On Economics of Contempt’s Reliance on His Own Brand Fumes

Economics of Contempt is aptly named. While his stand alone pieces on various aspects of regulation are informative, if too often skewed towards officialdom cheerleading (he too often comes off as an unpaid PR service for Geithner), his manner of engaging with third parties leaves a lot be desired. He often resorts to the blogosphere version of a withering look rather than dealing with an argument in a fair minded manner. This then puts the target in a funny position: do you deal with these drive-by shootings which have either not engaged or misrepresented your argument, by cherry picking and selective omission? If you do, you can look overly zealous or argumentative. But if you do nothing, particularly if it’s in an important area of regulatory debate, you’ve let disinformation, at the expense of your reputation, stand.

Since he’s given the same treatment to Neil Barofsky, at least I’m in good company.

The object lesson is EoC’s comment on a detailed post I wrote, with considerable input from derivatives expert Satyajit Das, on the FDIC’s “counterfactual”: a report it released to argue, via a long narrative, that it could have resolved Lehman successfully (and with credulity-straining low losses to unsecured creditors) had it has Dodd Frank resolution powers in 2008.

I know that Yves has a post claiming that the FDIC’s hypothetical Lehman resolution wouldn’t work, but her analysis is quite flawed. Among the myriad mistakes in the post, she and Satyajit Das both invoke scary-sounding cross-jurisdictional problems that simply wouldn’t arise under the resolution authority — since Lehman’s London broker-dealer (LBIE) was funded almost entirely by the holding company (LBHI), selling LBHI to Barclays under the resolution authority would have obviated the need for LBIE to file for bankruptcy in the UK. That’s, umm, kind of the point of the resolution authority.

Although it is tempting to engage in a lengthy discussion, I’m going to try to keep this high level.

First, EoC proceeds from erroneous assumptions. Das, who as we shall so politely put it is in a good position to know granular details about the Lehman BK, wrote (emphasis mine):

You can correct a few facts:

a) Lehman dealt derivatives through a variety of vehicle including LBSF (Lehman Brothers Special Financing) and also a Swiss Entity.

b) I don’t think that LBIE or LBSF was entirely funded by LBHI. It was guaranteed on some transactions but not necessarily all. This means that they would have their own creditors – including derivative counterparties who have posted collateral. I do not understand why these creditors would have submitted to a resolution regime that would not have given them the outcome they believed they were under the applicable law and the jurisdiction’s legal systems.

c) Also there is an issue of structural subordination to deal with. The creditors of each local entity (as senior or junior creditors) would have first claims on any assets of the local entity (this of course includes business licenses and franchise). Lehman’s parent as shareholders would have been subordinated to that claim. Why would local creditors sacrifice that priority in a resolution?

d)The fact is that a portion (probably large) of the contracts are under English law with exclusive on non-exclusive English court jurisdiction. There are fundamental differences in rights in bankruptcy which would complicate any resolution. Given the kind of amount involved and the complexity of the issues, these fights are fierce.

e) Also at law creditors would appoint different bankruptcy trustees or administrators (irrespective of what Dodd-Frank says) to just protect their rights. In fact, the entire resolution authority system would mean a sensible overseas creditor would almost immediately appoint one when entitled to do so to forestall any further action until they had all the information to judge how they should behave.

In addition, EoC’s complaint does not address the other problems mentioned in our lengthy post.
For instance, the FDIC paper rests critically on the assumption that Barclays would have bought all of Lehman has the resolution process gone 90 days and started in March 2008. We shot at the timeline assumptions on multiple grounds, including:

The political drama that would have resulted from taking down a company when the CEO was insistent it was sound (and recall key noisy commentators, notably CNBC, were soundly in his camp, and the other major papers in March to May 2008 were interested in but still skeptical of the bear case on Lehman, led by David Einhorn) would have delayed action, particularly since the FDIC, Fed, and Treasury all have to agree to move forward.

The idea that customers and counterparties would sit pat with an untested resolution regime with unclear creditor priorities that are not the same as in a bankruptcy (a critical defect stressed by Josh Rosner in Congressional testimony) creates uncertainty as to their risks depending on how things play out. Do you think they will sit pat when words gets out the FDIC has taken up residence and the company is being hawked? Financial firms tend not to go down in isolation; they whole sector is usually under stress when key players look terminal. Thus the assumption that a buyer will surface for the whole business is also pretty cheery. There may be no buyer, or only buyers for few trophy operations.

We did not address the assumption that Barclays would buy the whole entity without a subsidy. That with Lehman seems unwarranted. The FSA got involved twice to protect Barclays from itself. The first intervention has gotten attention in the US but not so much the second. The first was the refusal to waive the 30 day shareholder approval period requirement. The alternative was to have Barclays guarantee Lehman’s positions with some sort of government backstop and that was a non-starter. But the second one was in the purchase of certain Lehman assets. The FSA pushed to have the deal sweetened by the inclusion of IIRC $7 billion of good collateral (leaving JP Morgan with “goat poo”).

