Monday, December 28, 2009

Safety nets and whatnot

Over on Felix Salmon's blog, I made the following comment:

I think this is exactly right. If you want people to take more risks, you can either:

A. Increase the benefits they get from successful outcomes (which I view as the generally Republican view, such as reducing capital gains taxes or inheritance taxes)

B. Decrease the costs they bear from unsuccessful outcomes

C. Increase the probability of a successful outcome

I think all of these are plausible goals, but in my eyes if you want me to walk a tightrope, making the wire more stable and adding a safety net is going to jack up the probability much more than adding some gold to the pot on the other side.

As Greg Mankiw or Charlie Munger would say, incentives matter.  But there are often a variety of (changes in) incentives that would induce the same (changes in) behavior.  I left at least one alternative out:
D.  You can make the existing situation (e.g., current job, retirement system) more risky

In any event, it's easy to find examples of people arguing that bigger payoffs encourage more risk-taking.  Some interesting quotes from a 2002 article that does it (not sure why the Hawaii Reporter was the first google result, but who cares?):
President George W. Bush renewed his call for permanent repeal of the estate tax on March 19. "It is unfair, patently unfair, for any entrepreneur ... to develop her own business and have that business taxed twice as she tries to leave her assets to whomever she chooses," Bush told a Women's Entrepreneurship Summit in Washington, D.C. "We must make the repeal of the death tax permanent. I call upon Congress to do this immediately."
 "I do not believe the role of government is to create wealth," the president told last Tuesday's group at the Ronald Reagan Building and International Trade Center. "The role of government is to create an environment that encourages risk taking, an environment that facilitates the flow of capital, and an environment in which people can realize their dreams. ... And that's exactly what I intend to do as the President."

So why is it that I see so much push towards increasing payoffs to investment, but relatively little on enhancing the safety nets for failed outcomes?  I mean, it's understandable to think about the successes, but we can't ignore the "risk" in "risk-taking".  If we truly want to encourage people to take more risks, with the belief that risk-taking promotes economic growth, shouldn't we be using a full mix of incentives?  In other words, why so much "Incentive A" from above, but so little "Incentives B & C"?  Especially since, in my personal view, the likelihood that my future huge estate will be taxed upon my death is an infinitely minor reason for me not to strike out on my own.

One thing I find interesting is that "Incentive D" is in accord with Greg Mankiw's argument for negative real interest rates - make the status quo less desirable to push people into more investment.

Also, as I noted on Felix's blog, I recently saw Man On Wire, which I thought was fantastic.  Hat tip to Tyler Cowen for that.

Sunday, December 13, 2009

Can this possibly be true?

On the nytimes website, Randall Stross writes:
I LOVE my iPhone. I just wish it were matched with Verizon Wireless, the carrier with the most envied reputation as fast, ubiquitous, reliable, nigh perfect.
I find myself saying this about 8 times a day.  But it turns out that Randall and I could be directing our angst at the wrong target.  

Consumer Reports has just released its annual survey of cellphone service, and its respondents collectively agree with me about the rankings: AT&T occupies the bottom and Verizon, the top.
And the iPhone itself may not be so great after all. Its design is contributing to performance problems.

I don't have any particular commentary to add to this, other than the fact that I'm absolutely stunned.  A few consequences:

  1. I have an iphone now and had long ago decided that I was switching to Verizon as soon as they started offering the iphone.  Not so much now.
  2. I have to acknowledge the fact that I don't know jack about technology and I should perhaps stop having such strong opinions about technology-related products.  
  3. I already have a hard time thinking about what my next cell phone will be (I'm definitely upgrading - I've got a first generation iphone), and this confusion is going to make it harder for me.

So, I guess, sorry AT&T for my absolute-but-maybe-not-deserved hatred of you for the past few years?

Friday, December 11, 2009

Housing as an investment 2

The discussion on rortybomb continues, so I thought I’d add some more thoughts.

