only by the greedy & ignorant? Must be a great plan, then. I’ll take all this addle-pated nonsense about “gangs of people getting together to sell shares of a stock” seriously when several things also happen:

• The same idiots decide to go after “gangs of people getting together to buy shares of a stock” (Cramer – I’m looking at you and everyone like you).
• Someone explains to me the difference between a short seller selling a share of stock and an actual holder of the stock selling a share of stock. The market neither knows nor cares.
• Which raises the question of what’s next? Disallowing down-ticks entirely? Disallowing any sale of the stocks of the protected 799 alleged-financial companies? Even by widows and orphans who actually hold shares? What is this, the Hotel California?

“Issue Two” (please read that to yourself in John McGlaughlin’s voice, for best effect)
Read the rest of this story »

Bookmark to:

In a post yesterday, (just below), I mentioned the difficulties in the Pakistani stock market, and the related destruction at the Karachi stock exchange. I contrasted, in a brief and cursory manner, the market there (and the reaction to its fall) to the market here in the US (and the general lack of reaction to its fall).

I also asserted that most of the tools available to the Pakistani government for reacting to the problem are available in other markets, and that they generally don’t work, because they don’t actually address the problems, instead focusing on the symptoms.

Finally, I mentioned in passing that the solution that seems most likely to help resolve matters can be found in monetary policy. It’s the one that everyone has avoided, though they surely have thought of it. Fed chairman Bernanke has begun nibbling around the edges of monetary policy, but may not, based on recent past history, be able to pull the trigger on any actual implementation – huffing and puffing that you really dislike inflation isn’t the same as, say, Paul Volcker (with the full support of Ronald Reagan, and not caring at all what Wall Street wanted) jacking interest rates to the moon and killing inflation dead.

Monetary policy is a complex subject, and one at which I’d hardly claim to be an expert. The meat and potatoes are simple – make money too easy to borrow and people will treat it cheaply, spend it too easily, and invest carelessly (think “drunken sailors”). Result? A debased and devalued currency. Follow that with a commodities supply/demand crunch, and the devaluation of a currency can spiral, as crucial commodities, priced in dollars, increase in price due to the decreases in the real value of the dollar, encouraging (if the Fed is gutless enough) further loosening of credit, further real devaluation of the currency (now itself effectively valued in “barrels of oil”, “tons of iron”, “Euros”, &c).

Silly “stimulus checks”, of the sort pushed by Congress this year and shamefully not vetoed by Mr. Bush, had a one-time effect on spending, which makes sense – they were a one-time return of tax dollars, disproportionate to actual taxes paid, and could reasonably be expected by anyone with a memory extending longer than six months ago to have had precisely the anemic and worthless effect that they did. Undaunted, Speaker Nancy Pelosi thinks (or at least claims to think) that all we need is $50 billion more in such stimulus. Which proves at a minimum only that her memory extends even less into the past that the rest of the nitwits who voted for the somewhat politically astute, but utterly economically absurd notion of the initial stimulus.

Politically astute – why only “somewhat”? Because one-time stimulus is politically astute only if one is trying to impress those who lack mental acuity. On one view of how we might measure such a thing, elementary statistics, something close to 50% of all people have less than average intelligence. Or, as George Carlin put it:

Think of how stupid the average person is, and realize half of them are stupider than that.

Of course that one-time stimulus seems helpful, at the time, and if you don’t think too deeply about it, to have someone handing out money. Better yet if it’s someone else’s money. And if it’s done in a crafty enough way, those same people who don’t think deep thoughts might be gulled into missing the realization that if the money’s better in our hands than the government’s during these current difficulties, why not every year?

But enough of that – I could go on in (small) circles about monetary policy, but have already devolved into fiscal and tax policy, so to keep this from turning into more of a rant than it already is, I’d like to tie this post back to the one from yesterday, and I have found the perfect foil with which to do so.

In an article in the Saturday July 19, 2008 Wall Street Journal, the always-readable James Grant, of Grant’s Interest Rate Observer asks “Why No Outrage?” (subhead: “Through history, outrageous financial behavior has been met with outrage. But today Wall Street’s damaging recklessness has been met with near-silence, from a too-tolerant populace”)

No, he’s not suggesting that we man the barricades, pitchforks in hand, Molotov cocktails at the ready. But he does make the easy case that things haven’t worked out as well as hoped in our current system of carrots, sticks, checks, and balances.

“Raise less corn and more hell,” Mary Elizabeth Lease harangued Kansas farmers during America’s Populist era, but no such voice cries out today. America’s 21st-century financial victims make no protest against the Federal Reserve’s policy of showering dollars on the people who would seem to need them least.

Long ago and far away, a brilliant man of letters floated an idea. To stop a financial panic cold, he proposed, a central bank should lend freely, though at a high rate of interest. Nonsense, countered a certain hard-headed commercial banker. Such a policy would only instigate more crises by egging on lenders and borrowers to take more risks. The commercial banker wrote clumsily, the man of letters fluently. It was no contest.