More broadly, the FSA set a boundary condition in September 2008. Per Bloomberg:

The U.K. financial regulator told Barclays Plc in September 2008 that an acquisition of Lehman Brothers Holdings Inc. might damage the balance sheet of one of the country’s most important banks. The Financial Services Authority told Barclays it would look very closely at the effect any transaction would have on Barclays’ liquidity and capital and “would not countenance” a drop of Tier 1 capital below FSA requirements, according to a statement the regulator gave to Lehman’s bankruptcy examiner in January that was made public today.

In the post, we’ve parsed out the Lehman losses ex what can be attributed to the disorderly bankruptcy (code for derivative positions blowing out). The FDIC’s comparatively leisurely timetable would have allowed for adequate due diligence, including the discovery of the complete and utter mess of the Lehman derivatives books (inability within +/-5% to even know how many open positions they had, numerous systems that were independent and did not aggregate). And the black hole was far bigger than the FDIC suggested, which argues against both their loss estimates and their tidy transfer assumption:

And the last sighting from the bankruptcy trustee Alvarez & Marsal shows losses vastly in excess of what the FDIC reports. This was our summary of the latest sighting in the Financial Times: Take the creditor claims of $250 to $350 billion. Against that we now have assets we will generously peg at $60 billion. So we now have a $190 to $290 billion shortfall. The midpoint is nearly double the last loss estimate.

Of that total, bankruptcy overseer Alvarez & Marsal has tried to claim that $50 to $75 billion was due to the disorderly failure. Even if you accept the high end of their range, you get $115 to $215 billion in losses. But Alvarez & Marsal has reason to exaggerate the “disorderly BK” losses. The experts I am in contact with who are working on the BK say that $15 to at the very top $30 billion in losses is attributable to the rushed process. That gives a range of $160 to $260 billion in losses to unsecured creditors.

By contrast, the FDIC in the report tries to claim the losses were only the asset side overvaluations of $50 to $70 billion of troubled assets and that the losses would have been only $40 billion. This is a gap of roughly $120 to $220 billion. We are supposed to trust them based on their willingness to engage in phony math like this? Yes, the Lehman entities had franchise value that was lost in a liquidation but the scale of the losses being realized demonstrates that the black hole in Lehman’s balance sheet was far greater than the FDIC is pretending that it was.

Finally, EoC naively ignores the sheer logistical nightmare of the valuations and who owed money to whom which has a material impact of the settlement and the negotiating stance of individual parties. Has EoC ever had to deal with this in practice?

It’s a shame that EoC applies his considerable expertise to defending a flawed process when it would serve the public better to take a more skeptical stance. But his stalwart support for the various “reforms”, with only the occasional, not terribly consequential quibble, makes clear where his loyalties lie.

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  1. Philip Pilkington

    “This then puts the target in a funny position: do you deal with these drive-by shootings which have either not engaged or misrepresented your argument, by cherry picking and selective omission?”

    If the blogosphere informally stuck to avoiding this mode of argument and engaging directly with the words people actually write — which is essentially what is informally (perhaps even formally) adhered to in academia — it would be a better place for it. If an argument is consistent every part of it should stand alone and not rely on some broad (usually ideological) point being made therein. If this mode of argument were adhered to we wouldn’t have to put up with nonsense blog posts by Krugman et all about MMT — who knows… people might actually have to put the effort in to understanding exactly what others, not to mention themselves, are actually saying. Scary prospect.

    1. Francois T

      “it should stand alone and not rely on some broad (usually ideological) point being made therein”

      Like the ideological point you made on Krugman 2 lines below the quote above?


      1. Philip Pilkington

        You see how bad it’s got people? This poor sod can’t tell the difference between ideology and engaging properly with your interlocutors.

        The blogosphere has fried the poor chap’s brain!

      2. Philip Pilkington

        Sorry, dude… here we’ll attempt some reconstruction…

        Krugman notoriously caricatured the MMTers argument when he ‘argued against it’ on his blog. The accusation alluded to in my comment — which readers of this blog should be familiar with — is that Krugman didn’t engage in a real debate about MMT. This had nothing to do with ideology on Krugman’s part — him and the MMTers share the same ideology — it was just pure blogosphere sloppiness…

        Pheeeew! The internetz, eh? I don’t even know why I bother sometimes, but hey… Pharmakon… the poison is the cure, right…

  2. Dean Sayers

    Yves, it’s absolutely absurd that these TBTF problem is not being seriously addressed. The cheerleading on all the mainstream circuits is insufferable at times, since it leads to very convenient conclusions that the pundits couldn’t have come up with outside the context of regulations (or deregulations) they sought to defend.

    I read a while ago that a large number of banks ‘miraculously’ experienced solvency in major turn-arounds of their asset valuations. IIRC, the regulatory regime was changed in order to allow banks to determine their own asset values (i.e. Mark-To-Market lost its teeth). Of course, this is like handing someone a blank check.

    Do you think this argument has veracity or am I missing something?