As humans, we are effectively short food and shelter for the rest of our lives, and you could probably add in insurance/medical care.  (I think Mike at Rortybomb made this point a while ago, but I couldn’t easily google it.)  That means that we need to somehow structure our earnings, consumption, and investment to satisfy those expected needs (future payments), bearing in mind that in our later years we’ll be doing very little earning and investing, and lots of consumption.

However, we have a choice on how we satisfy those needs.  One way is to prepay them while we are working, which is what one commenter suggests for our housing needs:

My view of the housing market, and why I think a lot of this anti-housing as an investment is silly, is that it’s a consumption good you will always need to consume. You’re not going to suddenly decide in 2027 that you might do without housing for a while. On that basis alone then it’s quite sensible to store it up for when you have no income, ie in retirement. It’s an almost perfect hedge of a large chunk of your consumption needs.

The commenter is right in one regard – we certainly do need to store up for our future consumption, when we’ll have no income.  However, the choice is not whether to save for the future, but in what vehicle.  Specifically, the above comment seems to argue that we should be prepaying for our housing needs.  Paraphrasing:  “Buy a house now so that you’ll have one when you’re not employed.” 

While I certainly agree with the need to save for future consumption, I don't see any reason that we should prepay our housing needs in the form of a single, non-diversified asset with large transactions costs.  Similarly, I think we can effectively save for our future food needs without filling our basements with cans of vegetables, soup, and spam.  (And beer!  Don’t forget the beer.  Some, especially stouts and barleywines age very well.)

So the choice isn’t save or don’t save for future housing consumption.  But rather, in what form.  Putting aside some very important factors (differences of housing types available for rent or sale, other payments like property taxes, maintenance, possible rent increases), it's an economic tradeoff between two different-looking cash flow streams.  In the same way that annuities can be easily converted into lump sums (and vice versa), it's straightforward to compare renting (effectively a negative annuity) with buying (a one-time lump sum).  It's inappropriate (in my opinion) to imply that buying is somehow different (and better) than renting because of the timing of the payments.

My impression of this debate is that most people arguing for housing as an investment view the purchase of a home as qualitatively better than renting a home (for reasons that are often poorly articulated), while the other side views it as more of a straightforward evaluation of the timing and magnitude of the cash flows.

Thursday, December 10, 2009

Housing as an investment

Over on the fantastic rortyblog, Mike gets involved in a conversation on housing.  Specifically, he discusses the notion that housing is a good investment decision, as argued by Adam Ozimek.

I largely agree with Mike's broad point - too often people overvalue the notion that housing is an investment.  My particular bete noir is the idea that "rent is throwing money away" while mortgage payments are building up equity.  I think it's pretty intuitive that the decision to rent versus buy any asset hinges upon the relative cost of doing each.  Historically, it's been a very good idea to buy in most markets, especially considering that labor mobility wasn't as important as it is today and people were able to stay in one place for longer periods of time, avoiding the significant transaction costs associated with moving.

In any event, I fall in Mike's and Felix Salmon's camp of thinking that housing as an investment is generally a bad idea.  But I actually disagree (I think) with one of Mike's comments:

Felix notes: “DanHess and Matt Turner make the point that buying a house is a great way of forcing people to save over the long term.” There are no free lunches of course, and the reason it is a great way of forcing people to save over the long term is that it is incredibly expensive and difficult to get any money out of it.
I think the more straightforward reason is behavioral.  You've gotten people to commit to saving in a way that isn't transparent, so they're not actually aware they're doing it.  It's just that, 30 years later, they get to put a mortgage document on their grill and have a party when they realize how much equity they've built up.

It doesn't seem terribly different (to me, of course) from:
- withholding social security payments involuntarily
- automatic 401(k) enrollment
- the new programs where employees can commit that future raises will go toward retirement contributions (are these just hypothetical?  I feel like I've read about the idea many times, but haven't seen any actual examples)

In all of these cases, it strikes me that saving is made easier because there was something automated about the process, where the individual doesn't feel the "pain" of foregone consumption. 

(You could also point out that the mechanism of withholding income taxes accomplishes the same thing - reducing the public's understanding of how much in tax they actually pay.)

