McTeer on the Dollar
Here's his take. The short version - we want the dollar to get stronger, but not yet.
I was going to add a comment of my own, but I think I'd rather go to sleep.
Will the JPM-BSC deal stand?
Here's an interesting possibility:
Did Bear agree to the lowball offer only to buy time? Harte hypothesized about that prospect a report today: "We suspect that many BSC shareholders will be disappointed with the outcome, and while we believe an approval is the more likely outcome, we do not believe it is incomprehensible that this deal may have bought BSC additional time to assess its situation which may lead shareholders to reject the offer."One other whimsical thought that occurred to me last night, to the extent that Paulson's and/or Bernanke's hands were in this, was that they may have wanted the sale price to be nominal specifically to send a message that they're not going to bail out investors.
It will be interesting to see what unfolds, but I think I'm done for tonight.
Fed officials don't dispute that their decision carries "moral hazard" — the risk that any sort of bailout encourages more of the same risky behavior later. But they believe that compared with the alternative scenario, that cost is small. The funding is structured so that the greater benefit is to those who lent money to Bear Stearns in the "repo" market for secured, overnight loans, not to Bear Stearns itself. Moreover, they note it's unlikely any firm will consider the loss Bear Stearns's shareholders are likely to sustain as an acceptable price for taking the same risks in hopes of a bailout.I think that's a fair assessment.
The equity holders sure weren't bailed out, but the counterparties and bondholders kind of arguably were (though, as I mentioned earlier, the reaction of JPM's stock price today suggests that Bear Sterns without liquidity issues is worth well over zero). This kind of bailout might make senior lenders less scrupulous in their vetting. But I think that's a much smaller consideration.
Megan McArdle makes the same point.
UPDATE: Drexel economist Joseph Mason thinks I shouldn't be so dismissive of moral hazard in counter-party risk. He's probably right. Though in this particular case, it was more of a liquidity thing than a long-run risk thing; if the federal reserve can reliably tell the difference (a big if, I grant), I have no objection to their routinely bailing out liquidity situations and letting fundamentally bad companies die.
Based on the performance of JPM shares today, the market isn't terribly concerned that J.P. Morgan is buying a pig in a poke. Here's BusinessWeek on the deal, if you care.
Greenspan on Risk Management
Greenspan on risk management:
I do not say that the current systems of risk management or econometric forecasting are not in large measure soundly rooted in the real world. The exploration of the benefits of diversification in risk-management models is unquestionably sound and the use of an elaborate macroeconometric model does enforce forecasting discipline. It requires, for example, that saving equal investment, that the marginal propensity to consume be positive, and that inventories be non-negative. These restraints, among others, eliminated most of the distressing inconsistencies of the unsophisticated forecasting world of a half century ago.
But these models do not fully capture what I believe has been, to date, only a peripheral addendum to business-cycle and financial modelling – the innate human responses that result in swings between euphoria and fear that repeat themselves generation after generation with little evidence of a learning curve. Asset-price bubbles build and burst today as they have since the early 18th century, when modern competitive markets evolved. To be sure, we tend to label such behavioural responses as non-rational. But forecasters’ concerns should be not whether human response is rational or irrational, only that it is observable and systematic.
This, to me, is the large missing “explanatory variable” in both risk-management and macroeconometric models. Current practice is to introduce notions of “animal spirits”, as John Maynard Keynes put it, through “add factors”. That is, we arbitrarily change the outcome of our model’s equations. Add-factoring, however, is an implicit recognition that models, as we currently employ them, are structurally deficient; it does not sufficiently address the problem of the missing variable.
J P Morgan to Acquire Bear Sterns?
This just came across the wire:
Bear Stearns Cos. was closing in on a deal Sunday afternoon to sell itself to J.P. Morgan Chase & Co., as worries deepened that the financial crisis of confidence could spread if Bear failed to find a buyer by Monday morning.I don't know what Bear Sterns looks like internally right now, but I suspect this is more than their shareholders would get without an acquisition, and is either a very good or a very bad deal for JPM.
People familiar with the discussions said all sides were pushing hard to complete an agreement before financial markets in Asia open for Monday trading. "None of these things is done until they're done," Treasury Department spokeswoman Michele Davis said Sunday afternoon. "But I think everyone's expectation is sometime in the early evening hopefully" the deal will be done.
While terms of the deal were still being hammered out Sunday afternoon, Bear Stearns could fetch roughly $2.2 billion, or slightly less than $20 a share, said people familiar with the talks. Reflecting the dire situation at Bear, that valuation is one-third lower than the company's stock price of $30 in New York Stock Exchange composite trading Friday at 4 p.m. Last year, the shares hit $170.
I suppose I'm not really adding value here.
UPDATE: It's interesting how price can color one's impression of the value (especially when it's about all one knows) - at $20/share, I figured it could be either a good deal or a bad deal. But at $2 per share, as recent reports suggest, I suspect Morgan is doing a favor for Hank Paulson, paying more than zero for something worth less than zero. Unless Morgan already has counter-party liability.
I should probably mention at some point that I own shares of JPM.