  3. Ezcariot

    Seems to me that the underlying flaw is the timeline scenarios. It simply doesn’t scan, The atmosphere at the time was, well, hour to hour positioning. The Regulatory Authorities were in reaction mode: see BAC and Merrill shotgun wedding. Velocity was present, and it was torquing the ability of people to use all their resources to determine potential outcomes. That was Market Velocity, clearly beyond the control of any regulatory authority or management control. Action reigned, contemplation was not a real option. The Counterfactual is Monday morning Quarterbacking, and is meant to be.

    And a subplot of the post: it is a very hard call. In my experience I think it has to do with the weight of the party doing the driveby: are they worth your time and effort? I don’t know that website so I can’t make a call. You are making observations and asking questions. No need to defend either activity. The mob is beyond reasonableness.

  4. charles 2

    Yves, you should ask EoC to sketch what a living will for Citigroup, with its countless retail subsidiaries across the world, would look like.
    Then, sit back and enjoy…

    For the rest, EoC seems to be afflicted by the typical american lawyer : believing that once a legal problem is solved domestically in the US, it is solved globally. European lawyers, especially in the City, are more realistic, as they deal with transnational issues regularly. It is not for nothing that the offshore bond market is called “eurobond”…

  5. Siggy

    EoC is a driveby propagandist.

    EoC is attempting to defend TBTF with a discourse in asserted minutiae that is a lie on its face. Except that, it is tedious to unravel the lie for what it is.

    There is no person, group, institution or government that is too big to fail. To fail, or to refuse, to understand that is to be profoundly stupid. To persistently attemt to refute that premise is to be profoundly malicious.

    I read malice in the EoC blatherings. What is especially infuriating is that EoC appears to neither care nor understand that its diatribe abets what should be recognized as a pandemic of fraud.

  6. Hal Horvath

    “He often resorts to the blogosphere version of a withering look rather than dealing with an argument in a fair minded manner.”

    As you say: “…if you do nothing, particularly if it’s in an important area of regulatory debate, you’ve let disinformation, at the expense of your reputation, stand.”

    This reminds me of some very old situations and very old concepts.

    The best solution to this everyday, commonplace social problem is civility. In the end, you only win arguments about big issues through civil (respectful) means.

    In other words, ML King, Jr. won the debate of the day. Malcom X did not. Ghandi did. The Weathermen did not. etc. It’s very consistent.

    The big changes tend to start with the new idea being uncivilly attacked.

    Then the only question is whether the person presenting the new idea can keep their cool and be civil in reply to incivility.

    That’s not easy. It’s more than some very well known writers/columnists/public figures have managed.

    Polemic is often uncivil, and then loses the public debate.

    But if the polemicist is civil to everyone, then their argument is listened to instead of dismissed.

    Its subtle. If someone is uncivil to even just some people, and then pretends to be civil while presenting their ideas, it fails to ring true.

    It takes character to win big public debates.

    1. Dean Sayers

      “In the end, you only win arguments about big issues through civil (respectful) means.”

      This is completely false. One needn’t look further than the antisemitism that rival bankers levied at Goldman Sachs in the 30s, to the race-war vitriol surrounding the Israeli-Palestinian conflict, to see that the most uncivil voices are not only often the loudest, but also tend to be the most powerful.

      Yitzhak Rabin was a liberal Israeli counterbalance to the warmongering of the regime. He was assassinated during his tenure as Prime Minister of Israel as he pursued a vigorous drive for peace, because of concessions made to Palestinians.

      Take your case study. Malcolm X was assassinated precisely because he split from the racist position of the Nation of Islam. This threatened power and, those who held that power responded.

      It is really comforting to think that “words can save us.” But I don’t think its realistic. If nothing else, power simply doesn’t manifest in “civil discourse” as much as it does in economic violence.

      1. Hal Horvath

        Power wins temporarily, and eventually exhausts itself, and loses over time to ideas and words, which are more powerful over time. Even smears are only temporarily effective.

        While many great voices were silenced (and smeared), their names are the ones we know today, and their ideas have shaped much of our culture. But more, many of them, perhaps most, would prefer it that way — to have stood for something true (better than the previous idea/ideal) and to have made a difference even while taking the hit.

    2. Mark P.

      While I take your point, I don’t think the world is so neat and pretty. Stalin pretty conclusively won in his own day, for example.

      1. Hal Horvath

        Yes, Stalin won temporarily, in a way that probably rarely gave him comfort. I think King won in a timeless way, that is gradually winning over the world, and has progressed far. Malcom X, in contrast, to most racist was only fuel for their convictions. King made them ashamed, and won generations.

      2. Hal H

        Yes, Stalin won temporarily, in a way that probably rarely gave him comfort. I think King won in a timeless way, that is gradually winning over the world, and has progressed far.

    3. Rex

      I, too, agree in principle that slow and rational is the best course, but it seems that in the recent “health care debate” the screaming death-panel loonies came out closer to what became the end result than the rational single payer or public option supporters.

      The conservatives seem to be specialists in the derogatory terminology. The invective “Obama Care” is still spewed quite often while “tea bagger” seems to have been found too offensive for the left to keep using.

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