So overall, I actually do think it's a free lunch, in much the same way that a lot of valuable internet content is a free lunch.  Of course there's a cost - individuals truly are foregoing consumption, and internet contributors truly are laboring to create content without compensation.  It's just that in those cases, the people bearing the cost don't seem to mind as much as they probably should.

Wednesday, December 9, 2009

That didn't go as planned

So Jennifer left Top Chef last week, but I think my predictions had some merit.  First, I think the time off did Jennifer well - she seemed to be much stronger (both in attitude and in hair) than she did at the end of the regular season.  She performed well in the quickfire and seemed* to do well in the elimination challenge.

Mike V. also lived up to my expectations, in terms of making ostensibly risky decisions (the 63 degree egg, which led to the awesome "it's up to the egg at this point" statement).

The big disappointment for me was in the show's editing.  Leading up to the final announcement, it seemed that Michael's dish was not strong (i.e., the risky egg decision had backfired AS I PREDICTED LAST WEEK) and Jennifer seemed to have done well.  When they announced that Jennifer would be packing her knives, I was a bit surprised.  Then, reading Tom's blog I read:

"It may not make sense to you but it was clear to us immediately that it would be Jen who would be going home. What it came down to was that both of her dishes were way too salty. Jen’s overseasoning of both her dishes stood out to the judges like a sore thumb. We had our conversation at Judges' Table about whom to send home, but it was pro forma; we already knew and were in complete accord."


Meh.  I still vote Kevin for the win, as does apparently ever other person on the internet.

Other notes:
This is a relative statement, but Padma didn't look nearly as attractive as she historically has.  The bangs looked somewhat ridiculous.

I had the Daisy Cutter Pale Ale, which gets insanely high ratings on, higher than Alpha King even.  I don't get it.  It smelled fantastic, like a thick and rich double IPA, but it tasted very, very thin.  I didn't care for the disconnect at all - for that taste, I wanted something much richer and velvety.

Wednesday, December 2, 2009

Tonight I'm looking forward to ...

Watching Top Chef, where the final 4 cheftestants have been fairly obvious for several weeks. I don't believe there's a weak link among them, so I expect tonight's loser will fall because of some type of mistake, rather than by simply being outclassed.

For reasons I can't articulate, I'm rooting for
Jennifer Carroll. Toward the end of the regular season, she seemed to clearly hit a wall and begin to wilt under the pressure. While that's a bad sign, I think it makes the break and change in locale especially valuable for her.

So if Jennifer stays, who goes? I think that it's one of the 2 Voltaggio brothers. My take is that Michael is the more talented, but also the more adventurous, of the two. I think at this point in the competition, the day-to-day variance is more important than the chef-specific talent, so I'm predicting that Michael V. takes a risk that doesn't pan(!) out. (I think Chris at
Procrastiblog has it wrong, specifically undervaluing the time off for Jennifer.)

I'm looking forward to drinking something new tonight, and I have several choices:

Lagunitas Brown Shugga', which is apparently a new version of their barleywine.

Another Barleywine - Avery Hog Heaven

Daily Cutter Pale Ale, which is fairly new and apparently battling with 3 Floyd's Alpha King for Pale Ale supremacy in the greater Chicago area.

Lagunitas Lucky 13. Lagunitas doesn't make the best beers in the craft world, but it's really hard to beat the quality/value combo they offer.

The Brown Shugga is in 12 oz. bottles, while the remaining beers are in 22 oz. bottles. I think the Hog Heaven is too strong to drink a bomber on a weeknight, so I'll probably go with the Brown Shugga or the Daisy Cutter.

[I'm just going to pretend that there's nothing unusual about updating a blog I haven't touched in about 8 months. I'd like to write some things about financial literacy, but I'll believe it when I see it.]

Tuesday, April 7, 2009


This is very curious.  I'm having a Sierra Nevada Torpedo right now, which I believe makes it the third time I've tried it.  It's gotten better each time, by quite a lot.  