The doctrine of activist central banking owes much to its progenitor, the Victorian genius Walter Bagehot. But Bagehot might not recognize his own idea in practice today. Late in the spring of 2007, American banks paid an average of 4.35% on three-month certificates of deposit. Then came the mortgage mess, and the Fed’s crash program of interest-rate therapy. Today, a three-month CD yields just 2.65%, or little more than half the measured rate of inflation. It wasn’t the nation’s small savers who brought down Bear Stearns, or tried to fob off subprime mortgages as “triple-A.” Yet it’s the savers who took a pay cut — and the savers who, today, in the heat of a presidential election year, are holding their tongues.

Possibly, there aren’t enough thrifty voters in the 50 states to constitute a respectable quorum. But what about the rest of us, the uncounted improvident? Have we, too, not suffered at the hands of what used to be called The Interests? Have the stewards of other people’s money not made a hash of high finance? Did they not enrich themselves in boom times, only to pass the cup to us, the taxpayers, in the bust? Where is the people’s wrath?

(continues)

No calls for violence there, no stoning or burning either. But he does wonder why people just accept this asinine state of affairs.

So do I.

Half-baked solutions, designed to appeal only to the stupid, will not solve the problem, and will actively and quickly make it worse. Freely available money, ala Bagehot, but at near-punitively high interest rates, can make it possible for the blockages in our financial system to work themselves out.

The alternative, where the Fed (and the implicit “Bernanke Put“, and let’s not forget the “Greenspan Put“, either) continues to think that Wall Street is more important than Main Street, hasn’t worked and won’t. (Candidate Obama has used that Wall Street/Main Street formulation in his stump speeches; the difference between his use and mine might be that I actually understand what it means, and why it’s a crucial failure in our system).

It’s probably best that I’ve never been a combat medic, because I think that a quick bleed, with full understanding of where the blood is likely to gush, is preferable to a five year drip, or worse, a five year internal bleed of reasonably knowable but still-indeterminate origin.

And if that bleed (the quick gusher) occurs on Wall Street, then so be it. Chasing the dollar down to $250 per barrel of oil/$250 per metric ton of iron ore/$0.25 per Euro seems hardly worth it, when the sole reason for doing so is to continue the pretense that what’s good for Wall Street is good for America.

The rot’s got to stop before the economy can properly heal. Half-measures will continue not to do.

See also:
   WSJ – Stupidity and the State, and Stupidity and the State, Part II
   NYT – Given a Shovel, Americans Dig Deeper Into Debt

Bookmark to:

From Bloomberg, dated yesterday (first seen in this morning’s WSJ – Breakingviews column):

Nov. 5 (Bloomberg) — Gisele Bundchen wants to remain the world’s richest model and is insisting that she be paid in almost any currency but the U.S. dollar.

Or perhaps not – the story might be apocryphal, and even contains its own counterargument:

“Contracts starting now are more attractive in euros because we don’t know what will happen to the dollar,” Patricia Bundchen, the model’s twin sister and manager in Brazil, said in a telephone interview in September from Sao Paulo. She declined to discuss details of the arrangements last week.

No shock, that. The question is, how long it remains true.

“Gisele has contracts in dollars,” said Anne Nelson, Bundchen’s agent in New York at IMG Models, in an interview today. “When she works in Europe she gets paid in euros, when she works in the U.S. she gets paid in dollars, when she works in Brazil she gets paid in reais, and so on and so forth.”

Also self-evident. And it goes without saying that, in a world of fixed exchange rates (which, with few exceptions, doesn’t exist now and hasn’t for years), she could choose to simply do the math, and get her desired real pay rate at whatever nominal rate & currency she chose.

The fact that she or her IMG handler is reported to have decided to denominate pay in a currency other than dollars, presumably for future contracts, brings to mind the market mania of early this century, when people actually thought tech stocks would stay high forever.

Read the rest of the Bloomberg piece, by the way – it provides far more detail than did the Breakingviews column (due to format and space availability differences, I’m sure), and goes well beyond the only-moderately interesting fact of Gisele Bundchen’s purported payment preferences.

Bookmark to:

I can’t be certain, since I didn’t read Wednesday’s LA Times, NY Times, or Financial Times, but based at least on tangentially related articles in WSJ and the UK Telegraph, there’s a rumble in the markets about cheap consumer debt, and the ill effects thereof.

First came the WSJ story, “DAY OF RECKONING – ‘Subprime’ Aftermath: Losing the Family Home“.

Mortgages Bolstered Detroit’s Middle Class — Until Money Ran Out

By MARK WHITEHOUSE
May 30, 2007; Page A1

DETROIT — For decades, the 5100 block of West Outer Drive in Detroit has been a model of middle-class home ownership, part of an urban enclave of well-kept Colonial residences and manicured lawns. But on a recent spring day, locals saw something disturbing: dandelions growing wild on several properties.

