Flashman Letters

Here Is How The 50% Greek Haircut Is Actually Just 28% | ZeroHedge

Greece has €350 billion in total debt including about €70 billion in Troika "post-petition" loans; these are untouched.

Of the €280 billion, roughly €75 billion is held by the ECB: this, like the Troika loans, will be untouched.

This leaves just ~€200 billion in actual debt to undergo a haircut.

Apply a 50% haircut to this debt (ignoring the fact that of this about €35 billion is held by Greek pension funds, and once the realization that Greek pensions have been cut in half dawns upon the population, the result will be the biggest riots ever seen in Athens yet).

Total debt to be cut: just about €100 billion.

Hence, of the total €350 billion, just €100 billion is eliminated, most of it used to backstop and service Greek pension and retirement obligations

€250, or the residual, of €350, the original, means 72%, or a 28% haircut.

Greek GDP was €230 billion on December 31, 2010 and declining fast.

And that is how a 50% haircut is "cut" almost in half

via www.zerohedge.com

European summits in ivory towers

The result of this failure of the ECB to be a lender of last resort has been that a surrogate institution, the EFSF/ESM, had to be created that everybody knows will be ineffective. It has insufficient firepower and has an unworkable governance structure where each country keeps its veto power. In times of crisis it will be paralysed. As markets know this, its credibility will be weak.

To hide these shortcomings European leaders are now creating the fiction that by some clever leveraging trick the resources of the EFSF/ESM can be multiplied, allowing the ECB to retire to its Panglossian garden of inflation targeting. European leaders should know, however, that leverage creates risk, very large risks. These appear with full force when liquidity crises erupt. Thus when the leverage trick will be most needed, it will fail as it will show how risky the positions are of those who have guaranteed the leverage construction. Governments which now enjoy AAA creditworthiness will take the full blow of a 100% loss on their equity tranches and will lose their creditworthiness in one blow. The whole risky construction will collapse like other clever financial constructions of the recent past.

via www.nakedcapitalism.com

Herman Cain - Wouldn't Former Kansas City Fed Chairman sound better than Former Godfather's Pizza CEO.

Cain became a member of the board of directors of the Federal Reserve Bank of Kansas City in 1992 and served as its chairman from January 1995 to August 1996, when he resigned to become active in national politics.^[39]

Cain was on the board of directors of Aquila, Inc. from 1992 to 2008, and also served as a board member for Nabisco, Whirlpool, Reader's Digest, and AGCO, Inc.^[40][24][41

via en.wikipedia.org

The history and future of banking, according to Andy Haldane

These governance changes created an asymmetric risk profile. As Robert Merton explained, the equity of an LLC “can be valued as a call option on its assets, with a strike price equal to the value of its liabilities”. And “because volatility increases the upside return without affecting the downside risk. If banks seek to maximise shareholder value, they will seek bigger and riskier bets.”

5. As well as creating “volatility junkies”, the changes encouraged banks to gear-up their balance sheets. “As unlimited liability was phased out, leverage rose from around 3-4 in the middle of the 19th century to around 5-6 at its close. As extended liability was removed, leverage continued its upward trend into the 20th century, by its close reaching over 20. Seven years into the 21st century, at its high-water mark, leverage hit 30 or more.”

6. The “largely silent” changes to the relative treatment of debt and equity catalysed the growth of leverage. From the early 20th century debt interest costs became deductible from profits, unlike — at least in most countries — the cost of equity financing. New evidence suggests there’s an empirical relationship between this and leverage: “a fall in the tax shield by 10 percentage points would lower the debt-to-asset ratio of a typical firm by 2.8 percentage points.”

7. Debt doesn’t have the disciplinary effects commonly assumed. Plus, there is a time-consistency problem in crises. “As much as bank management and the authorities may pre-commit to debtor’s bearing risk ex-ante, they may be tempted to capitulate ex-post.” Creditors realise this, and price and lend accordingly.

8. The time-consistency problem has in turn been made worse by the emergence of too-big-to-fail banks: creditors know that governments have to cover the risk of any one of these failing. “That is doubly unfortunate, as it means debtor discipline will be weakest among institutions for whom society would wish it to be strongest.”