Sierra Nevada Pale Ale is probably responsible for me enjoying craft beers.  It was my go-to beer for many years in grad school while my friends drank margaritas.  I had read a great deal of hype about Torpedo and was a little disappointed with my first sample.  But, for whatever reason, it's really grown on me. 

No numbers right now. 

Friday, April 3, 2009

Is this a change?

I haven't had a chance to look closely, but the "revised" mark-to-market rules seem remarkably similar to the old rules.  So there's more judgment allowed in classifying assets as Level 3 vs. Level 2?  That doesn't seem too overwhelmingly different.  The important thing is that firms accurately disclose the dollar amounts of assets/liabilities in each category (i.e., Level 1, Level 2, Level 3) and how the stated values compare to both historical cost and current (even if dislocated) markets.  Let investors then decide how much of a haircut they want to apply to Level 3 assets depending on how they view the integrity of the manager. 

But hey, maybe the masses need some shot of good news, even if the item isn't necessarily news or good.

Up next - eliminate short selling!

Tonight's beers:
Bell's HopSlam - still very good, but the wonderful hop taste seems to be fading

Sierra Nevada Torpedo - I think this is a good to very good beer and probably wins on value against a lot of other beers.  However, I'm going to pay the extra $2 per 6 pack to get 3 Floyd's Alpha King or Bell's Two Hearted.

Friday, March 13, 2009

Jack Ciesielski sheds some actual information on the debate (not for the first time)

I'm a big fan of Jack Ciesielski's blog, and I think he's been especially on target with his discussion of mark-to-market accounting, and how most critics appear woefully uninformed about the newness of the fair value requirements. Read the whole thing.

The Lynch Mob Forms
So there's only one thing left to do: blame the accountants. There's an angry mob forming, and it looks like they brought a rope. They're converging at the Rayburn House Office Building in Washington, DC on Thursday, March 12, when Congressman Paul Kanjorski holds a hearing to "address problems facing mark-to-market accounting."

The press is having a field day with this: it's been a long time since an accounting standard was in the news so much. Ben Stein
threw a tantrum in the Sunday New York Times, calling for someone, anyone, to "immediately end the near-universal applicability of the accounting rule formally known as FAS 157." Ben: get a grip. Statement 157 is universal, all right - it applies to any balance sheet account that had been given fair value treatment before the issuance of Statement 157. The most pervasive and confidence-destroying myth about Statement 157 is that it's somehow requiring fair value reporting for the first time in places where it hadn't ever been used before. 
If folks like Ben would maybe just READ Statement 157, they'd understand that. If they'd really stretch and read the SEC's Congress-mandated study on fair value accounting, they'd know that at the banks where all the alleged fair value damage has been wrought, only about 31% of total assets are given the fair value treatment - hardly "near-universal." The biggest assets on banks' balance sheets are their loans - and they do not receive fair value treatment. Their greatest amount of assets were unaffected by the implementation of Statement 157. It's easier to deflect blame on an accounting rule than face culpability for bad loans made, however.

The conventional wisdom (hard to call it that) that Statement 157 is creating fair value reporting where it had not been applied before. It's simply misinformation: Statement 157 put one definition of fair value into the accounting rules and added more disclosures for users - including the widely-used Level 1, 2 and 3 fair value hierarchy disclosures.

Good and bad news on mark-to-market accounting

Some good news and some bad news on the mark-to-market accounting (MTM) front.

First the bad news:
Speaking to my dad a while ago, he argued that much of the current problems would go away if we got rid of MTM accounting and reinstituted the uptick rule for short sales. Yay for Fox News/CNBC talking points!

The good news:
There are some intelligent discussions of some of the nuances in MTM accounting. Two examples:

Nobody Says Mark to Market Doesn’t Matter as GE Falls
When I saw the headline, my immediate reaction was huge disappointment. "Not another badly-written article talking superficially about how MTM is the root cause of everything." But I was pleasantly surprised when the article spoke about exactly the opposite. The whole article is worth reading, but here's the punch line:

"For more than a decade General Electric Co. could easily avoid disclosing the value of its real estate and business loans. Not any more.