Ouch. It’s a long story, well worth a read if you haven’t seen it (and you’ve got a WSJ online subscription).

The Telegraph story, in tomorrow morning’s edition, is entitled “A million debtors face court action“. It’s specific to the British market, and isn’t directly related to subprime mortgages, but does involve easy credit:

Up to a million households struggling with rising living costs and lured by offers of easy credit will face court action over their debts this year.

Easy credit, generally described, can be laid at the doorstep of banks trying too hard to put money to work, saturating the market in good credit risks, and forcing a need to move down-market to the riskier borrowers. It happens in cycles, is specific to the banking and credit card industry, and, aside from central bank interest rate target setting, tends not to be driven by government attempts to help broaden the credit base. The same problem, of course, exists at times (including now) in the US.

Where the US credit problem, typified by Detroit in the WSJ story, differs is that it’s not the banks and credit card companies driving the train. They’re involved, of course, but the prime drivers have been mortgage brokers (the 21st century version of used car salesmen?), Wall Street, and the federal government. No, it’s not been the Federal Reserve’s interest rate setting mechanism in this case, but instead the well-intentioned efforts to ensure that credit is more widely available, particularly for home purchases:

Back in its heyday, the idea that West Outer Drive could suffer from a glut of credit would have seemed far-fetched. Many blacks moving into the neighborhood had to either depend on federal mortgage programs or buy their homes outright. That’s because banks actively avoided lending to them, a practice known as “redlining” — a reference to maps that designated certain neighborhoods as unduly risky. Various attempts to get the money to flow, such as the Community Reinvestment Act of 1977, which pushed banks to do more lending in the communities where they operated, had only a limited effect.

Bank charters, and particularly those of banks seeking to merge or sell themselves to larger banks, have periodically been tied up in state and federal oversight, with one of the exits from that maze being commitments to increase their home community lending. All well and good.

Where does Wall Street come into the picture?

But beginning in the mid-1990s, the evolution of subprime lending from a local niche business to a global market drastically rearranged lenders’ incentives. Instead of putting their own money at risk, mortgage lenders began reselling loans at a profit to Wall Street banks. The bankers, in turn, transformed a large chunk of the subprime loans into highly rated securities, which attracted investors from all over the world by paying a better return than other securities with the same rating. The investors cared much more about the broader qualities of the securities — things like the average credit score and overall geographic distribution — than exactly where and to whom the loans were being made.

There are many good reasons for consolidating loans into securities, not least of which is the ability, just as insurance companies do, to pool risk and manage it via a larger sample by statistical means. The fact that a market has evolved and matured to facilitate that is utterly unsurprising. The fact that sleazy mortgage brokers have seized on that market to essentially steal from unsuspecting or unsophisticated borrowers is equally unsurprising, and deeply unsettling to any right-thinking person.

Given the broad expanse of mortgage brokers who’ve hit the market in the past seven years, many feeding on borrowers’ silly belief that home prices would continue to rise to the skies, the benefits of homeownership have been overtaken, particularly in the imaginations of subprime borrowers, by visions of massive capital gains. And with those potential (now highly unlikely) gains in mind, people have rushed into debts they would never have incurred in leaner banking times.

Several vignettes from the WSJ story that don’t flatter the mortgage brokers:

Minority-dominated communities attracted more than their fair share of subprime loans, which carry higher interest rates than traditional mortgages. A 2006 study by the Center for Responsible Lending found that African-Americans were between 6% and 29% more likely to get higher-rate loans than white borrowers with the same credit quality.

Is that redlining? An argument can be made that it’s not. Not a good argument, but an argument.

“A lot of people were steered into subprime loans because of the area they were in, even though they could have qualified for something better,” says John Bettis, president of broker Urban Mortgage in Detroit. He says a broker’s commission on a $100,000 subprime loan could easily reach $5,000, while the commission on a similar prime loan typically wouldn’t exceed $3,000.

That extra 66% commission? From selling initially attractive mortgage rates that soon became quite ugly. Like this one:

April Williams was feeling the pain of the downturn back in 2002, when she saw an ad from subprime lender World Wide Financial Services Inc. offering cash to solve her financial problems. …after a loan officer from World Wide paid a visit, they became convinced they could afford stainless-steel appliances, custom tile, a new bay window, and central air-conditioning — and a $195,500 loan to retire their old mortgage and pay for the improvements. The loan carried an interest rate of 9.75% for the first two years, then a “margin” of 9.125 percentage points over the benchmark short-term rate at which banks lend money to each other — known as the London interbank offered rate, or Libor. The average subprime loan charges a margin of about 6.5% over six-month Libor, which as of Tuesday stood at 5.38%.

“I knew better than to be stupid like that,” she says. “But they caught me at a time when I was down.”