9. On top of all this, long-term bank shareholders haven’t received the benefits from these flaws — it’s all gone to short-term investors and bank management. “The purchaser of a portfolio of global banking stocks in the early 1990s is today sitting on a real loss.” Average holding period for US and UK bank stocks fell to 3 months in 2008 from 3 years in 1998. (“Banking became, quite literally, quarterly capitalism.”)

10. In the late 1990s return on equity (ROE) became more important as a bank’s performance target. This creates a “myopia loop”: investors become more short-termist, a focus on ROE encourages short-term risky behaviour, which further incentivises short-term investment. By the eve of the last financial crisis the principal-agent problem was writ large: “In 2006, the top 5 equity stakes of US bank CEOs ran as follows: Dick Fuld (Lehman Brothers), James Cayne (Bear Stearns), Stan O’Neal (Merrill Lynch), John Mack (Morgan Stanley) and Angelo Mozilo (Countrywide) (Fahlenbrach and Stulz (2011)). We know how these disaster movies ended.”

via ftalphaville.ft.com

Why do we need a financial sector?

Some articles in the literature address the questions posed here. Chari and Kehoe (2009) use US firm-level data and find that the amount spent on investment exceeds the amount of internally-available funds (revenues minus wages minus material costs minus interest payments minus taxes) for only 16% of all firms considered. If investment could in principal be done using the firms’ own funds, then the role for financial intermediaries is obviously diminished. Haldane (2010) discusses in detail the earnings of the financial sector and concludes that “risk illusion, rather than a productivity miracle, appears to have driven high returns to finance”. Philippon and Reshef (2008) study wages earned in the financial sector and conclude that a large part of the observed wage differential between the financial sector and the rest of the economy cannot be explained by observables like skill differences, but is likely to be due to the presence of rents. Philippon (2008) argues that an increase in the types of firms that invest (young firms) can explain part of the increased income share of the financial sector; the increase in the last decade remains puzzling.

via www.voxeu.org

Advertising is a poison that demeans even love – and we're hooked on it | George Monbiot | Comment is free | The Guardian

I am talking about the industry whose output frames this column and pays for it: advertising. For obvious reasons, it is seldom confronted by either the newspapers or the broadcasters.

The problem was laid out by Rory Sutherland when president of the Institute of Practitioners in Advertising. Marketing, he argued, is either ineffectual or it "raises enormous ethical questions every day". With admirable if disturbing candour he concluded that "I would rather be thought of as evil than useless." A new report by the Public Interest Research Centre and WWF opens up the discussion he appears to invite. Think of Me as Evil? asks the ethical questions that most of the media ignore.

Advertising claims to enhance our choice, but it offers us little choice about whether we see and hear it, and ever less choice about whether we respond to it. Since Edward Bernays began to apply the findings of his uncle Sigmund Freud, advertisers have been developing sophisticated means of overcoming our defences. In public they insist that if we become informed consumers and school our children in media literacy we have nothing to fear from their attempts at persuasion. In private they employ neurobiologists to find ingenious methods of bypassing the conscious mind.

Pervasiveness and repetition act like a battering ram against our minds. The first time we see an advertisement, we are likely to be aware of what it's telling us and what it is encouraging us to buy. From then on, we process it passively, absorbing its imagery and messages without contesting them, as we are no longer fully switched on. Brands and memes then become linked in ways our conscious minds fail to detect. As a report by the progressive thinktank Compass explains, the messages used by advertisers are designed to trigger emotional rather than rational responses. The low-attention processing model developed by Robert Heath at the University of Bath shows how, in a crowded advertising market, passive and implicit learning become the key drivers of emotional attachment. They are particularly powerful among children, as the prefrontal cortex – which helps us to interpret and analyse what we see – is not yet fully developed.

