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Craig Pirrong at Streetwise Professor explains the latest jive from Europe.
Following Europe’s plan of the week to deal with its sovereign debt crisis (and directly associated banking crisis) can make one’s head spin. It might therefore help to try to identify a few central concepts that can help put the details of this plan or that into perspective.
A key distinction is between measures intended to prevent things from getting worse, and those intended to allocate losses already incurred; the interaction between those issues is an important factor in the dynamics, and will play a huge role in determining the ultimate outcome.
In terms of preventing things from getting worse, the near-term danger Europe faces is runs on sovereigns, especially Italy. …
… Someone with a weapon is confronted by a crowd of 100 people. If all 100 rush him, he’s had it. But someone has to start the rush, and the first mover is at greatest risk of getting shot, so each person may hold back wanting someone else to take the lead, allowing the outnumbered gunman to escape unharmed. But some in the crowd may be hotheaded and charge. Here’s where the nature of the weapon matters. If it’s a single shot pistol, once the hothead is shot the rest of the crowd knows its in no danger and will charge. If it’s a revolver, it takes six hotheads to start a run. If it’s an automatic with 10 rounds in the magazine, it takes even more hotheads. (To make the analogy fit, there has to be some advantage of being first to get to the guy with the gun.)
The European plans are all based on the idea of convincing investors that there are a lot of bullets in the gun in the hope that this will deter a self-feeding run. This is why Europe is so focused on expanding the size of backstop funds, including the use of ECB leverage. The bigger the country that is at risk of a run, the bigger the fund must be to reduce the likelihood of a run. This is why Italy’s problems are a real challenge to Europe. Italy’s debt is so much larger than Greece’s or Portugal’s that commensurately bigger sums are needed to reassure investors that a run cannot get started. …
Gretchen Morgenson has more.
… Some investors who have been worrying about potential losses associated with European banks may have taken comfort in the results of financial stress tests conducted earlier this year by the Committee of European Banking Supervisors. Of the 91 top European banks tested — accounting for 65 percent of bank assets — only seven failed the toughest measures.
But, as an August report by Dun & Bradstreet pointed out, these tests were not as stringent as they might have been. They only assessed the risks posed by deteriorating assets in banks’ trading accounts. The tests did not measure those assets carried in the so-called held-to-maturity accounts.
“In order to give a more adequate picture of European financial sector risk beyond the short term,” Dun & Bradstreet said, “we believe the hold-to-maturity bonds should have been included in the stress tests.” There is clearly a great deal that investors do not know about exposures to Europe, notwithstanding the assurances from Mr. Geithner and others. Three years ago, investors were ignorant of the risks in faulty mortgage securities. If we’ve learned anything from that episode, it’s that what you don’t know can, in fact, hurt you.
A critique of TARP from Forbes.
The $700 billion “Troubled Asset Relief Program” (TARP) was enacted in Washington three years ago this week, and while most economists, policymakers and journalists still believe it made things better (“helping us avoid a second Great Depression,” they like to say), in fact it made things much worse – and today we’re still suffering from its bearish effects. As just one example, a similar scheme, modeled on TARP – the “European Financial Stability Facility” (EFSF) – is being adopted abroad, further undermining bank stocks.
Those who fail to grasp TARP’s true impact will find it difficult to comprehend the currently-bearish impact of the EFSF. The problem with most U.S. banks in 2008 was not that they were “under-capitalized” but that they held so many shaky (sub-prime) residential mortgage-backed securities (RMBS), assets which bank regulators insisted were some of the safest assets they could own, because they were “backed” by the taxpayer-backed mortgage GSEs (Fannie Mae and Freddie Mac) and thus required virtually no capital.
Instead of U.S. banks shedding bad assets, merging and raising private capital, TARP compelled them to take unwanted, high-cost capital injections with “strings attached” that became a noose around their necks. Similarly, the problem with Europe’s shakier banks today is not they’re “under-capitalized” but that they hold shaky government bonds (issued by Greece, Portugal, Italy, Spain, etc.), assets which bank regulators insisted were the safest things they could possibly own, and thus required little or no capital.
TARP didn’t prevent the crisis of September-October 2008 but contributed to it. Of course, the initial root cause of the bearishness was the U.S. recession that had already begun in December 2007, long before TARP was concocted, and which was caused by the Fed’s deliberate and prior inversion of the Treasury yield curve. That policy narrowed banks’ net interest margins, killed the incentive for credit intermediation (“borrowing short, lending long”), and cratered asset prices, wiping out some banks’ capital cushions. …
How’s this for a Steve Jobs obit? It’s from Dilbert.
I once thought his success was mostly a matter of luck. Anyone can be at the right place at the right time.
But then he did it again.
And again.
And again.
And again.
He was my only hero.
Niall Ferguson with an interesting essay.
… So the question is not, how do we produce more Steves? The normal process of human reproduction will ensure a steady supply of what Malcolm Gladwell has called “outliers.” The question should be, how do we ensure that the next Steve Jobs fulfills his potential?
An adopted child, the biological son of a Syrian Muslim immigrant, a college dropout, a hippie who briefly converted to Buddhism and experimented with LSD—Jobs was the type of guy no sane human resources department would have hired. I doubt that Apple itself would hire someone with his résumé at age 20. The only chance he ever had to become a chief executive officer was by founding his own company.
And that—China, please note—is why capitalism needs to be embedded in a truly free society in order to flourish. In a free society a weirdo can do his own thing. In a free society he can even fail at his own thing, as Jobs undoubtedly did in his first stint in charge of Apple. And in a free society he can bounce back and revolutionize all our lives.
Somewhere in his father’s native Syria another Steve Jobs has just died. But this other Steve was gunned down by a tyrannical government. And what wonders his genius might have produced we shall never know.
Andrew Malcolm with late-night humor.