(ellipsis and emphasis mine)

Of course she knew better, but she was borrowing in an environment that seemed to encourage hucksters and dirtballs to actively seek out people in her position. And she was hardly the only one:

Raymond Dixon, a 36-year-old with his own business installing security systems, borrowed $180,000 from Fremont Investment & Loan in 2004 to buy a first home for himself, his wife and six children, across the street from Ms. Hollifield at 5151 West Outer Drive. After all the papers had been signed, he says, he realized that he had paid more than $20,000 to the broker and other go-betweens. “They took us for a ride,” he says.

Good grief. Sure, he got taken for a ride, and he should have known better, but what ever happened to the protections that are supposed to be built into the system to keep people from rushing into bad deals? That $20,000 for the broker and the go-betweens? It was based on the juice available when the interest rate reset and Dixon’s monthly mortgage payment went up by 33%.

But the other structural problem in the market is summarized here:

“You have no time to look really deeply at every single borrower,” says Michael Thiemann, chief investment officer at Collineo Asset Management GmbH, a Dortmund, Germany-based firm that invests on behalf of European banks and insurance companies. “You’re looking at statistical distributions.”

It’s possible to offer too much separation between lenders and risk, to the point where the lenders can rely on statistics, rather than reality, to comfort themselves that they’ve done well. And where the statistics tell untruths is in cases like West Outer Drive, where:

Subprime mortgages accounted for more than half of all loans made from 2002 though 2006 in the 48235 ZIP Code, which includes the 5100 block of West Outer Drive, according to estimates from First American LoanPerformance. Over that period, the total volume of subprime lending in the ZIP Code amounted to more than half a billion dollars — mostly in the form of adjustable-rate mortgages, the payments on which are fixed for an initial period then rise and fall with short-term interest rates.

That’s the other side of the coin, and the counterargument to whether redlining is occurring when “African-Americans are 6% and 29% more likely to get higher-rate loans”. When a neighborhood like West Outer Drive is inundated with homeowners who’ve been flatly taken advantage of by mortgage brokers who are unchecked by the financing system, the good risks get mixed in with the results of the bad, and the good risks become bad risks themselves, just due to neighborhood deterioration. Improperly managed, synonymous in my mind with “managed with far too many levels of indirection between borrower, property, and lender”, pockets of default risk can be found in any securitized mortgage pool. Mix the good with the bad and the mortgage pool can come out unscathed. Not so the neighborhoods with clustered risk that doesn’t register in the larger statistical picture of the mortgage pool.

The Basel Capital Accord of 1988, designed to manage risk in the global banking system, has been the subject of much debate since then. Among the many suggestions for change over the years, you could find many titles, such as “Reforming Bank Capital Regulation: Using Subordinated Debt to Enhance Market and Supervisory Discipline“. The key to such regulatory changes is simple – it ensures that a noteworthy chunk of a bank’s capital comes in a form that invites far closer scrutiny, from more sophisticated investors who have the power to shut a bank down if its operations seem to be spinning out of risk control.

If such a think makes sense for the banking system (and it does), it hardly seems rational to exempt the mortgage market from some strictures that would force its participants to be far more cognizant of the riskiness, and clustered risks, of its borrowers. Too much indirection in risk concern, let alone risk control, can have severe effects on neighborhoods, cities (Detroit needs all the help it can get), and social classes. I’m all for free markets and the ability to parcel out risk to willing buyers, but without any recourse to the ultimate purveyors of these poisoned dreams of homeownership (the mortgage brokers), the risk that’s being sold off into the mortgage pools is only imagined to be all the risk that really exists.

Why should regulation be considered to seriously crack down on the abuses? Because we’ve seen what happens when Detroit is in flames, including every Halloween. Left unchecked, this issue could become one in which the federal government is forced, politically, to step in and bail out those who’ve been fleeced. I shudder to think of the cost of that, political and financial, even though doing so seems more justified than spending billions to turn New Orleans back into something it never was.

Addendum – And no, rising Treasury yields aren’t going to be enough to solve the problem.

Bookmark to:

In a Houston Chronicle (AP) story from yesterday evening that I initially missed, I find that the “House approves anti-OPEC bill“.

WASHINGTON — Decrying near-record high gasoline prices, the House voted Tuesday to allow the government to sue OPEC over oil production quotas.

The White House objected, saying that might disrupt supplies and lead to even higher costs at the pump. The Organization of Petroleum Exporting Countries is the cartel that accounts for 40 percent of the world’s oil production.

My reaction wouldn’t be much different if they’d deigned to “allow the government to give every citizen a unicorn”.

The current, nominally “record high”, prices at the pump are a populist’s dream come true. They provide a platform from which our congressmen can cater to the least-intelligent of their constituents, those who think Congress can solve all problems.

“We don’t have to stand by and watch OPEC dictate the price of gas,” Judiciary Committee Chairman John Conyers, D-Mich., the bill’s chief sponsor, declared, reflecting the frustration lawmakers have felt over their inability to address people’s worries about high summer fuel costs.

