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Streetwise Professor

January 30, 2010

Perfectly In Character

Filed under: Economics,Financial crisis,Politics,Russia — The Professor @ 5:24 pm

Henry Paulson’s new book alleges that Russia attempted to convince China to join it in selling large quantities of Fannie Mae and Freddie Mac (government supported entity, or GSE) bonds in order to force the US government to prop up the GSEs:

Russian officials had made a top-level approach to the Chinese, suggesting that together they might sell big chunks of their GSE holdings to force the US to use its emergency authorities to prop up these companies,” he said.

. . . .

“The Chinese had declined to go along with the disruptive scheme, but the report was deeply troubling,” he said. A senior Russian official told the Financial Times that he could not comment on the allegation.

Bloomberg has more:

Paulson learned of the “disruptive scheme” while attending the Beijing Summer Olympics, according to his memoir, “On The Brink.”

The Russians made a “top-level approach” to the Chinese “that together they might sell big chunks of their GSE holdings to force the U.S. to use its emergency authorities to prop up these companies,” Paulson said, referring to the acronym for government sponsored entities. The Chinese declined, he said.

Russia’s five-day war with U.S. ally Georgia started on Aug. 8, the same day as the opening ceremonies of the Beijing Games. Prime Minister Vladimir Putin told U.S. President George W. Bush during those ceremonies that “war has started,” according to Dmitry Peskov, Putin’s spokesman.

“The report was deeply troubling — heavy selling could create a sudden loss of confidence in the GSEs and shake the capital markets,” Paulson wrote. “I waited till I was back home and in a secure environment to inform the president.”

Putin spokesman Peskov denies the allegation:

Russia never approached China about dumping U.S. bonds, Peskov said today. “This is not the case,” he said by phone.

Note that Peskov is quoted in Bloomberg as a source of information about Putin telling Bush that war had begun; he is not necessarily a definitive source about this other allegation.  Note further that the FT could not get official comment one way or the other.

This occurred about a month before the Feds seized the GSEs, and 5-6 weeks before it all hit the fan in mid-September.  Although there were clouds on the horizon in the late-summer of 2008, there was little to suggest the severity of the impending tempest.  Thus, the Russians should be congratulated for their perspicacity.  I wonder what information led them to this conclusion, and how they obtained it.  (Although, their foresight was not perfect.  Even though the Russian market had already begun to show serious cracks post-Mechel and with the onset of the Russo-Georgian War, the official attitude was that Russia was becoming an economic juggernaut that was immune from adverse economic shocks from abroad.  Not exactly, as events proved.)

Of course, there is a single source for this allegation–Paulson–and he doesn’t provide any real detail as to how he came to know of this gambit, or what information led him to this conclusion.

That said, it is eminently believable.  Combine mercenary motives with the Putinists’ raging complexes and resentments of the US, and their desire to knock America down a few pegs, and to that add the “I wish my neighbor’s cow would die” element of the Russian character, and you can easily see this happening.

If it did happen, it says a lot about the Russian M.O. Clearly, Russia had 65.6 billion reasons to be concerned about Fannie and Freddie.  Moreover, they were rightly anxious about the financial condition of the GSEs, and the potential for a substantial loss in the value of their investment.  But, if Paulson is right, rather than behaving in a constructive and forthright way, Russia instead acted the manipulative gangster, and attempted to play Machiavellian Great Games and score geopolitical points.

Such attitudes should be kept in mind when dreaming about resets, and negotiating arms control agreements, Afghanistan logistics arrangements, and actions against Iran.

January 28, 2010

The Real AIG Question Remains Unanswered

Filed under: Derivatives,Financial crisis,Politics — The Professor @ 10:14 pm

I’m not a big fan of Zero Hedge; it’s very high variance.  (Which kinda makes sense, if they’re not hedged:)  But every once in awhile “Tyler Durden” hits the nail.  Apropos AIG, he asks the question I asked, and Hank Greenberg asked: why didn’t the Fed/Treasury simply guarantee AIG’s contracts?:

Why did the Fed not guarantee AIG’s assets ahead of the firm’s implosion. Surely, the realization, which as everyone trumpets these days, that AIG’s failure would have destroyed the world should have been known to at least one person in authority? And as all know, the collateral call toxic spiral commenced only once AIG was formally downgraded by the rating agencies. Well, had the AIG had the formal guarantee of the Federal Reserve, which is implicitly a guarantee by the U.S., then AIG would not have been downgraded in the first place, and no collateral calls would be forthcoming. Of course, Goldman would end up owning CDOs that as Janet Tavakoli points out, and contrary to what the Fed claims, are now worth at best pennies on the dollar. Furthermore, Goldman’s AIG CDS would immediately have become worthless, with Goldman unable to sell them in the open market for a profit of billions of dollars, yet the firm would continue extracting collateral as per its prior arrangement with AIG, in essence not impairing Goldman at all. And had AIG not started down the downgrade spiral, then numerous other adverse consequences of the nationalization of the insurance company would not have transpired. While it would not have saved America’s financial system, it would have made the descent more manageable. Yet with Goldman having benefited massively from the elimination of a vast swath of competitors, one wonders if the guarantee track may have been considered and subsequently denied, under the wise tutelage of 85 Broad advisors. We suggest Senator [sic] Issa and Neil Barofsky focus very closely on any email released as part of the disclosure process that highlight the Fed’s reasoning as to why AIG should not receive a guarantee, and what the nature of such reasoning may have been. [Emphasis added.]

I agree completely that this is the most important question.  The stuff about the disclosures is perhaps easier for the politicians and public to understand, but that’s a side issue, at best.

Timmy! Geithner basically blew off this issue.  Bernanke definitely blew it off.  Issa asked him about it, and in his response letter, Bernanke didn’t answer; he said only that that question had been answered by FRBNY General Counsel Thomas Baxter.  What, is Helicopter Ben averse to spending a few pixels to explain, in his own words, why this option wasn’t chosen?  Lawyering up always looks suspicious.

The refusal to answer this question is very telling.  That’s where the story really is.  Guarantee: no cash out the door, but no AIG implosion either, allowing time to manage the crisis.  There had to have been a compelling reason to eschew this option.  I haven’t heard it yet.  Like Z-H says, let’s see the paper trail.

John Gapper Gets It . . . But Doesn’t Really

Filed under: Economics,Financial crisis,Politics — The Professor @ 9:54 pm

In his article on the Volcker Plan in today’s FT, John Gapper meanders around in an attempt to defend it, and then stumbles on this realization that undermines most of his previous justifications:

There is, however, one substantial objection to the Volcker rule as it has been structured by the administration. [And believe me--it's substantial.  Like so substantial as to demolish the case altogether.]  It focuses on deposit-taking banks rather than, as Mr Volcker’s G30 report last year phrased it, “systemically important financial institutions”.

This means that it would apply to, for example, JPMorgan and Bank of America, but probably not to Goldman Sachs and Morgan Stanley. These investment banks have the option of giving up their bank holding company status, shedding deposit-taking, and being able to continue combining proprietary and customer businesses.

Leaving aside the strange consequence that an attempt to curb banks could end up helping Goldman by reducing the competition, this is wrong in principle. Even if Goldman and Morgan Stanley surrendered access to the discount window and their bank status, do we really believe this deals with the problem?

Of course not, for we cannot (much as everyone would like to) erase the memory of the last time trouble struck. The Treasury was forced to bail out Goldman and intervene to prop up American International Group, the full details of which are now embarrassing Mr Geithner. [Emphasis added.]

Well, exactly.  But immediately after having the lightbulb go on, and figuring out that rules limited to deposit taking banks with access to the discount window will do nothing to prevent a recurrence of a financial crisis, and may actually make one more likely, he lamely sticks up for Volcker:

The Volcker rule is not perfect but is the best attempt yet to confront head on the legacy of that time. If it were extended to Wall Street as a whole, it would be better still.

Just what does “extend[ing] [the rule] to Wall Street as a whole” mean, exactly?  No prop trading by anybody?  That’s asinine.  If he means addressing To Big To Fail more comprehensively, well I agree with that, but it’s hard to figure how a non-asinine extension of the Volcker rule could do it.

Which means that you have to do something different altogether.  The Volcker plan is clearly insufficient to address TBTF in a serious way.  It seems the creation of a man–sorry to say it–who is past his prime and somewhat nostalgic for a Glass-Steagall world of his prime even though the repeal of Glass-Steagall really had zip to do with fomenting the financial crisis.  Volcker clearly has good intentions to tackle TBTF, but good intentions aren’t enough.

Some more imaginative thinking is in order.  TBTF is the result of the interaction between two, distinct, entities: financial institutions and the government.  All of the noodling has been directed at the former, very little at the latter.  TBTF wouldn’t exist if it were possible to make credible government commitments not to bail out.  To focus on banks alone is to assert that government is beyond hope.  That it has as much ability to make commitments not to indulge in bad habits as your typical methhead.