via www.guardian.co.uk

Felix Zulauf talking points

• We are on a spiral caused by mass credit creation, excessive borrowing, reckless spending, and a enormous credit crisis. The end result is inevitable, and most likely unavoidable.
• The Europeans have created their own credit crisis, and it is attributable, in part, to the creation of the EU. They EU is following a path similar to what the US went through n 2008-09.
• There will be yet another bailout in the US and QE3 (or more) — but not until the situation gets much worse; That refers to both the market and the economy.
• There was a window for an Austrian economics solution, but that opportunity has passed. Worse still, imposing Austrian economics on weak countries here and now will only make the situation worse, causing a recession or making any contraction worse.
• Equities remain in a long term secular bear market dating back to 2000, one that is unlikely to end before 2017.
• Multiples will compress over this time period. Look at more than P/E — consider Price to Sales as well.
• Of all the currencies in thew world, the US Dollar is the least ugly. That says less about the Greenback than it does about the Euro and Yen.
• The Eurozone was problematic since its inception. You cannot have a monetary union but not simultaneous fiscal union.
• Policy makers inevitably punish savers.
• Germany is the creditor to the rest of Europe. Given their history, their biggest concern is hyper inflation, while nations like Greece, Italy and Ireland are facing deflation
• Watch for rising populism in response to economic turmoil. It is already happening in Europe, and will eventually come to the US.
• The political situation in Europe is unlikely to improve until the crisis is much worse. The same is likely true in the US.
• There will be an eventual repricing of all currencies.
• Greece may very well will leave the Euro, but Italy is probably to big to do so.
• Countries that can print & devalue their own currencies get to invite tourists, stimulate economy, and climb out of their morass. Tied to the Euro, they simply cannot.
• There is no currency that will retain its value over the next decade except Gold. Every other currency is in a race to print and devalue, inflating away the debt.
• There is no price target on Gold, but he expects higher prices, and perhaps significantly higher prices over the next decade.

via www.ritholtz.com

Occupy Wall Street and Washington's History of Financial Bailouts

The bailouts of large creditors -- such as the 1984 rescue of Continental Illinois, the 1995 rescue of Mexico, and the 1998 government-orchestrated attempt to save the creditors of Long-Term Capital Management -- sent a signal to large lenders that they might lose little or nothing if the investments they fund go bust. That in turn made lenders much less cautious, allowing financial institutions to use borrowed money, rather than their own capital, to finance the housing boom.

Using borrowed money instead of equity lets you keep the upside for yourself. Such an arrangement is always appealing. But why did lenders accept such risks when they do not share in the upside, especially when the investments were increasingly risky? Part of the reason is that government created expectations that lenders might get their money anyway.

And they often did. When Bear Stearns went belly up in March 2008, the government did not let the firm go bankrupt. The Federal Reserve guaranteed the toxic assets of Bear Stearns to make the acquisition deal sweeter for J.P. Morgan Chase. But the real impact of the deal was that Bear's creditors -- mostly other large Wall Street firms -- paid no price for financing Bear's debt-financed mistakes. J.P. Morgan Chase honored those obligations 100 cents on the dollar. That reinforced the expectation that large firms could lend and borrow from one another with little or no risk. Reckless leverage is what made the crisis a crisis rather than something milder.

The received wisdom is that it was the failure to rescue Lehman Brothers that worsened the financial crisis. But it was the rescue of Bear Sterns' creditors that let Lehman continue to roll the dice, using borrowed money rather than pulling back and raising more capital.

The real cost to Main Street has not been the transfer of taxpayer money to Wall Street. The real cost to Main Street has been Wall Street's imprudent lending and investment, which led to lending trillions of dollars to build more and bigger houses. That was a bad use of precious capital. The incentives to invest wisely have been distorted. And we are all still paying the price for the collapse of highly leveraged firms.

This is not capitalism; it is crony capitalism. Occupy Wall Street's diagnosis of a parasitic symbiosis between Wall Street and Washington is correct. The coddling of Wall Street let borrowing get out of control, unnaturally enlarged the banks, and helped justify and fund bonuses that otherwise would have been much smaller.

via www.foreignaffairs.com

Occupy Wall Street and Washington's History of Financial Bailouts | Foreign Affairs

Occupy Wall Street reminds me of a doctor who sees a patient with a broken arm, decides that both arms are broken, and proceeds to amputate them: The diagnosis is half right, and the cure may be worse than the disease.