Actually, John, yes you do have to stand by and watch, because it’s their oil, and they control both the price and the market availability of the basic commodity from which we get our gasoline.

Conyers accused the OPEC engaging in a “price fixing conspiracy” that has “unfairly driven up the price” of crude oil and, in turn gasoline.

His measure would change antitrust laws so that the Justice Department can sue OPEC member countries for price-fixing, and would remove the immunity given a sovereign state against such lawsuits.

OPEC is often referred to by its common name. No, not “The Organization of the Petroleum Exporting Countries”, the other one – “The OPEC cartel”. Here, from Chapter 1, Article 2 of the OPEC charter:

A. The principal aim of the Organization shall be the co-ordination and unification of the petroleum policies of Member Countries and the determination of the best means for safeguarding their interests, individually and collectively.

B. The Organization shall devise ways and means of ensuring the stabilization of prices in international oil markets with a view to eliminating harmful and unnecessary fluctuations.

C. Due regard shall be given at all times to the interests of the producing nations and to the necessity of securing a steady income to the producing countries; an efficient, economic and regular supply of petroleum to consuming nations; and a fair return on their capital to those investing in the petroleum industry.

Sure, they mention, in passing, the “economic and regular supply” for consuming nations, but their prime purpose for existence is to ensure their own well being. And everyone, with the exception of those impressed by this symbolic populism in Congress, knows this. The situational congressional populists themselves even know it.

I was initially left wondering what jurisdiction the US Congress and court system has on this matter. There isn’t an international law of which I’m aware that forbids cartels, even those which blatantly (and transparently, in OPEC’s case) seek to control price via production changes.

Consider as a case study in extraterritorial law enforcement the divergence between US laws on bribery (verboten) and those elsewhere outside the OECD (winked at in some places, positively ingrained in the social fabric in some others). Solution? Easy – the Foreign Corrupt Practices Act (as extended in 1988 and amended in 1998) attempts, and largely succeeds, to ensure that US persons and issuers of joint stock cannot pay (and therefore, presumably, can’t be forced to pay) bribes outside the US.

But applying such reverse judo to those within the US whose business involves transactions with OPEC isn’t so simple. If the government were to try clamping down on the buyers of OPEC oil, it would crush the US & world economies, long before it motivated change on the part of OPEC. It would likely be a massive failure, even as it separately had the desired effect. And perhaps worse, if OPEC blinked, and Congress’ effort didn’t fail, how would the US be any better than Hugo Chavez, another well known expropriator of others’ property?

Changing antitrust laws probably seemed like a great idea, until one realizes that the targets of such legal maneuvers are not subject to US law, being themselves sovereign states. So Conyers took it a step further, proposing the removal of sovereign immunity in an attempt to extend US law internationally. This is clearly bad policy, as the administration points out,

…because such suits could spawn retaliatory measures and lead to oil supply disruptions and an escalation in the price of gasoline, natural gas, home heating oil.

Just what we need – more oil supply disruptions, and the price eruptions that go with them. Thanks, Mr. Conyers! Assuming the Senate is equally so ill-advised as to attempt economic alchemy, Bush will surely pull out his veto sword for the third, count ‘em, third time. Won’t he?

In that same article, there was a vague hint of light near the end:

“Increased crude oil prices have played a relatively minor role in (the recent) increase in retail prices,” William Kovacic, a member of the Federal Trade Commission, told Stupak’s subcommittee. He said the price of benchmark West Texas crude increased no more than 15 cents a gallon over the last three months, while retail gas prices jumped 80 cents to 90 cents a gallon, depending on location.

But it was quickly overwhelmed by the acrid smoke of more economic illiteracy from Rep. Bart Stupak, of Michigan:

“Big Oil is often quick to blame world crude oil prices, but that argument doesn’t appear to be the full story,” said Stupak.

“While consumers pay record prices, oil companies are making record profits,” said Stupak. Refinery profits have jumped sharply to as much as 70 cents for every gallon of gasoline produced, he said.

No kidding? He’s saying that crude oil prices don’t appear to be the full story? Of course they’re not – once the oil is extracted, it has to be turned into gasoline and other byproducts. “Big Oil” knows this, just as Stupak does. And the economics behind that aren’t linearly related to the price of the inputs. Supply and demand play a huge part, and the availability of refinery capacity hasn’t exactly been steady this year. As an example, see the Reuters story from last Thursday, entitled “Oil surges to $70 on U.S. gasoline concerns“.

Despite record gasoline pump prices above $3 a gallon, there has been no let up in robust demand in the world’s top consumer.

That increase in demand, particularly in advance of the “summer driving season” starting Memorial Day weekend, coupled with refinery and pipeline disruptions is easy to pinpoint as the main driver in gas prices. (How that would drive the price of oil up escapes me just now, but if I’m eventually able to attribute rational basis to the Reuters headline writer, I’ll make an addendum to this piece.) If supply of refinery capacity increased along with the demand, price would stay steady, given steady input pricing.

