Dollars and Jens
Monday, September 29, 2008
End of the World XIII
Google finance currently has the Dow closing down 738.42 points today, which I believe is the largest one-day point drop ever. It's possible some trades are still coming in and numbers could change; it's also possible I'm wrong about the size of the largest previous point drop.

Update: "Dow suffers biggest point drop in history, falling 748 points in reaction to House vote rejecting economic rescue" blares the headline at


End of the World XII
The VIX closed at 47.65 today, its highest since 2002.


End of the world XI
TED touched 355 bp this morning, now down to 320bp.


Sunday, September 28, 2008
Two articles in the Atlanta Journal-Constitution:
  1. Q&A about gasoline shortages in northern Georgia.
    Q: Why does it seem that there’s more of a shortage now than after Hurricane Katrina?

    A: The stockpiles of gasoline and other products are lower now than after Hurricane Katrina. So current shutdowns are mainly due to power outages in the areas where there are refineries. The good news is they’re starting to come back online. Production will be restored faster than it was after Katrina and Rita because the refineries weren’t damaged as badly. As of Friday, only four of 56 Gulf Coast refineries remain closed.
    Well, there's another pretty salient reason, too:
  2. A rather jarringly oblivious article about the state's price gouging laws.
    However, state officials are getting fewer complaints about gas gouging than they did after Hurricane Katrina three years ago.

    “I think part of that may well be that the stations are much more attuned to the price-gouging laws than they were before Katrina,” Cloud said. “It sunk in with enough people that we don’t go away on this.”

    The agency learned a lot from the aftermath of Hurricane Katrina in 2005, when there was a run on gas because of fears of fuel shortages.

    Cloud’s office received 6,000 price-gouging complaints, including reports of jacked-up hotel rates and gas prices.

    In the end, Consumer Affairs wound up getting settlements in 83 cases. The next highest state for gas gouging settlements was New York, which had 14.
    Which would suggest why Georgia is particularly hard hit by stations running out of gas:
    He delayed buying gas in the hopes of finding cheaper fuel in Georgia. After crossing into the state from Tennessee, he couldn’t find an open station.

    “I went back to Chattanooga and filled up there,” he said.
Before I saw this last article, I wondered whether, aside from fear of a "price gouging" law, retailers might simply fear social opprobrium from raising prices temporarily more than from running out of gas. I wondered whether it might make sense for the state to fix gas prices at $5 a gallon for a couple weeks — not that I'd have any real hope of politicians doing that. In any case, this looks less like market failure than like government failure at this point.


Saturday, September 27, 2008
Washington Mutual falls
I'm more and more starting to agree that Washington Mutual was seized and sold, if not prematurely, in a manner unfair to some of its creditors. If JP Morgan had bought the operations for this price without OTS/FDIC involvement, I'd think you have pretty strong grounds for calling the conveyance constructively fraudulent: they were surely worth more than the price that was paid. The strongest defense OTS/FDIC have is that they apparently did have an auction with multiple bidders, though they seem reluctant to make public the terms of the other bids. They may, in fact, have made what otherwise would have been FDIC claims against WM effectively senior to debt with which it should have been pari passu.


Friday, September 26, 2008
2Q revised downward somewhat since the preliminary release, with consumption looking a bit weaker than previously reported:
4.8% -.2% .9%2.8%
Consumption 1.44  .67  .61 0.87
Inventories .69 -.96 -.02-1.50
Fixed investment-.15 -.97 -.86 -.25
Net Exports2.03.94.772.93
Government Spending.


