Category Archives: Credit markets

Scott Fullwiler: Paul Krugman—The Conscience of a Neo-Liberal?

By Scott Fullwiler, Associate Professor of Economics at Wartburg College

The old saying that bad press is better than no press is definitely true in this case. Without the advent of the blogosphere, our work would likely never even be noticed by the likes of Paul Krugman, so the fact that he’s writing about us (here and here) this weekend at least means we’re doing better than that, even if his assessment of us is far less than glowing. At the same time, and particularly given that Krugman is so widely read, it’s imperative to at the very least set the record straight on where MMT and Krugman differ. I should note before I start that others have done very good critiques already that overlap mine in several places (see here, here, here, and here).

Krugman makes three incorrect assumptions about what MMT policy proposals actually are while also demonstrating a lack of understanding of our modern monetary system (as is generally verified by volumes of empirical research on the monetary system by both MMT’ers and non-MMTer’s). These are the following:

Assumption A: The size of the monetary base directly (or indirectly, for that matter) affects inflation if we’re not in a “liquidity trap”

Assumption B: MMT’s preferred fiscal policy approach or strategy—Abba Lerner’s functional finance—is Non-Ricardian

Assumption C: Bond markets alone set interest rates on the national debt of a sovereign currency issuer operating under flexible exchange rates

Assumptions A and C are central to the Neo-Liberal macroeconomic model. Assumption B is a common misconception about MMT and a common perception of Neo-Liberals about the nature and macroeconomic effects of fiscal policy (i.e., Neo-Liberals often believe that activist fiscal policy is Non-Ricardian).

While MMT’ers argue that all three assumptions are false, one does not need to necessarily agree. The point is that to critique MMT on the basis of assumptions that are inconsistent with MMT is to actually not critique MMT at all. It is a straw man.

Complexity and War or How Financial Firms Wreck Economies for Fun and Profit

There’s a great post up, “Human Complexity: The Strategic Game of ? and ?,” by Richard Bookstaber, former risk manager, author of the book A Demon of Our Own Design and currently an advisor to the Financial Stability Oversight Council. As insightful as it is, Bookstaber does not draw out some obvious implications, perhaps because they might not be well received by his current clients: that the current preferred profit path for the major capital markets firms is inherently destructive.

I suggest you read the post in its entirety. Bookstaber sets out to define what sort of complexity is relevant in financial markets:

The measurement of complexity in physics, engineering, and computer science falls into one of three camps: The amount of information content, the effect of non-linearity, and the connectedness of components.

Information theory takes the concept of “entropy” as a starting point…

Sleaze Watch: Florida Attorney General Cavils About “Moral Hazard” While Letting Foreclosure Mill Off the Hook

t’s becoming increasingly clear that morality applies only to little people, especially the sort that are cannon fodder for our mortgage industrial complex.

The Florida attorney general, Pam Bondi, joined three other Republican attorneys general in arguing against the principal reductions called for in the so-called mortgage settlement on the basis of “moral hazard”. Their argument? That it would reward those who “simply choose not to pay their mortgage”.

Boy, am I naive. The term “strategic default” appeared out of nowhere and had a pre-packaged sound about it.

Slapping Team Obama: Several Democratic AGs to Withdraw from Proposed Mortgage Fraud Settlement; Federal Negotiations in Disarray

The so-called mortgage settlement looks to be coming apart at the seams. That does not mean there will not be a deal of some sort. Remember, a hallmark of the Obama administration is to do things simply to have more “achievements” to discuss. But not only, as has been rumored for some time, are a number of Republican attorneys general saying they will not join in the settlement, so are some Democrats as well.

It’s important to recognize that Democratic withdrawals are a far bigger problem for Obama than the Republicans. Given that a number of AGs signed up at the last minute, and some of the Republicans were not even on board with the concept of a mortgage settlement, defections among the GOP participants can be depicted as partisanship. By contrast, repudiation by Democrats, particularly Democrats that have garnered some attention in the national press by taking mortgage abuses seriously, is much harder for the Administration to explain away. And as David Dayen at Firedoglake reports, if enough AGs defect, the settlement becomes a dead letter:

Are Fannie and Freddie Giving Banks Yet Another Bailout by Not Pursuing PMI Claims?

The further you look at the banking mess, the more the same problems keeps staring back: too many losses, not anywhere enough equity or reserves, and a lot of tap dancing by the officialdom to pretend otherwise.