Maybe that’s true.

Is that what advocates of regulation actually believe?  Let them be explicit about it then.  Pretty scary thought: we have to trust the government with all sorts of powers over financial institutions because the government is constitutionally (small-c) unable to avoid taking destructive actions involving financial institutions.

Wouldn’t it be worth a little more effort to think of ways to improve the government’s ability to pre-commit, than to basically concede the point and focus all attention on how to keep banks from putting the government in a position where its willpower is tested?

Do we need to call in Dr. Strangelove?

It’s the Spending, Stupid

Filed under: Economics,Politics — The Professor @ 9:25 pm

Most public policy debates, e.g., healthcare, focus on the deficit.  As I said in a post some time ago, that’s a red herring.  What really matters is the amount of spending.  The deficit just relates to the Fram Oil Filter challenge: you can pay me now, or pay me later.  The first order issue is how much you spend and whether you spend it wisely, not how you finance it.  Deficits are correlated with bad outcomes to the extent that deficits are correlated with wasteful spending.  Spending badly and paying for it with a tax today so that it is deficit neutral is no better than spending badly and paying for it with taxes later.

Ed Lazear, whom I TA’d for some time around the Trojan War, makes the point quite nicely in a WSJ oped today:

The recent growth in spending has been camouflaged by a focus on deficits. Budgets and proposed legislation, like that on health care, are being judged not by their impact on spending and taxation, but by their projected effect on the deficit. Equal increases in spending and taxes reduce economic growth, even if they do not alter the deficit.

So the rhetoric surrounding the health-care bills misses this point. Were they to pass, it would mean more spending, more taxes and less growth. Both the White House and Congress have discussed fiscal responsibility in terms of the bills’ effect on the deficit, not the amount of spending.

The health legislation that looked likely until Massachusetts voted last week included about $1 trillion in new spending, $500 billion in promised Medicare cuts, and slightly more than $500 billion in increased taxes. If the Medicare cuts were to materialize, then the bill would reduce the deficit because tax increases exceed net new spending.

But even if the Medicare cuts were realized, the policy would contribute to the growing size of federal spending and the budget, which, when financed, is the major impediment to economic growth. Arguments over whether the legislation would increase or decrease the deficit or whether it would bend the “cost curve” down or raise it are secondary as far as economic growth is concerned. The largest impact comes from levying over $500 billion of new taxes to pay for the increased spending.

Despite all the talk about deficits, the irony is that we are in little danger of eliminating or reducing the federal deficit. Mr. Obama’s target is to lower the deficit to 4% of GDP by 2013. That is twice the level of the Bush deficit in the average year and larger than any Bush-year deficit. During President George W. Bush’s term, the ratio of federal spending to GDP averaged 20%. Mr. Obama’s budget aspires to reduce the spending ratio to 23% by 2013 from 24% today.

. . . .

Let us pay close attention to the president’s message. But let us not be confused by promises of jobs, coupled with fiscally responsible sounding language that masks the underlying irresponsibility of budget decisions. Proposals that increase taxes and spending, even if they do not increase the deficit, will place a substantial burden on our recovering economy and on future economic growth.

Just so.

Barone on 2010 vs. 1994

Filed under: Politics — The Professor @ 9:02 pm

SWP, 5 November, 2008:

The operative word here is “attempt.” I expect that if Obama and the extreme liberals that dominate Congress were to attempt to enact such an agenda–and it is the agenda of their desires–that even the dreamy types mesmerized by anodyne promises of change would awake from their reveries.  Talk of unspecified “hope” and “change” allows the lazy listener to imagine the changes she or he hopes to see, and assume that Obama shares the same vision. (That’s how cons work.) Things are quite different when one sees the specifics, and comprehends the dramatic implications thereof. The resulting popular outrage would make the Clinton 1993-1994 explosion look like a dud firecracker.

Michael Barone, 27 January, 2009 2010:

Many people ask me whether the Democrats are in as much trouble as they were in 1994. The numbers suggest they are in much deeper trouble, at least at this moment. Back in 1994 I wrote the first article in a nonpartisan publication suggesting that the Republicans had a serious chance to win the 40 seats necessary for a majority in the House. That article appeared in U.S. News & World Report in July 1994.



January 27, 2010

What Happened to the IPO Pop?

Filed under: Commodities,Economics,Exchanges,Politics,Russia — The Professor @ 1:10 pm

Most IPOs “pop” on their first day of trading.  Their prices typically rise, and often by a lot, above the offering price.  The pops tend to be bigger on less developed markets.