Rational Choice in an Uncertain World
I can't sleep, so I thought I'd offer a couple excerpts of a book I'm reading. It's written by two psychologists on the subject of decision making.
At the risk of overgeneralization, we offer here some conclusions about typical judgment habits that are true of both amateur and expert judgment:
  1. Judges (even experts) tend to rely on relatively few cues (3 to 5). There are some exceptions to this generalization, ...
  2. Few judgment policies exhibit nonlinearity — again, contrary to many judges' own beliefs about their policies.
  3. Judges lack insight into their policies — they are unable to estimate their own relative "cue utilization weights" accurately, especially when they are expert and highly experienced.
  4. Many studies ... reveal large individual differences in types of policies ... and low interjudge agreement on the judgments themselves. ... At a minimum, interjudge disagreements tell us someone is wrong and undermine our confidence in all judgments.
  5. When associated, but undiagnostic, irrelevant information is presented to judges, they become more confident in the accuracy of their judgments, although true accuracy does not increase.
Several pages later:
For years the nagging thought kept recurring: Maybe any linear model outperforms the experts. The possibility seemed absurd, but when a research assistant had some free time, Dawes [one of the authors of the book] asked him to go to several data sources and to construct linear models with weights 'determined randomly except for sign." ... After the first 100 such models outperformed human clinical judges, Dawes constructed 20,000 such "random linear models" .... On average, the random linear models accounted for 150% more variance between criteria and predictions than did the holistic clinical evaluations of the trained judges. For mathematical reasons, unit weighting (i.e., each variable is standardized and weighted +1 or -1 depending on direction) provided even better accountablility, averaging 261% more variance.
Note, in particular, that the last figure requires that the experts were predicting no more than 27% of the variance in the relevant statistics.

Washington Mutual falls
Washington Mutual is taken over by the FDIC and its operations sold to J.P. Morgan; equity is wiped out (I think), creditors take a large haircut, but the FDIC walks away whole and the franchise is preserved.

I've mentioned Washington Mutual a few times recently as "the last big financial entity that might deserve to fail but hasn't yet". This isn't to say that no other big financial entity will fail in the next year or two, just that I would regard such an event as almost certainly being due to a self-fulfilling credit run on an endogenously healthy bank.

Update: Actually, it looks very much like what I described earlier in the day, though of course there was no advisory opinion against a fraudulent transfer.

Update 2: I kind of forgot about Wachovia. Wachovia might well be insolvent, too.


Thursday, September 25, 2008
bankruptcies and fraudulent transfers
One of my thoughts for Bear Stearns was that they should have sold their operations to JPM, along with a long-term contract for JPM (viz. Bear Stearns operations) to continue to service and wind down BSC, which at that point would hold a bunch of assets and have a bunch of liabilities. (Perhaps it would be best to require that JPM own some stake in BSC as well to mitigate agency issues.) It seems to me the biggest impediment to this plan would have been the expectation by JPM of lawsuits; assuming BSC was insolvent in the sense of the Uniform Fradulent Transfers Act, JPM would be on the happy side of the law provided they paid "fair consideration" for what they received, but you can bet that people who still hold stock in a company that's going under are those who place the highest estimate on the value of the company's assets, and their notion of "fair consideration" would be different from those of the boards of directors; a judge might well be of the mindset that JPM would find themselves involuntarily having given away an option, being left with the operations (and BSC securities) if they deteriorated as a court date approached and being forced to pay out for any gains they realize in that time.

The common law legal tradition is averse to "advisory opinions", but it seems to me that this especially might be a good place for a bankruptcy court — that's where I'd expect the relevant expertise to be — to be able to put its imprimatur on a deal and say "this isn't constructively fraudulent", thereby shielding the buying company in a good-faith purchase from various successor liabilities that would otherwise make the valuable parts of the company impossible to preserve. That kind of indemnification could allow a lot of non-bankruptcy bankruptcies to take place where bankruptcy bankruptcies might do a poorer job of preserving the values of assets than they're supposed to.

A good current candidate for this process might be Washington Mutual. I have read recently that the retail banking business generates $8 billion a year, but that the thrift is facing unrecognized losses that could be tens of billions of dollars. If the operations continue to produce $8 billion a year, that's a positive net value for the firm, even if its current balance sheet, fairly reckoned, were $40 billion in the hole; that is not, however, how the financial system works, especially not today, and it's certainly not how thrift regulation works. A single large buyer of new preferred equity, in the amount of $50 billion or so, could probably extract a reasonable return while ensuring the company's solvency, but there's a coordination problem there. Recapitalizing a separate new entity that would purchase Washington Mutual's operations — probably, in part, for equity in this separate entity — would enable this source of new capital to be senior to existing Washington Mutual debtholders, and would allow the recapitalization of a valuable financial operation under terms that would also be worthwhile to the new investors. This would require less new capital to get it to a viable point.