We wrote yesterday, thanks to some sleuthing by Chris Whalen, that Fannie and Freddie might be sitting on north of $100 billion of unreported losses. If they started realizing those losses, one of the first parties that would take a hit would be the private mortgage insurers, since on high loan to value loans (over 80% of appraised value), they were in the business of guaranteeing the loan balance in excess of 80%. So while the failure of the GSEs to act is no doubt part of the extend and pretend shell game, it serves to keep PMIs that would otherwise be as dead as certain notorious parrots alive.

Matt Stoller: The Federal Reserve’s Wheezy Independence Takes Another Hit

By Matt Stoller, a fellow at the Roosevelt Institute. His Twitter feed is:
http://www.twitter.com/matthewstoller

You might have noted a few days ago that the Supreme Court ruled against Federal Reserve secrecy. The case had to do with a lawsuit by Bloomberg’s Mark Pittman demanding access to emergency loan documents relating to the Fed’s bailout of Bear Stearns. As the case traveled up the court system, major banks joined the Fed’s attempt to shield the information from public scrutiny. Eventually, the Fed dropped the suit, but the banks didn’t give up.

A few days ago, the Supreme Court refused to hear the case, letting a lower court decision in favor of Pittman stand. The Fed will now be releasing Bear Stearns-related emergency lending documents in a few days.

It’s a historic case. You wouldn’t know that, however, by the response from Wall Street.
You might have noted a few days ago that the Supreme Court ruled against Federal Reserve secrecy. The case had to do with a lawsuit by Bloomberg’s Mark Pittman demanding access to emergency loan documents relating to the Fed’s bailout of Bear Stearns. As the case traveled up the court system, major banks joined the Fed’s attempt to shield the information from public scrutiny. Eventually, the Fed dropped the suit, but the banks didn’t give up.

Fannie and Freddie Hiding Over $100 Billion of Losses?

Bank expert Chris Whalen has a little bombshell in his current newsletter. It’s so obvious that it should not only have occurred to me but pretty much everyone on the real estate beat. And that begs the question why no one has even mentioned it.

Beware the Predatory Pro Se Borrower!

Somehow, “predatory pro se borrower” reminds me of “The Attack of the Killer Tomatoes.” Pro se defendants are generally lost souls in the court system. They typically get up, flail around before a frustrated judge, and lose (cinematic examples to the contrary, like “Find Me Guilty”, notwithstanding). So the idea that they could rise to the level of being threatening enough to be “predatory” seems like more than a bit of an oxymoron.

But this document depicts these usually hapless defendants as a danger (hat tip April Charney):

Sleaze Watch: NY Fed Official Responsible for AIG Loans Joins AIG As AIG Pushes Sweetheart Repurchase to NY Fed

The corruption in high places is getting more and more brazen with every passing day. The only thing that separates the US from conventional banana republic status is that no one leaves keys to new luxury cars on the desks of officials to secure their cooperation. It’s just not enough of an inducement to get anyone to take action.

More on the Lack of Criminal Prosecutions: Was the SEC Deterred by a Widely Overlooked Ruling?

Bloomberg’s Jonathan Weil, who is normally an effective critic of bank chichanery and weak regulatory oversight, may have missed the mark on a key issue in an article last week, “Moral for CEOs Is Choose Your Fraud Carefully“. In it, he criticizes the SEC for failing to attack accounting fraud:

It seems the Securities and Exchange Commission won’t be doing anything to challenge that pretense, either, and that this may be by design. The SEC for years has been bending over backward to avoid accusing major financial institutions of cooking their books, even when it’s obvious they did. So much for upholding financial integrity.

Weil cites a series of object lessons where the SEC has not gone after financial firms executives for accounting fraud: Fannie Mae’s Donald Mudd, Countrywide’s Angelo Mozilo, and three executives at Indy Mac. Weil charges them with “see no accounting evil”.

Let’s be clear: I’m no fan of the SEC’s actions in the wake of the crisis. The regulator has been kept resource starved. Under Arthur Levitt (hardly the most aggressive of SEC chiefs) any effort at enforcement led to threats from Congress of budget cuts (Joe Lieberman was particularly aggressive). Chris Cox was put in charge, as far as I can tell, to make sure the agency did at little as possible. So the SEC only knows how to do insider trading cases, and on any other type of action, it seeks to get a settlement, when a trial in some cases might have more value as a deterrent (plus you don’t get to be good at litigating if you never litigate).