Daring to be different, Oleg Deripaska’s Rusal had a negative pop.  Indeed, it was down 10.6 percent below the offering price.  Now, some of this can be attributed to the fact that the Chinese market has been trending down, and went down between the pricing date and the first trading date.  The Chinese aluminum firm Chalco went down 9.7 percent between the day that the Rusal issue was priced, and the first trading day.

But however you measure it, Rusal was a big underperformer, relative to typical IPOs.

In some sense this isn’t a surprise.  UralSib’s Chris Weafer suggested the issue was as much as 50 percent overpriced.

So why did the issue sell out when it was arguably overpriced?  Well, one possibility is that this was a combination of a state bailout of Deripaska/Rusal, and a debt restructuring.  Russian state owned bank VEB took about a third of the issue, and Sberbank and VTB, also Russian state banks took down pieces as well (though I haven’t been able to find out how much).  Moreover, participation was limited by the HKSE to big institutional investors, including many banks who had lent Rusal a large amount of money, some of which was to be repaid with IPO proceeds.  Overpaying by the state banks would effectively provide state support for Rusal.  Overpaying by those who had lent Rusal money, who were then paid for their debt using the IPO proceeds, would be a backdoor way of making the banks take a haircut on the debt.

Given that this whole IPO was pushed by the banks as a way of reducing their exposure to Rusal, overpaying 10 percent for the equity can reasonably be seen as a small price t0 pay to take a few pieces out of the Rusal albatross hanging around their necks.

This is a black eye for the Hong Kong Stock Exchange, though.  The negative pop is just the culmination of a very ugly, ugly process.  I don’t know if there’s soap strong enough to wash the Deripaska/Rusal stench from the HKSE.

Not that they weren’t warned, and not that they should have needed a warning to know.  Deripaska is P-O-I-S-O-N.

January 25, 2010

But I’m just a soul whose intentions are good / Oh Lord, please don’t let me be misunderstood

Filed under: Politics — The Professor @ 5:03 pm

Apparently the diagnosis within the White House is that Obama is a soul whose intentions and actions are good, but because he was so busy successfully acting on those intentions, he failed to communicate their total wonderfulness.  And as a result, he’s just misunderstood:

One thing I regret this year is that we were so busy just getting stuff done . . . that I think we lost some of that sense of speaking directly to the American people. . . . I think the assumption was, if I just focus on policy, if I just focus on the, you know, this provision, or that law, or are we making a good, rational decision here, that people will get it.

So prepare for another chorus of paeans to The One’s new clothes. A propaganda offensive for all you hicks out there just not smart enough to get it on your own, so it has to be spelled out for you.

But Obama’s problem isn’t that people don’t know what he’s done and what he intends to do, but that they know them all too well.  Consequently, this new communications barrage is only likely to make things worse for him politically, not better.  It’s sort of like what Twain said: better to remain silent and let people think you’re an idiot, than open your mouth and remove all doubt.

Title H/T: Eric Burden and the Animals.

January 24, 2010

I Hate Reruns

Filed under: Economics,Energy,Politics,Russia — The Professor @ 8:31 pm

ExxonMobil is at loggerheads with the Russian government over the Sakhalin I project.  The issue is the one that eventually spelled Shell’s doom in Sakhalin II: development costs under the production sharing agreement (PSA):

The government rejected a proposal by ExxonMobil, the world’s largest company by market value, to invest $3.5 billion this year in the Sakhalin offshore fields, putting the oil producer’s plans at risk again, Sakhalin Governor Alexander Khoroshavin said Thursday.

Higher expenses in production sharing agreements — such as Sakhalin-1, which is operated by an Exxon-led consortium — would delay the government in receiving its share of revenues until the companies that develop fields recoup their investment.

“We believe it is an inflated amount,” Khoroshavin told reporters after a Cabinet session Thursday that discussed unrelated issues. “The consortium can’t substantiate it for us, this $3.5 billion.”

Exxon said it had to suspend work on a Sakhalin field for several weeks at the start of last year as it argued with the government about the 2009 investment budget for the project that it co-owns with Rosneft, Japan’s Sodeco and India’s ONGK Videsh. The consortium has been producing oil at a field off Sakhalin for a few years and is investing in another field.

An ExxonMobil spokesman said the company was working to respond to the government’s concerns and hoped to return to discussions on the matter in the spring.