End of the world X
TED at new high, spread between high and low grade commercial paper way up from already high levels.


Tuesday, September 23, 2008
new spam email going around
From: Minister of the Treasury Paulson

Dear American:

I need to ask you to support an urgent secret business relationship with a transfer of funds of great magnitude.

I am Ministry of the Treasury of the Republic of America. My country has had crisis that has caused the need for large transfer of funds of 800 billion dollars US. If you would assist me in this transfer, it would be most profitable to you.

I am working with Mr. Phil Gram, lobbyist for UBS, who will be my replacement as Ministry of the Treasury in January. As a Senator, you may know him as the leader of the American banking deregulation movement in the 1990s. This transactin is 100% safe.

This is a matter of great urgency. We need a blank check. We need the funds as quickly as possible. We cannot directly transfer these funds in the names of our close friends because we are constantly under surveillance. My family lawyer advised me that I should look for a reliable and trustworthy person who will act as a next of kin so the funds can be transferred.

Please reply with all of your bank account, IRA and college fund account numbers and those of your children and grandchildren to so that we may transfer your commission for this transaction. After I receive that information, I will respond with detailed information about safeguards that will be used to protect the funds.

Yours Faithfully Minister of Treasury Paulson

Wednesday, September 17, 2008
End of the world IX
TSLF auctions today see the fed leasing out its securities at 2.5% and 3% annual rates.


End of the world VIIb
TED has broken 300 bp, and has hit its highest value since October 1987.


End of the world VIII
Gold, silver up 10% on the day.


As I check it now, the 3-month yield is 9bp, down from 69. The 5-year note is under 2.5%.

cash-management T-bill auction
Term:                         35-Day
High Rate: 0.300%
Investment Rate*: 0.304%
Price: $99.970833
Allotted at High: 83.72%
Total Tendered**: $98,002,170
Total Accepted**: $40,000,050
Issue Date: 09/18/2008
Maturity Date: 10/23/2008
CUSIP: 912795H38
Most cash-management bills are shorter than 35 days.

End of the world VII
TED spread at 279 basis points. Not that LIBOR hasn't come down a bit from its recent spike:
U.S. Treasury three-month bill rates dropped to the lowest since at least 1954 on concern that credit market losses will widen after the bankruptcy of Lehman Brothers Holdings Inc. and the federal takeover of American International Group Inc.

Investors pushed the rate as low as 0.233 percent as the loss of confidence in credit markets deepened.


AIG bailout
From the Fed announcement on the AIG bailout:
Interest will accrue on the outstanding balance at a rate of three-month Libor plus 850 basis points. AIG will be permitted to draw up to $85 billion under the facility.

The interests of taxpayers are protected by key terms of the loan. The loan is collateralized by all the assets of AIG, and of its primary non-regulated subsidiaries. These assets include the stock of substantially all of the regulated subsidiaries. The loan is expected to be repaid from the proceeds of the sale of the firm’s assets. The U.S. government will receive a 79.9 percent equity interest in AIG and has the right to veto the payment of dividends to common and preferred shareholders.
I'm not sure "bailout" captures the flavor of this nearly as well as "non-bankruptcy bankruptcy". The money costs a lot, and, if AIG doesn't end up having to liquidate, the shareholders are diluted to the sky. If shareholders are wiped out, bond holders aren't probably getting a whole lot out of this that doesn't amount to a little more order in the way things are wound down. If the market responds in the next couple days as though it believes this alleviates all worries about AIG's existence as a going concern, then AIG will continue, mostly as it was, but with heavy Fed ownership. If AIG is forced to use this facility, though, you're probably going to be watching a gradual liquidation.

Update: Just to note: When I first heard that the Fed was lending a bunch of money to AIG, I was disappointed. When I read these terms, I wanted to hug Bernanke.

Tuesday, September 16, 2008
End of the world VI
One of the first and largest money market funds has put a seven-day freeze on redemptions after the net asset value of its shares fell below $1. Primary Fund (RFIXX, , ) , a $62 billion fund managed by money market fund inventor The Reserve, said Tuesday afternoon that its $785 million holding of Lehman Brothers Holdings debt has been valued at zero. As of 4 p.m., the value of the fund's share is 97 cents.