Start with the diagnosis. "Us against them" always makes for good theater. But is the big problem with the American economy really the top one percent versus the rest of us? Are we being victimized by the fat cats? The data seems undeniable. The share of income going to the top one percent has risen dramatically over the last 40 years. If the top one percent have more, surely the rest of us have less, right? But as the writer P.J. O'Rourke has said, wealth is not a pizza. If we're sharing a pie, and you get a bigger piece, that does not mean that I have less to eat. It depends on what happens to the size of the pizza. Ten percent of an enormous pizza is more filling than all of a tiny one.

The protesters are right about one thing: Washington has been coddling Wall Street. But they have missed the most important way that Wall Street lives off the rest of us. Programs like the Troubled Asset Relief Program of 2008 are red herrings. TARP did send $700 billion to Wall Street, but most of it has been paid back.

There is a much more important, albeit quieter, favor Washington has been performing for Wall Street over the last 25 years: When large financial institutions get into trouble, policymakers make sure that their creditors receive 100 cents on the dollar.

via www.foreignaffairs.com

Law, Governance, and the Eurozone - Full Speed ahead; damn the torpedoes

Here is an example of what I mean by the sense that in the eurozone crisis, law is a follower, not a leader, and at most a negotiable hold-up. This is drawn from one of my favorite economists, the Very Great Tyler Cowen, on how to exit the eurozone. From the end of his post (emphasis added):

Let’s sum up which problems have been addressed and which not. The domestic banking system is saved, at least provided the new conversion rate is credible enough that no one expects a repeat of the depreciation. It’s key to make that first announcement a real surprise, good luck! A negative wealth shock will come anyway and my plan has accelerated the arrival of that shock; the best one can do is to combine it with monetary expansion and the positive export shock from devaluation. To fix the external banks, the wealthier countries will need to exercise and perhaps improve their LOLR [Lender of Last Resort] powers, but that is the case under any plan, not just this one.

Admittedly this plan makes the wealth loss in Ruritania quite transparent, which may be politically unpopular, but that transparency eases the economics of the transition.

Voila! Rinse and repeat as necessary. A lot of this would be eased by high inflation from the eurozone itself but a) that would involve collateral costs on the healthier economies, and b) in any case it doesn’t look like it will happen. I’m sticking with what a small country can do on its own.

No need to write in the comments section that this is “illegal.” Breaking the three percent deficit rule, as France and Germany did, was illegal too. Ruritania will not be hauled before a court of law and I also predict Ruritania will not be ejected from EU per se. Maybe their agricultural subsidies will be cut, let them eat floating exchange rates I say.

This is drafted, from my international contracts lawyer point of view, the way a business person would draft a term sheet – a summary roadmap through the practicalities of business, finance, and some political considerations. But the legal and regulatory issues are essentially treated as revisable or else some form of negotiable hold-up; problems for the lawyers to work out but not as deeply part of the economic deal. They act as constraints on this account, transaction costs that must be paid off – but not truly “constitutional” constraints.

I mean by that, constraints in law that are more than just “hard” to change, but which are hard to change because they are part of a constitutional order, in which the constraints carry important legitimacy all their own that arise because they are, well, constitutive. Built into the structure in a way that is hard to change because people wanted it that way, to tie their hands into the future in a mutual undertaking in which people came together to tie not just each other’s hands but their genuinely collective hands, people together – and to tie the hands of the people who would come after. This idea of the independent power of legitimacy, and the function of constitutionalism as more than just a “really big holdup” is, in my experience, very hard to convey to economists, mostly because their world-view doesn’t make room for the underlying concept. At most, there’s some handwaving in the direction of “Oh, you mean institutional economics.” Actually, I mean more than that. I mean “constitutional law.”

But then Tyler Cowen points to a rather serious problem for my argument above. For years, we have been told in endless academic papers, books, symposia – mostly funded, however, by the EU in its one-way ratchet of ideological integration – that the EU is indeed a constitutional order, but of a special kind, a new phenomenon in the world, one that has th

via volokh.com