Since Jan. 2, GE has lost 45 percent on the New York Stock Exchange, mostly because shareholders are no longer willing to accept whatever the Fairfield, Connecticut-based company tells them about its finance subsidiary unless it’s based on so-called mark-to-market accounting rules."

That’s an excellent antidote to the arguments against MTM. Yes, firms are currently forced to reveal the substantial decreases in market value for their financial instruments, and that’s making them look bad. Maybe that decrease is temporary (liquidity-driven), maybe it’s permanent (reflecting changes in estimated future cash-flows). But it’s providing information to the market, which is likely better than not having that information at all. It seems investors may have been skeptical of GE’s non-MTM financial instruments because the absence of information is probably worse than the presence of (perhaps) noisy information.

The second piece of good news relates to the supposed consequences of MTM accounting. The critical issue for MTM accounting is this: What do you actually do with the MTM adjustments?

One of the big arguments against MTM accounting claims a sequential, recursive process:
  1. MTM accounting forces Firm A to write down the value of certain assets (perhaps residential mortgage backed securities) because they have declined in value since origination/purchase.
  2. After writing down those assets, Firm A is in violation of regulatory requirements and must de-leverage. The firm can de-leverage by raising capital through equity issuances or by selling off some assets and paying down debt.
  3. In the current environment, capital isn’t available, so Firm A has to sell off assets.
  4. When Firm A sells off those assets with highly uncertain value, it is forced to accept fire-sale prices, because investors require steep discounts to make up for the uncertainty about future cash flows.
  5. Firm B, which holds similar assets, is now forced to use the fire-sale price as the measure of market value, which to reduce the valuations on their balance sheets.
  6. In order to meet regulatory requirements, Firm B must de-leverage by selling off some of its assets.
  7. Firm C uses the new marks, ad infinitum.

Critics of MTM have said, “Stop the madness! End MTM accounting and you will end this recursive death spiral.” But what the critics should be saying is, “Stop the madness! Stop taking mechanical actions based on marks if those marks are uncertain. Keep the MTM accounting, but loosen up the regulatory requirements.” (This assumes that there is something wrong with the current process, which I’m not sure is a premise I agree with.)

I am not surprised to find myself agreeing with Warren Buffett, as conveyed by Holman Jenkins in the WSJ:
Buffett's Unmentionable Bank Solution
“Now comes Warren Buffett, a big investor in Wells Fargo, M&T Bank and several other banks, who, during his marathon appearance on CNBC Monday, clearly called for suspension of mark-to-market accounting for regulatory capital purposes.

We add the italics for the benefit of a House hearing tomorrow on this very issue. Mark-to-market accounting is fine for disclosure purposes, because investors are not required to take actions based on it. It's not so fine for regulatory purposes. It doesn't just inform but can dictate actions that make no sense in the circumstances. Banks can be forced to raise capital when capital is unavailable or unduly expensive; regulators can be forced to treat banks as insolvent though their assets continue to perform.


CNBC, sadly, has been playing a loop of Mr. Buffett's remarks that does a consummate job of leaving out his most important point. Nobody cares about the merits of mark-to-market in the abstract, but how it impacts our current banking crisis. And his exact words were that it is "gasoline on the fire in terms of financial institutions."

Wednesday, February 11, 2009

I think I like this plan

CalculatedRisk describes his view/guess as to the administration's plan.  I hope he's right, because it sounds very reasonable.  Excerpt:
It sounds like the stress tests could be completed within "weeks" at some banks, and I think 30 days is sufficient for all 18 or so banks with $100 billion in assets.

The banks will probably fall into one of three categories:

1) No additional assistance required. These banks will definitely want this publicized!

2) The banks in between that will need additional capital. This is where the Capital Assistance Program comes in:
Capital Assistance Program: While banks will be encouraged to access private markets to raise any additional capital needed to establish this buffer, a financial institution that has undergone a comprehensive “stress test” will have access to a Treasury provided “capital buffer” to help absorb losses and serve as a bridge to receiving increased private capital. ... Firms will receive a preferred security investment from Treasury in convertible securities that they can convert into common equity if needed to preserve lending in a worse-than-expected economic environment. This convertible preferred security will carry a dividend to be specified later and a conversion price set at a modest discount from the prevailing level of the institution’s stock price as of February 9, 2009.
emphasis added
3) Banks that will need to be nationalized or sold.