End of the world V


End of the world IV
Lehman Brothers Holdings Inc.'s London landlord, Songbird Estates Plc, said rent payments for its largest tenant in the Canary Wharf financial district are insured by American International Group Inc.


Monday, September 15, 2008
The end of the world, part III
The rate for overnight loans between banks soared to its greatest margin over the Federal Reserve's target rate in at least a decade as banks hoard cash after Lehman Brothers Holdings Inc.'s bankruptcy.

Fed funds traded as high as 6 percent, or 4 percentage points above the target rate, according to ICAP Plc, the world's largest inter-dealer broker. The difference is the greatest since Bloomberg began tracking the data in 1998. The rate dropped to 4 percent after the central bank added a total of $70 billion in temporary reserves to the banking system.


end of the world, contd.
Ted spread at 175 bp. Have a nice day.

Incidentally, a comment I left at another blog:
It's a real tragedy that some of us have this neurosis wherein we like to follow financial developments in real time. You and I both well know that signal-to-noise in any week is very low, and this week it's likely to be even lower. Those who are sane and wish to remain so will be reading a book, going to the park with their children, or practicing a new recipe this week. Those of us who are incurable will be glued to the financial media and growing ulcers.
Which isn't to imply that I think this is going to be played out by the end of the week.


Sunday, September 14, 2008
financial crisis
By the way, the world is coming to an end. Here's a summary.


Friday, September 12, 2008
financial system, capitalization, etc.
Some blokes* presented a paper at Jackson Hole last month with the idea of having banks buy insurance against a financial systemic risk; this wouldn't give them extra capital if they got themselves in idiosyncratic trouble while the rest of the financial system was holding up, but if it was determined that there was a systemic crisis these policies would infuse banks with a lot of extra equity capital. They went through various contortions to avoid defaults on the insurance policies and to deal with the sheer scope and correlation of these things -- you have hundreds of billions of dollars in insurance claims that, by their design, will either never pay out or will all pay out at exactly the same time -- that seemed to me to be a complicated way of issuing catastrophe bonds, but with extra transaction costs. I don't know why the banks don't issue catastrophe bonds that knock out on the relevant trigger, suddenly moving from the liabilities section of the balance sheet to the equity section. I suppose those would have idiosyncratic credit risk if the bank went under before they triggered, but I can't imagine that's a big impediment to their use for this purpose.

Anyway, I didn't read past about page 10 of the paper, and maybe I should have, but the tricky thing in my mind to this sort of thing -- through insurance or a knock-out liability -- is defining the trigger. You could concoct something around a sustained rise in a swap spread, I suppose; what the regulator might prefer is that the regulator simply be able to declare an event, and that that would be it, but if you're going to actually place these risks with investors, the regulator is going to have to have reasonable credibility with them that he isn't going to declare an event because GDP comes in below 2%; there needs to be a sense that the regulator won't abuse this discretion, but also that what the regulator sees, in good faith, as systemic crises isn't going to include a broader set of possible outcomes than what the investor sees that way, or than is necessary or appropriate. (Regulators are, on some level, paid to be anxious.) Presumably such credibility could be developed; I don't know whether Bernanke has it now. If such a system weren't simply still-born, though, due to this problem, presumably some modus vivendi would develop in which what was priced in by investors was about what regulators actually used as their criteria, but it could well take a long time for things to get to that point.