But over the last 10 years, according to the US Energy Information Agency, refining capacity has increased from 15.6 million BPD in March 1997 to 17.5 million BPD in February 2007. That’s roughly 1.1% per year, and has come without the completed construction of a single new refinery in more than 30 years, relying instead on capacity upgrades at existing facilities, and even then at a rate too low to keep up with demand growth. Why? The cost of upgrades, let alone brand new plant, is out of control. From an Apache Corp report in March, 2007:

Many refiners now express reluctance to invest in expensive upgrades. Bruce Smith, Tesoro’s chief executive officer, noted recently that industrial development in India and China have forced materials costs (such as steel) upward, which in turn has pushed refinery construction costs higher. In some instances, costs have doubled from original bids.

While the latest figures as of this writing available at the DOE are for 2004, even then the daily demand for distilled oil products exceeded 20 million BPD. Stupak’s not alone in thinking the market’s rigged – the San Francisco Chronicle’s March 9 2007 story, “Refinery profit margins double in West“, tried hard to make the case that refiners in CA and elsewhere were “pulling an Enron”, by withholding supply in order to increase prices. Read the entire article, however, and both the refiners and the California Energy Commission make clear that there’s no incentive for them to do so.

So, among many factors, there’s your problem, Messrs Conyers and Stupak. Why not just force the US refiners to build even more capacity? Or force those greedy souls in China and India to quit competing for commodities that refiners need in order to build refineries affordably? Doing either would make precisely as much sense as pretending to force OPEC to quit being OPEC.

Bookmark to:

Who knew that trail mix was cheaper than corn? Not me, at least not until this morning’s WSJ article entitled “With Corn Prices Rising, Pigs Switch To Fatty Snacks“.

GARLAND, N.C. — When Alfred Smith’s hogs eat trail mix, they usually shun the Brazil nuts.

“Pigs can be picky eaters,” Mr. Smith says, scooping a handful of banana chips, yogurt-covered raisins, dried papaya and cashews from one of the 12 one-ton boxes in his shed. Generally, he says, “they like the sweet stuff.”

Mr. Smith is just happy his pigs aren’t eating him out of house and home. Growing demand for corn-based ethanol, a biofuel that has surged in popularity over the past year, has pushed up the price of corn, Mr. Smith’s main feed, to near-record levels.

…

Mr. Smith says he’s paying about $63 to feed a single pig for five or six months before it goes to market — up 13% from last year. His costs would be even higher if he didn’t augment his feed with trail mix, which he says helps him save on average about $8 a ton on feed.

(ellipsis mine)

The presumption that corn-based ethanol was somehow going to be a great net-positive for the US economy has always been based on the thinnest of pretense, put forward by the farm lobby in the US. As covered in an earlier post here (regarding Michael Bloomberg’s energy plan), corn is just about the stupidest way to make ethanol, perhaps second only to making ethanol out of oil itself, if such a thing is even possible.

And even if it were technically wise to do so, the mad rush to corn-based ethanol, driven by government mandates and subsidies that help nobody but the farm lobby, was always going to affect the supply/demand curve for corn.

Better late than never, there appears to be a sudden realization of the problem, if recent press mentions count for anything:

• LA Times (via Truth About Trade) –
     Why ethanol backfires
• Food USA –
     Expanding US ethanol market provokes food price surge
• From the investing world, Seeking Alpha –
     Taking Stock in Ethanol: Risks, Challenges and Opportunities
• Pork Magazine (really) –
     Ethanol Industry Needs to Look Beyond Corn
• Rochester (NY) Democrat and Chronicle –
     U.S. should buy cane-based ethanol from Brazil
• Spero News –
     Expert says Brazil could meet world’s gas needs

The items above are cherry-picked from among many, many other such recent stories. The last two are of a genre that puts the lie to the entire boondoggle being foisted onto the American consumer, particularly given that cane-based ethanol actually generates far more energy than it takes to produce, unlike corn-based ethanol. Cane-based suffers, however, from the choke-hold the farm lobby continues to wield on the American legislative windpipe.

Much the same as, say, in the waste industry, where at a high enough price for landfill space, people are willing to recycle, prices for oil in the energy market can cause people to willingly overpay for alternatives. But when the costs of the alternatives, direct and indirect, become high enough, as they appear to be doing in the ethanol market, consumers are certain to rethink that entire “energy independence” thing.

Corn based ethanol is “ethanol done wrong”. Add to that the fact that it’s “ethanol done expensive”, and you can just wait for the increased backlash, attempting to drown out the farm lobby. The question, of course, is whether our legislative overlords will be allowed to listen and undo the damage they’ve done over the past twenty years on this front.