There are still several issues:
1.  How do you announce the results?  Uncertainty is bad and announcing the results piecemeal will cause great uncertainty.  I think it might be better to announce a fixed date upon which the results for all large banks will be announced.  Even then, I can't even imagine the options market behavior leading up to that date.

2.  Getting new money injected can be tricky.  Especially difficult is figuring out what the government should get in return.  I think that aiming for public-private partnerships would work well.  For example, tell firms that need money, "Listen, if you want money, we'd prefer you arrange for private transactions, such as those executed between Berkshire Hathaway and Goldman Sachs, General Electric, and Harley Davidson.  For every dollar you raise privately, the government will be willing to provide up to $10 in exactly the same structure deal."  This works for both liquidity issues and solvency issues.  If a bank isn't able to convince private investors (including the managers) to raise 10% of the needed cash, I think it's hard to make a case that the government should be willing to save it.

3.  How do you nationalize?  I assume this isn't simply a purchase of 100% of the firm's equity at the most recent market price.  Is it just the OTS coming in like they normally do?  Am I overthinking this?

4.  What's happening to the lenders?  We can't have equity holders wiped out while debt holders are made completely whole.  And what about pension obligations?  I don't know what the solution to this is.  I suspect Luigi Zingales would argue for a cram-down, and I largely agree with him.  But I'm not sure I'm considering all the important factors.  For example, what happens if we piss off foreign debt holders?  Is that important?

In any event, these are difficult challenges.  I think, though, that things are moving in much better directions than they were in October of last year.  In terms of the stock market, it seems clear that investors do not like uncertainty, but I'm convinced that the long-term outlook of the U.S. economy is better now than it was in October.   

That means either investors were still too confident in October or investors are too pessimistic now.

Friday, February 6, 2009

Enough with the "Toxic Assets" meme

I don't know how to solve the banking crisis. Let's get that out of the way.

What I do know is that if people are thinking about the problem in the wrong way, they're less likely to come up with a good solution. One of the wrong ways that people are thinking about the problem relates to the notion of "toxic assets".

Here's one example from Fortune:
Don't forget those toxic assets
which includes the following quote:
The trouble is that the toxic assets did not melt away on their own and they contaminate the ability of banks to redress the quality of their balance sheets. Until the banks do so, they stand virtually no chance of returning to more normal lending activity.

Banks serve as intermediaries between savers (who have money) and borrowers (who want it). They take money from savers in the form of checking accounts, savings accounts, and CDs. From the bank’s perspective, these are liabilities. In order to generate funds to satisfy the savers (e.g., to pay interest on savings accounts), pay their operating expenses, and earn a return for the owners (shareholders), banks need to invest that money. Sometimes they’ll lend that money directly to borrowers who want to buy a house or a car or go to school. These loans outstanding are assets from the bank’s perspective. As long as the borrowers make their payments as expected (homeowners make their mortgage payments), the bank can pay its employees, satisfy its obligations to the savers, and have money left over to return to shareholders.

However, when the bank’s assets don’t perform as expected, banks run into problems. So when homeowners begin defaulting on their mortgages at higher-than-expected rates, banks’ assets are worth less than expected, and they have difficulty satisfying their obligations. Right now, banks are having a problem because their assets (money they have lent to borrowers) aren’t worth enough to satisfy their obligations. So that’s the big issue. BANKS’ ASSETS AREN’T SUFFICIENT TO SATISFY THEIR OBLIGATIONS (which effectively means meeting regulatory requirements that asset values have to exceed liabilities by a certain amount).