Moreover, the SEC also seems to believe it needs to win pretty much all of its cases to be perceived as a threat. That isn’t true either. Look at the Green Bay Packers, who were correctly the favorites to win the Super Bowl despite having a lousy win/loss record prior to the playoffs. But all those losses had been close, in hard-fought, well-played games. In litigation, embarrassing revelations in discovery or on the stand can also have deterrent value, and can serve as building blocks for future cases.

Let’s deal with the misconstructions in Weil’s article. He argues:

Satyajit Das: Controlling Sovereign CDS Trading – The Dysfunctional Debate

By Satyajit Das, author of Extreme Money: The Masters of the Universe and the Cult of Risk (Forthcoming September 2011) and Traders, Guns & Money: Knowns and Unknowns in the Dazzling World of Derivatives – Revised Edition (2006 and 2010)

In an opinion piece entitled “Hedging bans risk pushing up debt costs” published on 9 March 2011 in the Financial Times, Conrad Voldstad, the chief executive of the International Swaps and Derivatives Association (“ISDA”) and formerly a senior derivatives banker with JP Morgan and Merrill Lynch, made the case against the EU ban on “naked” credit default swap (“CDS”) contracts on sovereigns.

Just as “patriotism is the last refuge of a scoundrel”, arguments citing market efficiency and the benefits of speculation seem to be the first resort of dealers.

The Elizabeth Warren Rorschach Test

The spectacle of a bunch of Republican Congressmen spending over two hours pillorying Elizabeth Warren, following weeks of death of a thousand unkind and generally offbase cuts coverage in the Wall Street Journal has led a lot of folks from what passes for the left, and even not so left, to ride in to her defense. A partial list includes Paul Krugman, Simon Johnson, Joe Nocera, Mike Konczal, and Adam Levitin.

The last time I can recall the Journal becoming quite so unhinged about an individual was over Eliot Spitzer. And since Warren seems pretty unlikely to be found to have similar personal failings, the specter of the right throwing what look to be ineffective punches at her makes for a peculiar spectacle. What is the real aim behind this drama?

Clearing Up Some Misperceptions on the Mortgage Modification/Second Lien Debate

A fairly long discussion, by blogosphere standards, has broken out over second liens. For those comparatively new to the topic, a recap is in order.

Second liens are either second mortgages or home equity lines of credit on homes. The bone of contention is that mortgage servicers, which also happen to units within the biggest US banks, have not been playing nicely at all with stressed borrowers out of an interest in preserving the value of their parent banks’ second liens. And the reason for that is that writing down second liens to anything within hailing distance of reality, given how badly underwater a lot of borrowers in the US are, would blow a very big hole in the equity of major banks and force a revival of the TARP. That is one of the very last things Team Obama would like to see happen, hence its eagerness to promote various extend and pretend policies.

The mortgage settlement proposal includes a provision that would call for second liens to be reduced pro-rata with the firsts. That, as Gretchen Morgenson noted, and Jesse Eisinger amplified, is contrary to long-standing principles of priority of creditor payments. Felix Salmon then argued that the banks were within their rights to try to extract some value from the seconds, which led to further rebuttals…

On the Clouded Title Mess and the Difficulties of Cleaning It Up

Abigail Field’s latest piece at Daily Finance is a great one-stop summary of the most thorny problem underlying the securitization mess: how can we clean up title given how badly it has been screwed up? As we and many others have noted, integrity of property ownership is an essential foundation of development; this is straight Hernando de Soto gospel. And as our Richard Smith has pointed out, the various fixes to get around this mess run roughshod over well established court procedures that date back to the 1677 Statute of Frauds. Why was it necessary to implement those rules? Because without them, wealthy people could use the court system to steal property. Sound familiar?

One thing that it is important to stress: that the abuses to established real estate transfer and recording processes were not inherent to the securitization model. I’m not a fan of securitization but the sad reality is that no one is prepared to go back to the more costly in terms of equity required, model of on-balance sheet banking (it would result in a shrinkage of credit that every respectable economist would recommend against and hence will never happen). But no one (except the FDIC, which keeps being ignored) is thinking seriously enough about what it would take to make securitization safer.