Khoroshavin said Exxon would submit a revised spending plan to the government in March.

This negotiation takes place, of course, in the shadow of Gazprom, which needs the Sakhalin gas to meet its own commitments, and to achieve its ambitions to control the supply of gas to China:

The spending dispute has been recurring as Gazprom seeks to buy all future gas from Sakhalin-1 to prevent it from flowing to China, which would create competition for Gazprom’s own plans to sell gas on that market. Exxon has said the project would sell gas to the highest bidder.

Gazprom also needs the Sakhalin-1 gas to fill a pipeline that it is constructing from the island to Vladivostok to supply clean fuel in time for the Asia-Pacific Economic Cooperation forum in the port city in 2012.

“Much will depend on Sakhalin-1, that is, whether Gazprom can buy their gas for the pipeline,” Khoroshavin said, referring to the prospect of fully loading the pipeline by 2012.

ExxonMobil currently has the right to market the gas itself, an exception from Gazprom’s gas export monopoly that grates on the Russian behemoth.  Given these circumstances, there is good reason to be suspicious of these standoffs.  They are quite likely pretexts to holdup XOM, and wrest control of Sakhalin I gas.  Given the experience of Shell, it is hard to imagine that a canny company like XOM would inflate costs, knowing that this would give Putin the perfect excuse to crank up the “these unfair PSAs were negotiated when Russia was on its knees and now we’re standing tall and will take back what’s ours” rhetoric.  That may be coming regardless, but Exxon has every incentive not to provide Putin any ammunition.

This isn’t over.  It’s almost certain that the pressure will intensify, especially as the 2012 APEC date approaches, and Gazprom becomes more desperate for gas to cover its own falling production.

I Thought DC Was On the Potomac, But I Guess It’s Actually on De Nile

Filed under: Politics — The Professor @ 5:59 pm

You just keep on believing, folks:

Gibbs said that Brown may have campaigned on stopping the health care bill but that’s not why voters elected him over Democrat Martha Coakley.

“More people voted to express their support for Barack Obama than to oppose him,” Gibbs said.

Yeah, go with that.  Right until that moment when you realize, Wiley Coyote-like, that you’ve just sprinted over the edge of a cliff.

Beep-beep!

Musical Interlude

Filed under: Uncategorized — The Professor @ 5:52 pm

This was a musical weekend with SWP daughter #1.  Friday night was saw a solo acoustic performance by Scott Miller, a country-ish, rocker-ish at a local venue, the Mucky Duck.  I am mainly familiar with him through his recordings with his band, The Commonwealth, and most of the songs he performed Friday were SM&C tunes.

He was an excellent musician, and entertainer.  He had a very cynical, jaded attitude, which was actually quite funny.  He put everything into the show.

He performed two Civil War-themed songs, and one about Sam Houston.  Not everyday that you hear a song about the travails of the Confederate defenders of the Mule Shoe at Spottsylvania on May 12, 1864, facing a massive Union attack in the dripping woods with muskets rendered useless by  rain-soaked powder.

Last night went to a more conventional show, by Everclear at the Houston House of Blues.  Everclear has been a favorite of mine since 1995.  The only original band member is frontman Art Alexakis, who’s almost as old as I am, and definitely has much higher mileage:)  The rest of the band could probably be his kids.  Nonetheless, he put on a very energetic show, hitting most of the best Everclear songs including Santa Monica, Volvo Driving Soccer Mom, Father of Mine, Heroin Girl, etc.  Only song I was really hoping to hear but didn’t was Rock Star.  And Local God and The Drama King.  Alexakis is an excellent songwriter, and it was great to hear songs I’ve listened to zillions of times live.

The lead off band was one of the best I’ve ever heard, Clayton Senne. He/they were infectious, playing mostly high tempo, singable/danceable tunes.  The drummer was a kick.  Mr. Happy, banging away with abandon, all the while a big ol’ sh*t eating grin on this face.  His very wide face: saw him downstairs after the show, and he was about as wide as was tall.  But he was great, as was lead singer and keyboardist Senne.  Like my daughter said, it was like a great combination of Something Corporate and Ben Folds.

Sat upstairs in the balcony, instead of standing on the main floor.  In some sense, probably a good idea after standing at the Mucky Duck for the entire 2 hour show on Friday.  Though I have to say, a good fraction of the people up there sat stock still in their seats.  How is that possible, when a good band is putting on a good, high tempo show?  And if you just want to sit motionless, why spend 50 clams when you could do that at home for free?  I don’t get it.

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