Now there’s some argument about why this is the case. In short, assets could:
1. Be worth a very small amount because, over the life of those assets (i.e., the term of the loans), the borrowers simply don’t make nearly the dollar amount of payments that banks expected. So a bank that simply holds on to its mortgages for the entire 30-year life gets far less than what was originally borrowed. Consider this a “real” or “permanent” decline in value because it reflects the fact that, in hindsight, banks made stupid loans and they’re going to lose money on those loans.

2. Have a low “market price”. That is, certain assets the bank holds (like investments in pools of mortgages) may actually be traded on an open market. The value of those assets on any given day is based on the observed market price of the asset (just as the value of my assets is based on the quoted prices I see in my brokerage account). Those market prices, in turn, are based on the market’s expectations of what the assets will generate in terms of future cash flows. So the market is trying to estimate, for a given pool of mortgages, say, how many of those mortgages will be paid early, how many of those mortgages will be satisfied over the contractual life, and how many of the mortgages will go in default because the homeowner doesn’t pay. Furthermore, the market has to estimate, for the expected defaults, how much of the mortgage they’ll recover through foreclosure or short sale.

Generally, markets are quite good at estimating the fair value of assets, even very complicated assets. But sometimes there is so much uncertainty that investors simply give up. That is, a bank may have an asset ABC that in 2006 was worth $100,000 based on observed market pricing. But now, investors simply have no idea how much the asset is worth, because they have no idea how high default rates are going to be, or how high recovery rates on foreclosed properties will be. So they say something like, “I wouldn’t be willing to pay more than $5,000 for that asset. But I wouldn’t sell it for less than $95,000. I simply have no idea how much it’s worth and I’m not going to risk money on something with so much uncertainty.”

So now you’ve got banks holding on to assets with highly uncertain values. They don’t want to sell the assets because no one is willing to buy them at what the bank deems a fair price. In the prior example, you might say the expected value of the asset is $50,000 based on the midpoint of the two estimates, but if the bank sold it they’d only get $5,000. These assets with highly uncertain values are being identified as “toxic assets”. And the argument that I see in stories like the Fortune article is that if you can simply remove these toxic assets from the bank’s Balance Sheet, the bank will be perfectly fine.

The argument doesn’t make any sense. The banks aren’t harmed by having those toxic assets on their Balance Sheets. The assets aren’t toxic in the sense that they will actually contaminate any other assets in close proximity. The banks are harmed because they have toxic assets and insufficient other, non-toxic assets to satisfy their obligations.
As an analogy, suppose I borrow some money and use that money to invest in baseball cards. In particular, I use all of the borrowed funds to buy a large supply of 1968 Johnny Bench rookie cards.

Subsequently, it turns out that nobody wants Johnny Bench rookie cards anymore – I can’t sell them, except at super-distressed prices. So I’m stuck. I’ve got to make payments on the loan and all I have are these toxic baseball cards. BUT SIMPLY REMOVING THESE CARDS FROM MY BALANCE SHEET DOES ME NO GOOD. If I burned these baseball cards, I still have no other assets and I still owe money. I can’t be better off by removing the assets from my Balance Sheet. The real issue is that I need some other assets with which I can satisfy my obligations.

The same is true for banks. They don’t benefit by simply removing the toxic assets from the Balance Sheet. They need other, more liquid assets. Framing the problem in any other way is simply obfuscating the central point.

The end result is that troubled banks will either receive capital, be allowed to survive with reduced regulatory requirements, or fail. Regardless of how you feel about letting banks fail in a structured fashion or letting them continue with reduced capital requirements (I think there are merits to both), if banks are going to receive capital from the government, the primary question is “what does the government get in return”. Does the government get shares of equity (common or preferred), does it get debt (and if so, what is it senior to?), does it get the “toxic” assets (i.e., a straight asset sale), or is it simply an injection with no strings attached?

Determining the right structure is difficult for many reasons, even putting aside the dollar amounts (e.g., should the government have voting rights, should the government be allowed to jump ahead of senior claimants in terms of debt priority?). But the dollar amounts are difficult for precisely the reason that these assets are “toxic” to begin with – nobody really has any idea how much they’re worth. So whether it’s a loan or an equity injection or an asset purchase, the question is going to be “how much does the government get in return?”