I wonder, though, whether something could be structured this way to protect an individual financial firm, whose operations depend on its ability to find counterparties to deals -- counterparties who have to trust its ability to make financial commitments. A loss in creditor confidence is a problem for a manufacturer which, even if solvent, might have to be creative in handling its finances while it tries to pay down debts for a while out of its operating profits. For a financial firm, however, a loss in creditor confidence shuts down the operating profits as well. I was suggesting (before the credit crisis began, in fact) that banks develop a subordinated debt cushion, possibly with PIK coupons that would allow the firm to give investors stock warrants instead of coupon payments; the idea, ultimately, is that financial commitments made in the course of operations, which are at a senior unsecured level, would have enough of an extra buffer above them that the firm could continue to make money from operations while trying to restructure its finances. What would be really nice, though, is if there were a way to abruptly repudiate some debt when things are going badly without threatening the standing of the operations or senior unsecured debt. This creates moral hazard issues, and I suppose is ultimately the purpose of equity per se; the large subordinated debt cushion itself would hopefully give way to a relatively nondisruptive pre-packaged bankruptcy if it became clear that the notional debt, even in its subordinated form, was preventing the firm from doing business. (Giving existing shareholders warrants on the post-bankruptcy equity might even be possible in such a situation, if the bankruptcy were likely to improve operating cash-flow to the point that it heavily benefited the subordinated debt holders.)

There may be a certain length of paragraph that should indicate to me that I'm probably babbling.

Update: *The paper to which I refer is called "Rethinking Capital Regulation", by Anil Kashyap and Raghuram Rajan at the University of Chicago and Jeremy Stein at Harvard. I have a copy on my computer, and it's probably on the web somewhere.


Monday, September 08, 2008
Shares of United Airlines parent company UAL Corp. were nearly completely wiped out Monday on false rumors that the company was about declare bankruptcy.

The Chicago-based carrier said it wasn't filing for bankruptcy and called the rumors "completely untrue."

According to a CNBC report, the rumors were sparked by a 4-year old news item regarding UAL and bankruptcy was republished on a news Web site.

Trade of UAL (UAUA: 11.43, -0.87, -7.1%) stock was halted at about 11:06 a.m. ET when it struck a penny a share. Though trading is still halted, shares have since risen to $8.97 each.

UAL trades on NASDAQ, which in the past has erased trades under similar circumstances, said NASDAQ spokesman Wayne Lee.

Fannie and Freddie
Mankiw on the bailout of Frannie Mac creditors. I agree with everything he says, which is more in the way of bragging than endorsement.

Fannie and Freddie
At the moment, FNM seems to have stabilized (sort of) around 80% below its close last Friday, with FRE off about 75%. Someone -- Citigroup? -- put out price targets for both around 30 cents per share; they're both 4 to 5 times that yet.

If you think the companies are long-term solvent, and that they'll pay back anything they need to borrow to the feds and reemerge with their current capital structures, I believe the Treasury is claiming 80% of the upside as part of the stand-by liquidity provision. If there was sense in the $60 per share at which they were trading a year ago, you could say they're still worth $12 per share, but I think 0 is pretty likely, and there is historically a tendency for lottery tickets to be overpriced.

Sunday, September 07, 2008
Fannie and Freddie
Federal officials unveiled an extraordinary takeover on Sunday of troubled mortgage giants Fannie Mae and Freddie Mac, signaling the most dramatic move to date aimed at shoring up the nation's housing market.

The plan, which was delivered by Treasury Secretary Henry Paulson and James Lockhart, director of the Office of Federal Housing Enterprise, places the twin mortgage buyers into "conservatorship" to be overseen by the Federal Housing Finance Agency.
Dividends on common and preferred equity are suspended, the CEOs are out — I kind of think the most recent CEOs are much less to blame for The Troubles than are their predecessors, but this may well be a good idea even if that's correct — and the boards are dissolved, though the stock (both common and preferred) remains "outstanding". It will be interesting to see where it trades tomorrow.

Friday, September 05, 2008
Fannie and Freddie
WSJ reports that the treasury department is nearing a plan to inject capital into Fannie Mae and Freddie Mac, probably impairing the equity. (Fannie Mae is down over 20% in after hours trading.) has picked up the report, and recapitulates a bit of the context.

Update: Washington Post:
The value of the company's common stock would be diluted but not wiped out while the holdings of other securities, including company debt and preferred shares, would be protected by the government.

jobs, or lack thereof
So what on earth are we producing 3.3% more of if nobody's doing the producing? The employment data are just emphatic that we're in a recession, and the growth data are just not. Big temporary moves in productivity are possible, but if this isn't just noise, either some sector of the economy is seeing dramatically improved labor productivity or the more productive sectors are increasing in size relative to the less productive sectors. This almost makes me want to go do some research as to what's going on.

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