A final tidbit from the WSJ piece:

Dwight Hess, a cattle feedlot operator in Marietta, Pa., is located in the heart of snack country, near Hershey and Herr Foods Inc., a maker of potato chips, pretzels and snack mixes. His cattle ration consists of about 17% “candy meal,” a blend of chocolate bars and large chunks of chocolate; 3% of what he calls “party mix,” a blend of popcorn, pretzels, potato chips and cheese curls; 8% corn gluten; and the remainder corn and barley he grows. He says the byproducts save him about 10% on feed costs. Still, it costs him about 65 cents to put a pound on a steer, up from 42 cents last year.

Near the Snake River in Idaho, Cevin Jones of Intermountain Beef is struggling to feed his 12,000 cattle in light of higher feed costs. Traditionally, he has used up to 30% corn or other grains in his feed mix. This year he’s using 100% byproducts, including french fries, Tater Tots and potato peels.

“It’s kind of funny,” Mr. Jones says, “every once in a while, you can spot a couple of cattle fighting over a whole potato.”

I suppose that soon, my family too will be able to eat junk food more cheaply than grains. I’m not looking forward to that, and I have something like 2% of the US population (plus 80% of the legislature) to thank for that sad fact.

See also – “Corn Too Expensive? Turn Pigs into Ethanol“

Bookmark to:

Friday evening, Reuters had a short story entitled “New York mayor goes to Texas, outlines energy plan“. In it, New York Mayor Michael Bloomberg had yet another chance to claim he’s not running in the 2008 presidential campaign.

And of course he isn’t. However, barring some true oddity, I think he will be, before the end of June.

Why? Well, that’s the easy part – nobody in Texas, at least nobody I know in Texas, was dying to hear the Mayor’s view of the nation’s energy plan. Because he knows nothing about it? Hardly – I’m sure he’s given it a good bit of thought, and he appears to have some interesting ideas, among the less practical ones. Because he has precisely zero control over it, including his lack of a bully pulpit from which to influence policy credibly on the matter, he has no national platform, as NYC Mayor, from which to insist his views be considered.

His Houston visit was politicking, pure and simple. Of course, he’s a politician, and that’s what politicians do. Except for Michael Bloomberg, that is. His Honor spent the entirety of his first term and the bulk, so far, of his second staying singularly focused on the needs of the voters who put him into office. Within the remit of his New York duties, he’s even proposed energy, conservation, and environmental policies that are quite far-reaching. From an April 26 story in The Economist:

…the mayor, Michael Bloomberg, has turned deficits into surpluses. He has also managed to make New Yorkers live healthier lives, banning smoking and trans-fats. Now, he has set his sights on the city’s long-term sustainability.
…
The mayor is proposing 127 new initiatives dealing with land, air, water, energy and transport. His proposals include introducing molluscs into the city’s waterways as natural bio-filters, adding bicycle lanes and hastening the cleaning and rezoning of 7,600 acres (3,100 hectares) of contaminated land.
…
Some of his provisions are even more ambitious. He plans to cut the city’s greenhouse gas emissions by 30% in part by improving the efficiency of power plants. To pay for this, a $2.50 monthly surcharge will go on electricity bills. He argues that by spending $30 a year until 2015, every household will save $240 a year after that. This bid for energy conservation would be the broadest attack on climate change ever undertaken by an American city.

(ellipses mine)

Serious stuff, in other words. However, it’s stuff that, New York City being what it is, can be implemented in New York City without needing validation or support from elsewhere in the US. Therefore, his newfound focus on opinionating, in Houston as well as what I presume will be future national venues, would seem to have nothing to do with his ambitious plans for his own city.

And there’s nothing wrong with that, I’d add. Contradictions between what he says and what he appears to be doing aren’t my point here, not least because I see no contradictions. Let’s look at what he’s said on the matter of his supposed candidacy, from the Reuters article:

“I’ve said repeatedly I am not a candidate for president of the United States. I plan to serve out my 965 days left to go” as mayor, he said at a press conference after his speech

“I am not” clearly isn’t the same as “I will not be”, and of course he plans to serve out his remaining 965 days (from May 11, 2007) as mayor, because he hasn’t formally started a run for, and has no guarantee of achieving, the nomination of his party for president in 2008.

So, since this isn’t an epistle about his (imaginary) squishiness regarding his plans for higher political office, what is it? Two things, actually.

First, an armchair critique of his energy plan, which plan is also summarized in the Reuters piece:

His proposals, offered up at the center of the nation’s energy industry, included increased offshore drilling for oil and gas and the construction of more nuclear plants.

He also pushed for development of more wind power and for government to encourage investment in clean energy sources.

Bloomberg said current federal ethanol policies made little sense because they promote production of corn-based ethanol over the more efficient sugar-based fuel.

He also threw out increases in government-mandate fuel efficiency standards, and the alternative of fluorescent bulbs over incandescent, stating that:

“If we do, Americans would save 120 million tons of carbon dioxide emissions and $14 billion every year,” he said.