I don’t know the right way to do this. But I do know that solutions posing as “removing the toxic assets from the Balance Sheet” aren’t doing anyone any favors. If those arguing for removal really mean converting the illiquid assets into cash, they should say so. And they should provide the mechanism by which the dollar amount should be determined. And they should indicate why an asset sale is better than a debt or equity injection. (The market in banks’ common equity is still liquid, so at least the government is more likely to get a fairly-determined price if they were to purchase equity compared to what they’d get if they purchased illiquid asset-backed securities.)

And if those arguing for removal actually believe that simply removing the assets from the Balance Sheet will solve the problem, they should be ignored. And they should send all their unwanted assets to me.

Thursday, February 5, 2009

A minor complaint

I'm drinking a fantastic beer right now, but as is my wont, I see the glass as half-empty.*  Here's the beer:
It's a really delicious, hoppy beer.  It's as if someone were smashing a pink grapefruit on my face, and I mean that in the best possible way.  It's about as good as 3 Floyd's Dreadnaught, which might be the best beer I've ever had.  Even better, it comes in 12 oz bottles instead of the 22 oz. bomber that Dreadnaught is sold in.

Complaints I don't have, but could:
  • It's expensive.  It costs $18 a 6-pack, which is pretty extreme, even for someone who's used to paying about $10 per 6-pack (Alpha King).  However, I'm generally happy to pay $10 for a 4-pack of Dogfish Head 90 Minute IPA, so that's pretty close on a per-bottle basis.  And compared to Dreadnaught ($11 for 22 oz.), it's a bargain.
  • It's seasonal.  It's only available in January and February.  In fact, when I bought 2 6-packs last week, the beer guy said he was surprised he still had any left.    The limited availability doesn't bother me, and I'm not sure why.  It might be due to the fact that this is the first year I've tried the beer, so I'm not familiar with the 10.5 month period of longing. Instead, I'm just savoring each one, knowing that my supply is extremely limited.
Here's my issue:
I don't know how to type the name of the beer.  (You may have noticed that I've avoided mentioning it by name.)  I'm pretty nitpicky and I like to identify things appropriately, but I have no idea whether to capitalize the S.  My go-to beer site ( lists it as "HopSlam".  But Bell's website lists it as "Hopslam".  And maybe the brewer's website should be the last word, but there are two more arguments for capitalization:
  1. The label strongly hints at a capital S.  Look at it - the S is almost twice as large as the preceding p.
  2. A capitalized S really distinguishes the two components of the name.  It says, "This is a Hop Slam.  You are about to get slammed by a large batch of hops."  A lower-case s doesn't carry the same impact.
So I deem it HopSlam.  I really hate the idea that I'm effectively telling Bell's (the brewer) that they're misspelling the name of one of their beers.  But HopSlam seems to be such a dominant name relative to Hopslam that I feel ok doing it.  

*My glass is quite literally half-empty right now, but I mean this more in the figurative sense.

I will not be motivated by your rebus

In the summer before my junior year in high school, each player on our football team received a gray t-shirt with the following graphic on the front:

I didn't get it.  Granted, I didn't stay up nights thinking about it, but I didn't understand what "Team Me" was.  Maybe that was a sign that I wasn't bound for football glory.  (I wasn't.)  Maybe it was a sign that I'm a very uncreative person.   Whatever it is, I simply wasn't motivated by it, even when I learned that it represented a mentality of "Big Team, little me".

I know that in team sports it's important to realize that individual accomplishments don't always lead to team success.  But for me, the message is lost when it's cast in a goofy puzzle.  Maybe my life would have been substantially different if my coach had gone with a shirt saying, "There's no I in TEAM."  That statement still involves some cute wordplay, but I'm pretty sure I would have grokked the point much more quickly. 

Wednesday, February 4, 2009

Easy choice

It's rare for me to see such lopsided competition.

Like a brussels sprout taking on a chocolate chip cookie.

This blog is off to an inauspicious start, at least in terms of beer/numbers relevance.