UPDATE 2: Greg Mankiw seems to know more than I do, low hurdle that that is.
Honest to Goodness Tulips
The latest news from the Netherlands is that a lot of people have lost money speculating in tulip bulbs. Yes, really.
I don't speak Dutch, but I did verify that this isn't just a story that has been circulating the Internet for the last 370 years.
Earlier today, I came across a post I made about subprime mortgages almost four years ago.
In case that was too subtle: I told you so.
A bit of a personal note here, on why my blogging is likely to be light for a while.
Friday I'm flying to Georgia; from the airport I will get a ride to near Springer Mountain, from where I will start walking north. I need to come back to civilization in late April for about a week and a half, and it's conceivable I'll check in then. In the next few days, I ought to be busy getting my apartment packed up and moved into storage and acquiring a couple last minute provisions; I shouldn't be spending time posting here, and certainly shouldn't be spending time reading all the other things I read that generally result in my posts here.
Only about 15% of people who set out to hike the Appalachian Trail actually complete it, so there's a reasonable chance you'll hear from me before late August. After that, I'm going to graduate school in economics.
The credit crisis, fed decisions, and economic data will roll on without me — whether they should or not.
pushing on a string
The CBOT fed funds futures are increasingly anticipating another 75bp cut from the fed two weeks from now, and I'm increasingly of the belief that that would be the wrong course for them to take. I would like to see the fed hold rates at 3% for about a year or a year and a half and then start raising them, though this, naturally, is based on a set of expectations for the economy that may or may not come to pass.
I sang the praises of Richard Fisher a few weeks ago, and today he explains (indirectly) his dissent from the last fed funds cut, issuing a bearish prognosis for the economy but also for inflation; inflation has, says conventional wisdom, been held down by globalization for the past several years, but Fisher suggests that it also means that demand weakening in the United States may not be enough to reduce prices of globally traded goods and services. I think I'm slightly more bearish than Fisher — I think we're already in a recession, and that general weakness is going to drag on for a while — and I wouldn't argue too strongly against another 25 or 50 bp from here. There are those who think the economic weakness will ipso facto bring core inflation back down; others believe there is some temporary inflation passing through from food and energy to core inflation that will abate of its own accord if food and energy reverse themselves, implicitly suggesting a measure of core inflation that would subtract a multiple of food and energy from the headline rate. These each have elements of plausibility to them, though the second of them is nearly the opposite of what conventional wisdom has held, and, as Bill Poole recently commented, food and energy prices may be volatile, but we may also be in a secular period in which their prices will persistently outrun core inflation. These being particularly tradable goods, this takes us back to Fisher's point.
My concern at this point, notwithstanding Fisher's comment that "a temporary economic slowdown [may be] what we must endure while we [contain inflation]", is that this is one of those places where macroeconomics takes itself too seriously. The U.S. economy is going through a needed realignment in its productive capacities; while I am absolutely certain we are seeing a drop in demand as well, no amount of demand stimulus is going to enable the economy to be more productive than it can be. Some of the "unutilized capacity" in the economy is simply still geared toward production of things that aren't worth what their prices were two years ago. Monetary policy, of course, can't produce things; in most contexts it will feed into decisions, economy-wide, as to what gets produced and what gets consumed, and it plays a valuable role there, but it is not necessarily the case that, for any state of the economy, enough monetary ease will prevent a recession. (In some sense, though these are usually terms applied to the long run, "potential growth" may be negative, and a recession may not imply an "output gap".) I think the fed will have a role in helping the economy make the adjustments it needs to make, but the fed funds target, at this point, has played most of the role it can play; economic weakness will be with us for a while, like it or not, and dropping the target below 2% is simply going to sow the seeds from which we last reaped the seventies.
Update: It's not all that often that, this soon after I post something that I feel is contradicting conventional assumptions in this way, I see almost exactly the same point somewhere else.
TAF and counterparty risk
Everyone else — I've just seen it for the third time — seems to be linking to this Q&A about exposure to counterparty risk to which the Fed might supposedly be exposing itself via the term auction facility's acceptance of less-than-stellar collateral, so I'll follow the herd, excerpting only the conclusion:
Q: So you’re saying there’s nothing to worry about?
A: There’s plenty to worry about, including the collapse of the housing market, early signs of decay in commercial real estate, soaring commodity prices, an over-leveraged consumer, losses and potential capital impairment at financial institutions and an economy that’s flat-lining. That’s enough to keep you up at night without tossing and turning over the Fed’s exposure to credit risk.
A whole lot of transcript of Buffett being interviewed at CNBC. No, I haven't read the whole thing, nor likely will I, but what I have is interesting. If your time is cheap, you could do worse things with it.
income and spending
Income and spending came out last Friday, and while I commented on the inflation numbers, I didn't note some other data from it. Real spending for both December and January is now reported as ever-so-slightly increasing, rather than ever-so-slightly decreasing, as December was at first; meanwhile, income from compensation of employees actually continues to grow at a pretty decent clip, though last month that wasn't a lot faster than inflation.