Which could be true, I guess, even though I don’t know whether he attributes those savings to the bulb change, the CAFE change, or both. No quibble here with the ideas, at least.

Of his other plans, increased offshore drilling for oil and gas and the construction of more nuclear power plants seem to make good sense, to the extent they’re coupled with reasonable attempts to become more energy efficient in addition to becoming more energy self-sufficient.

His thoughts on ethanol are great, as far as they go – focusing on sugar-based ethanol production as opposed to corn-based is an excellent choice, for several reasons. Sugar can be turned into ethanol far more efficiently, and shifting emphasis to sugar would go a long way toward opening up some of the grotesquely protected agricultural markets in the US. As covered in the May 10 Economist story “Insatiable”, the currently planned renewal of the farm bill, a once-every-five-years affirmation of welfare for farmers, the supports envisioned for “corn, wheat, rice and other favored crops” are slated to drop from $7.5 billion all the way down to $7 billion. Big deal. This is in addition to “just under $44 billion a year on other kinds of subsidies to poor farmers, including food stamps, school lunches and so forth”, for which no meaningful changes are planned.

That’s only part of the trouble, though – in addition to price supports, the government, at the behest of US farm conglomerates, maintains punishing tariffs on sugar imports, which limits the impact of one of Brazil’s best exports on the US market. From the April 12 Economist Survey of Brazil:

The showcase is ethanol. Brazil’s variety, based on sugar cane, is cheaper than anyone else’s and has encouraged a lot of innovation beyond the basic commodity. “With biofuels we’re suddenly at the forefront,” says Fernando Reinach of Votorantim Novos Negócios, which runs a venture-capital fund that invests in ethanol technology.

Contrast this with US, primarily corn-based, ethanol products, also via The Economist, on April 4:

Farmers love it because it provides a new source of subsidy. Hawks love it because it offers the possibility that America may wean itself off Middle Eastern oil. The automotive industry loves it, because it reckons that switching to a green fuel will take the global-warming heat off cars. The oil industry loves it because the use of ethanol as a fuel additive means it is business as usual, at least for the time being. Politicians love it because by subsidising it they can please all those constituencies. Taxpayers seem not to have noticed that they are footing the bill.

But corn-based ethanol, the sort produced in America, is neither cheap nor green. It requires almost as much energy to produce (more, say some studies) as it releases when it is burned. And the subsidies on it cost taxpayers, according to the International Institute for Sustainable Development, somewhere between $5.5 billion and $7.3 billion a year.

Ethanol made from sugar cane, by contrast, is good. It produces far more energy than is needed to grow it, and Brazil—the main producer of sugar ethanol—has plenty of land available on which to grow sugar without necessarily reducing food production or encroaching on rainforests. Other developing countries with tropical climates, such as India, the Philippines and even Cuba, could prosper by producing sugar ethanol and selling it to rich Americans to fuel their cars.

Long story made only slightly longer, focusing a bit on sugar-based ethanol seems like a half-measure. Focusing a lot on it, by increasing its use in US ethanol production, reducing subsidies for corn-based ethanol, and fully opening the incoming market for sugar-based product would be a full measure that made solid sense. Doing all that, plus focusing on cellulosic ethanol, made from wood, shrubs, and agricultural waste, would be like hitting the trifecta.

His other mildly objectionable idea is that of having the government “encourage investment in clean energy sources”, which has had dubious knock-on effects in both the past and present, using the current corn-based ethanol craze as one of many examples.

Overall, his energy plan probably rates a solid B, if not a B+.

The other purpose for this now-longer-than-planned screed is to wonder whether both Mr. Bloomberg and the voting public wouldn’t be well served by a bit of political Mau Mau.

Picture this: Bloomberg is a Republican in name only, and no, I’m not using that term in a derogatory fashion. Back when he was a Democrat, to the best of my knowledge, he could adequately have been described as a Democrat in name only, too.

He’s a capable politician, and a capable executive in charge of a large and complex polity. (Please ignore, for the purpose of this analysis, his nannyish actions on smoking and trans-fats, well-intentioned as I’m sure they were) These attributes seem far more interesting than some clap-on/clap-off political party affiliation. And as a result, the presumption that he would or should run in the race for the Republican presidential nomination strikes me as anything but a foregone conclusion.

Further picture this: A presidential race between Rudy Giuliani and Michael Bloomberg. They have some of their views in common with one another, not least, this (also from Reuters piece):

…when told Giuliani said in his Houston appearance that managing New York City was the best preparation for being president, a smiling Bloomberg agreed.

“I think he couldn’t be more right. And I could not have said it better myself,” he said.

I’m not actively rooting for such a match-up, mind you, and if such a race were to happen, I have no idea which candidate I’d prefer. But I do think it would be interesting, and could result, all other things being equal, in one of the cleanest presidential campaigns in memory.

Bookmark to: