"From 2002 to 2008, the five biggest Wall Street securities firms [Bear Stearns, Goldman Sachs, Lehman Brothers, Merrill Lynch, and Morgan Stanley] paid an estimated $190 billion in bonuses. Those companies churned out $76 billion in combined profits during the same period. Last year, the companies had a combined net loss of $25.3 billion, yet paid bonuses of roughly $26 billion."
Lucchetti, Aaron and Matthew Karnitschnig. 2009. "On Street, New Reality on Pay Sets In: Financial Firms Race to Reset Compensation Policies as U.S. Government Aims to Set Some Limits." Wall Street Journal (31 January): p. B 1.
http://online.wsj.com/article/SB123336341862935387.html?mod=todays_us_money_and_investing
Saturday, January 31, 2009
Marx before Minsky
Previously, I made the case that the financial meltdown was basically a delayed response to the severe neglect of investment in plant, equipment, and infrastructure. I also explained the cause of this neglect.
http://radicalnotes.com/content/view/73/39/
Here, I'm going to discuss the financial side of the crisis, which, while secondary, is still important.
This crisis has been nicely described as a Minsky moment, but it may just as well be described as a Marx moment. Marx's term fictitious capital and the more conventional discounted present value are not entirely different, but Marx's expression emphasizes the fact that the future is both unknown and unknowable.
As Keynes explained very well, the future takes on an appearance of being known, but this knowledge is not knowledge at all. It is merely an extrapolation of the past.
There was a time when the returns from holding General Motors stock would have seemed very predictable, almost as much as an investment with Bernie Madoff.
Anticipating Hyman Minsky, Marx realized that over time people would become less risk averse and the risk-corrected discounted present values would start to rise. Extrapolating, this trend would be expected to continue.
What I did, many years ago, in Karl Marx's Crises Theory: Labor, Scarcity and Fictitious Capital (New York: Praeger, 1987) was to explain that this psychological phenomenon would tend to delink prices from underlying values. Expensive corporate headquarters would be built into the overhead costs of business. At the same time, as such capital values accumulate, measures of invested capital will increase, pulling down the rate of profit. Hunting for yields to maintain profit rates will set off bubbles, further promoting an even more speculative environment. Over time, this speculative psychology will eliminate the limited coordinating powers of the market and set the stage for a future crisis.
When the crisis comes, much of the fictitious capital will disappear, bringing prices more in line with underlying values.
In a sense, this part of Marx's crisis theory is not that far from Hayek's, but I think that Hayek may have taken this from Marx without attribution.
All this sounds very Minskyian. Of course, Minsky knew his Marx, just as he knew his Keynes. And Keynes, though never really studied Marx by his own confession, was surrounded by people who did.
http://radicalnotes.com/content/view/73/39/
Here, I'm going to discuss the financial side of the crisis, which, while secondary, is still important.
This crisis has been nicely described as a Minsky moment, but it may just as well be described as a Marx moment. Marx's term fictitious capital and the more conventional discounted present value are not entirely different, but Marx's expression emphasizes the fact that the future is both unknown and unknowable.
As Keynes explained very well, the future takes on an appearance of being known, but this knowledge is not knowledge at all. It is merely an extrapolation of the past.
There was a time when the returns from holding General Motors stock would have seemed very predictable, almost as much as an investment with Bernie Madoff.
Anticipating Hyman Minsky, Marx realized that over time people would become less risk averse and the risk-corrected discounted present values would start to rise. Extrapolating, this trend would be expected to continue.
What I did, many years ago, in Karl Marx's Crises Theory: Labor, Scarcity and Fictitious Capital (New York: Praeger, 1987) was to explain that this psychological phenomenon would tend to delink prices from underlying values. Expensive corporate headquarters would be built into the overhead costs of business. At the same time, as such capital values accumulate, measures of invested capital will increase, pulling down the rate of profit. Hunting for yields to maintain profit rates will set off bubbles, further promoting an even more speculative environment. Over time, this speculative psychology will eliminate the limited coordinating powers of the market and set the stage for a future crisis.
When the crisis comes, much of the fictitious capital will disappear, bringing prices more in line with underlying values.
In a sense, this part of Marx's crisis theory is not that far from Hayek's, but I think that Hayek may have taken this from Marx without attribution.
All this sounds very Minskyian. Of course, Minsky knew his Marx, just as he knew his Keynes. And Keynes, though never really studied Marx by his own confession, was surrounded by people who did.
Does Protection Have No Impact on Aggregate Demand?
Nick Rowe makes an argument against the “Buy American” provisions that I have made in the past:
Nick then admits that if we are in a liquidity trap, the interest rate to capital account channel is cut off so a fiscal stimulus does not necessarily crowd-out net exports but then he writes:
Dani Rodrik, however, takes another view:
Dani also notes:
I guess Nick can come back and say Dani was assuming fixed exchange rates. So how is this all supposed to work out under fixed interest rates but floating exchange rates?
Our model is essentially:
Y = D(Y) + X(Y, e)
where Y = real GDP, D = domestic demand, X = net exports, and e is the real exchange rate. Let’s consider a hypothetical economy known as Obamia that has a domestic marginal propensity to spend = 0.8 and a marginal propensity to import = 0.2 and wants to increase real GDP by $1000 (think of America as one billion times the size of Obamia). Under fixed exchange rates and no trade protection, the multiplier is 2.5 so government purchases would have to be raised by $400 if no other policy tool was used. As real GDP rose increased by $1000, imports would increase by $200.
But suppose that the conservative part of Obamia balks at a large fiscal stimulus and its leaders reach some bipartisan compromise of having government purchases rise by only $200. Dani’s point is that if we adopt a mercantilist policy to increase the net export schedule by $200, then we can still achieve the real GDP goal.
Nick’s floating exchange rate version of the model, however, has the exchange rate automatically adjust such that the ultimate change in net exports is zero. In this case, the multiplier for fiscal policy is 5 and the multiplier for mercantilist policy is zero. In other words, a $200 increase in government purchases still achieves the goal of increasing real GDP by $1000. Lesson learned – floating exchange rates can achieve the same goal as Dani’s mercantilism. There is one difference, however, between the two approaches. Mercantilism often works by protecting the import competing sector. Under floating exchange rates, we are more likely to see increased employment in the export sector.
Most (all?) economists agree that in a global recession, when each country wants to boost demand for the goods it produces, policies which steer demand to domestically-produced goods are individually rational (provided other countries don't retaliate), but collectively irrational when all countries do the same. I think most economists are wrong. It's not just collectively irrational, but individually irrational as well, at least for countries with flexible exchange rates ... In normal times, outside of a liquidity trap, an expansionary fiscal policy will put upward pressure on interest rates as the demand for money increases with higher income. Or the central bank raises interest rates to offset the increased demand to keep inflation on target. An increase in domestic interest rates will cause a capital account inflow, which causes the exchange rate to appreciate. The exchange rate appreciation will cause net exports to fall. The fall in net exports offsets the expansionary fiscal policy. Under imperfect capital mobility the offset will be partial. Under perfect capital mobility there will be full offset, for a small open economy. So in normal times, part or all of the increased demand from an expansionary fiscal policy will be lost due to a decline in net exports. Some or all of the extra demand just leaks out to foreign countries.
Nick then admits that if we are in a liquidity trap, the interest rate to capital account channel is cut off so a fiscal stimulus does not necessarily crowd-out net exports but then he writes:
A "buy domestic" policy will not shift demand towards domestic goods. If it did, so that imports fell and net exports increased, the current account surplus would merely cause the exchange rate to appreciate so that net exports fell to their original level. The current account must stay the same, because the capital account stays the same, because the interest rate differential stays the same, because interest rates stay the same.
Dani Rodrik, however, takes another view:
Yes it does. And not just in theory, but also in practice. The evidence comes from the 1930s, and from the work of Ben Bernanke himself (along with other scholars like Barry Eichengreen). The important finding is that countries that devalued their currencies by getting off the gold standard were able to recover more quickly, thanks in part to an increase in their net exports relative to countries that stayed on gold. Note that a currency depreciation amounts to a policy of combining import tariffs with export subsidies--hence the mercantilist intent and effect.
Dani also notes:
How much of a boost to economic activity will a fiscal stimulus provide? For those who believe that we have entered a Keynesian world of shortage of aggregate demand--me included--the answer depends on the Keynesian multiplier. The size of this multiplier depends in turn on three things in particular, the marginal propensity to consume (c), the marginal tax rate (t), and the marginal propensity to import (m). If c = 0.8, t = 0.2, and m = 0.2, the Keynesian multiplier is 1.8 (=1/(1-c(1-t)+m)). A $1 trillion fiscal stimulus would increase GDP by $1.8 trillion. Now suppose that we had a way to raise the multiplier by more than half, from 1.8 to 2.8. The same fiscal stimulus would now produce an increase in GDP of $2.8 trillion--quite a difference. Nice deal if you can get it. In fact you can. It is pretty easy to increase the multiplier; just raise import tariffs by enough so that the marginal propensity to import out of income is reduced substantially (to zero if you want the multiplier to go all the way to 2.8). Yes, yes, import protection is inefficient and not a very neighborly thing to do--but should we really care if the alternative is significantly lower growth and higher unemployment? More to the point, will Obama and his advisers care?
I guess Nick can come back and say Dani was assuming fixed exchange rates. So how is this all supposed to work out under fixed interest rates but floating exchange rates?
Our model is essentially:
Y = D(Y) + X(Y, e)
where Y = real GDP, D = domestic demand, X = net exports, and e is the real exchange rate. Let’s consider a hypothetical economy known as Obamia that has a domestic marginal propensity to spend = 0.8 and a marginal propensity to import = 0.2 and wants to increase real GDP by $1000 (think of America as one billion times the size of Obamia). Under fixed exchange rates and no trade protection, the multiplier is 2.5 so government purchases would have to be raised by $400 if no other policy tool was used. As real GDP rose increased by $1000, imports would increase by $200.
But suppose that the conservative part of Obamia balks at a large fiscal stimulus and its leaders reach some bipartisan compromise of having government purchases rise by only $200. Dani’s point is that if we adopt a mercantilist policy to increase the net export schedule by $200, then we can still achieve the real GDP goal.
Nick’s floating exchange rate version of the model, however, has the exchange rate automatically adjust such that the ultimate change in net exports is zero. In this case, the multiplier for fiscal policy is 5 and the multiplier for mercantilist policy is zero. In other words, a $200 increase in government purchases still achieves the goal of increasing real GDP by $1000. Lesson learned – floating exchange rates can achieve the same goal as Dani’s mercantilism. There is one difference, however, between the two approaches. Mercantilism often works by protecting the import competing sector. Under floating exchange rates, we are more likely to see increased employment in the export sector.
The House's Modern-Day Hoovers
Time to turn the microphone over to Colbert I. King:
The pain of this recession was apparently lost on Boehner and his House Republicans. Their public fretting over the future impact of deficits on today's children and grandchildren is disingenuous. In truth, what really gets them hot and bothered is the thought of government taking on more responsibility to fight this deepening recession, and the huge amount of public spending it will take to pull the economy out of the doldrums. It so happened that the Republican standard-bearer in the 1920s, Herbert Hoover, felt that way, too. Hoover's distaste for government, and his belief that business was the answer to the country's economic tailspin, got Democrat Franklin Delano Roosevelt elected president in 1932. In their slavish devotion to Hooverism, today's Republicans are repeating the mistakes that banished their party to the political wilderness in the '30s.
Friday, January 30, 2009
The Disastrous Toll of Fictitious Value
The world of fictitious value mesmerizes itself by using a strange language. Financial operations refer to their "shop," as if they were standing over a workbench shaping metal or wood. Then they talk about "value creation."
What does that mean? Suppose I start a private equity company. People give me money to create value. I can create this value by taking over a company with very little of my own money. I need a banking accomplice to give me a bridge loan and a compliant company management. Then I can "unlock" the firm's value.
Once source of untapped value is a pension fund. Workers can be granted stock in the company as compensation. I can take over the firm, then use the pension fund to pay for some of the money I own. I can load the firm up with debt and charge it exorbitant fees. Now I have begun to "unlock" value.
Next, I can fire lots of workers, including those whose pension fund financed my takeover. By doing so, I can show that I am creating efficiencies. Once I cook the books to make the firm look profitable and sell it to a unsuspecting public.
Should anyone be surprised that many of these companies have been going bankrupt? And the workers whose pensions were central to the process? Well, they have some pretty paper.
Ain't capital wonderful?
What does that mean? Suppose I start a private equity company. People give me money to create value. I can create this value by taking over a company with very little of my own money. I need a banking accomplice to give me a bridge loan and a compliant company management. Then I can "unlock" the firm's value.
Once source of untapped value is a pension fund. Workers can be granted stock in the company as compensation. I can take over the firm, then use the pension fund to pay for some of the money I own. I can load the firm up with debt and charge it exorbitant fees. Now I have begun to "unlock" value.
Next, I can fire lots of workers, including those whose pension fund financed my takeover. By doing so, I can show that I am creating efficiencies. Once I cook the books to make the firm look profitable and sell it to a unsuspecting public.
Should anyone be surprised that many of these companies have been going bankrupt? And the workers whose pensions were central to the process? Well, they have some pretty paper.
Ain't capital wonderful?
(Harrisonburg, Pay Attention) The Wonders of City Bike Systems
There is now a nice, green policy that is being followed in as many as 21 European cities that is not yet being followed in a single US one that I am aware of, having just googled a bunch on the matter. It is a city bike system, also sometimes generically called a "Velib" system after the very popular and famous one in Paris that began in 2007. However, while it is doing very well (see the Wikipedia entry for "Velib" about it), it has some oddities that may make it less desirable for cities in the US thinking of adopting such a system, it being run by a private company for the city.
Probably the oldest running, since the 1970s, and the best run is the one in Copenhagen, where nearly 40% of trips are now done by city bike. The city (actually through a non-profit organization) owns bikes that are kept in parking stands. In Paris they make you pay a subscription, and then you can access the bikes, which are locked up in their stands. In both the stands are all over the city, but in Copenhagen they are free. You just pull one out and ride it to another stand. Reduces traffic, improves health, reduces pollution, and any city in the US would look very cool and progressive and innovative if it were the first one in the country to do it. The bikes tend to be three speed and pretty tough with a good-sized basket in front. The biggest problems have been with car traffic, and in Copenhagen, with cars turning right and not paying attention to bikes coming up. Anyway, a nice link about the Copenhagen system.
Probably the oldest running, since the 1970s, and the best run is the one in Copenhagen, where nearly 40% of trips are now done by city bike. The city (actually through a non-profit organization) owns bikes that are kept in parking stands. In Paris they make you pay a subscription, and then you can access the bikes, which are locked up in their stands. In both the stands are all over the city, but in Copenhagen they are free. You just pull one out and ride it to another stand. Reduces traffic, improves health, reduces pollution, and any city in the US would look very cool and progressive and innovative if it were the first one in the country to do it. The bikes tend to be three speed and pretty tough with a good-sized basket in front. The biggest problems have been with car traffic, and in Copenhagen, with cars turning right and not paying attention to bikes coming up. Anyway, a nice link about the Copenhagen system.
Draft Submission to the White House Task Force on Working Families
by the Sandwichman
White House press release:
· ensuring that the benefits of economic growth reach middle-class, working families;
· improving work and family balance;
· restoring labor standards;
· focusing on "green jobs" that "use renewable energy resources, reduce pollution, conserve energy and natural resources and reconstitute waste."
The underlying argument of this submission is that it is time to reconsider and rehabilitate the "surprisingly apposite" founding philosophy of the American labor movement. "Sharing the work and sparing the planet" comprehensively addresses the issues of green jobs, labor standards, work and family balance and fairness in the distribution of the benefits of economic growth.
White House press release:
President Barack Obama today announced the creation of a White House Task Force on Middle Class Working Families to be chaired by Vice President Joe Biden. The Task Force is a major initiative targeted at raising the living standards of middle-class, working families in America. It is comprised of top-level administration policy makers, and in addition to regular meetings, it will conduct outreach sessions with representatives of labor, business, and the advocacy communities.In response to the White House announcement, the Sandwichman is posting his Draft Submission to the White House Task Force on Working Families on EconoSpeak. This submission specifically addresses four of the major objectives for the Task Force, as elaborated in statements by President Obama and Vice President Biden, and in the theme for the first meeting of the Task Force on February 27, 2009 in Philadelphia, Pennsylvania:
· ensuring that the benefits of economic growth reach middle-class, working families;
· improving work and family balance;
· restoring labor standards;
· focusing on "green jobs" that "use renewable energy resources, reduce pollution, conserve energy and natural resources and reconstitute waste."
The underlying argument of this submission is that it is time to reconsider and rehabilitate the "surprisingly apposite" founding philosophy of the American labor movement. "Sharing the work and sparing the planet" comprehensively addresses the issues of green jobs, labor standards, work and family balance and fairness in the distribution of the benefits of economic growth.
Real GDP and Its Components: 2008QIV versus 2007QIII
BEA released its advanced estimate for the last quarter of 2008 and the news was awful:
While real GDP rose somewhat during the first two quarters of 2008, real GDP fell a bit during the last quarter of 2007. Real GDP was running at an annualized clip of $11,625.7 billion as of 2007QIII but real GDP for 2008QIV was reported to be only $11,599.4 billion.
I guess the silver lining was that both government purchases and net exports continued to improve. The improvement in real exports was tiny but imports fell – likely as a result of a weaker economy. Consumption demand fell by more than $90 billion – while investment demand fell by more than $190 billion. Maybe this will wake up a few Republicans in the Senate that we have indeed entered into a deep recession.
Real gross domestic product -- the output of goods and services produced by labor and property located in the United States -- decreased at an annual rate of 3.8 percent in the fourth quarter of 2008, (that is, from the third quarter to the fourth quarter), according to advance estimates released by the Bureau of Economic Analysis. In the third quarter, real GDP decreased 0.5 percent.
While real GDP rose somewhat during the first two quarters of 2008, real GDP fell a bit during the last quarter of 2007. Real GDP was running at an annualized clip of $11,625.7 billion as of 2007QIII but real GDP for 2008QIV was reported to be only $11,599.4 billion.
I guess the silver lining was that both government purchases and net exports continued to improve. The improvement in real exports was tiny but imports fell – likely as a result of a weaker economy. Consumption demand fell by more than $90 billion – while investment demand fell by more than $190 billion. Maybe this will wake up a few Republicans in the Senate that we have indeed entered into a deep recession.
About Hedge Funds
· ‘Survivorship bias’
Hedge funds that die are not included in the index, and since the mortality rate among hedge funds is higher than among mutual funds, it produces a greater gap between the returns reported in the indices versus those earned by a typical investor. There are about 9000 funds. Half of them have a life span of three years. About one out of ten goes bust.
· Distortion of returns reported to hedge funds versus the typical investor
– associated with the higher mortality rate of hedge funds. Also the reporting for hedge funds is voluntary and they tend not to report bad results.
· Lack of auditing.
They represent a relatively small share of total financial assets but their relative share has increased significantly.
· Substantial leverage
Hedge funds have the ability to take on substantial leverage.
· Large potential impact on financial market conditions
The substantial leverage of hedge funds magnifies the potential impact on financial market conditions.
· Hedge funds play a large (inappropriate) role as an insurer for regulated institutions
"Hedge funds have become an important source of protection to regulated institutions by being large sellers of credit insurance in the rapidly growing market for credit default swaps . But highly-leveraged and unregulated hedge funds are not the ideal type of insurer!"
· Hedge funds are receiving money from Australian superannuation funds.
Because of the current great doubt experienced by the two major political parties about the virtues of the fiduciary habits of ordinary workers, they feel compelled to take their savings away. The money is placed in pension funds for their old age. Workers are not allowed to withdraw this money and especially they are not permitted any control over the way in which these dollars are invested. (Meanwhile we'll continue to tout the virtues of a 'free market' system).
..Superannuation fund trustees have traditionally not invested in hedge funds both because of the infancy of the hedge fund market in Australia and because of the legal obligations described above. Rather,superannuation trustees have tended to prefer to invest in fixed interest investments, cash, government bonds and property investment trusts.
Hedge funds have not been favoured areas of investment principally because of perceptions concerning:
• the volatility of returns;
• level of regulation;
• the perceived lack of transparency of hedge funds ;
• levels of management fees; and
• additional risks associated with the use of derivatives by hedge fund managers.
In order to make such investments, superannuation trustees need to give careful consideration to the legal restrictions imposed in the form of general trustee duties and the investment parameters imposed by their trust deed, investment plan and the SIS Act.
However, despite this traditional reluctance to invest in hedge funds, superannuation trustees in Australia are now starting to use hedge funds to diversify their investments. Hedge fund investment is providing superannuation trustees with a way of counter-balancing the decline in returns on investments in traditional products. Those trustees are also attracted by the relative low correlation between the performance of some hedge funds and that of the equity markets more generally. There is also a considerable degree of liquidity with hedge funds, something that real estate or other structured assets may not offer. Finally, the introduction of hedge funds for retail investors has made the product apparently more mainstream and therefore, for trustees, possibly less likely to result in fund member concern..."
Australia: Some Legal Issues relating to Superannuation Trustees as Hedge Fund Investors
By Tessa Hoser and Katherine Henzell, Blake Dawson Waldron
1 December 2002.
· One third of hedge fund capital comes from pension funds
One third of hedge fund capital comes from pension funds. “Pension funds reusing hedge fund investment to diversify their own risks, but a situation where almost one-third of the capital for institutions on the cutting edge of financial risks comes from institutions whose first priority is safe investments certainly bears watching”.
Rodrigo Rato, IMF Managing Director
· The insurance provided by hedge funds lacks integrity.
1. How can you collect on an insurance contract when no-one can agree on the amount of the losses??
2. Both the buyer and seller of CDS may trade their obligation in the OTC market. There is nothing to prevent the insurer from offloading his obligation to an unqualified or unreliable party, in the process irreparably damaging the value of the insurance originally purchased.
I would be interested to learn if anyone can shed light on a potential problem in financial markets larger by at least an order of magnitude greater than subprime + CDO s sold to the SIV s and other institutions that hold them. Dr. Roubini has put numbers on subprime and alt-A plus CDO s, of about 1.5 trillion, and we don't have good estimates yet for auto loan and credit card securitized debt. Dwarfing these numbers is the 30 to 40 trillion dollar (or more) value of credit default swaps (CDS) outstanding. These swaps are essentially insurance policies between 2 parties. The FIRST buyer, presumably, is one with an asset (bond or securitized debt) to hedge. The FIRST seller, presumably, is a party known to the buyer who is financially able to provide the contracted protection in the event being insured (default) in return for the fee collected. But if both sides of this equation may TRADE their obligation in the OTC market, what is to prevent the INSURER from offloading his obligation to an UNQUALIFIED party, damaging irreparably the value of insurance originally purchased. If the insured has no control over the assignment to a third party of the obligation, of what value is the insurance. You may recall that in the DELPHI automotive bankruptcy, with 2 billion in bonds outstanding, there were over 20 billion in CDS outstanding. If the presumed solvency of unregulated insurance providers has enabled careless debt instrument purchases, watch out.
Written by RHK on 2007-11-06 08:01:26
3. The Over the Counter (OTC) trade is opaque and allows for the creation of fictionalised capital.
· There’s been a dramatic acceleration in number and type of derivative instruments.
(But current accounting and regulatory practice – as of December 2007 - allow for the creation of huge amounts of imaginary capital that is opaque and not subject to appropriate credit ratings. With the possibility of firms upping their trade in derivatives to hide the day of reckoning that comes with insolvency. See the linked article on credit default swaps.)
Hedge funds (holding Russian corporate bonds with ‘put options’) are demanding either full payment of debt or much higher interest rates; up to 16% during 2008.
· The total number of hedge funds has grown dramatically.
In 2007 there existed about 9000 funds. Half of them have a life span of three years. About one out of ten goes bust.
· Hedge funds are ‘Program Trading outfits’. They make money by buying large baskets of stocks.
A hedge fund, like investment banks, are referred to as ‘Program Trading outfits’. They make money by buying large baskets of stocks and then will blow out of those positions when their computers are programmed to sell.
· The range of hedge fund returns is large and unprecedented.
· Hedge fund managers’ earnings are astronomical. are determined by the gains of their own capital in their funds and their share of their firm’s management and performance fees. Most funds charge a 5% management fee and a 44% performance fee)
Of the 200-plus funds that Permal invests in, the poorest performer in the year to date – from January through to November 15 – had reported a loss of 7 per cent, and the top performer had returned 70 per cent. [unsourced]
“…Combined, the top 50 hedge fund managers last year earned $29 billion. That figure represents the managers’ own pay and excludes the compensation of their employees. Five of the top 10, including Mr. Simons and Mr. Soros, were also at the top of the list for 2006….”
Wall Street Winners Get Billion-Dollar Paydays
By JENNY ANDERSON
Published: April 16, 2008
+
“Hedge fund managers, those masters of a secretive, sometimes volatile financial universe, are making money on a scale that once seemed unimaginable, even in Wall Street's rarefied realms. One manager, John Paulson, made $3.7 billion last year. He reaped that bounty, probably the richest in Wall Street history, by betting against certain mortgages and complex financial products that held them. Paulson, the founder of Paulson & Company, was not the only big winner. The hedge fund managers James Simons and George Soros each earned almost $3 billion last year, according to an annual ranking of top hedge fund earners by Institutional Investor's Alpha magazine, which comes out Wednesday. Hedge fund managers have redefined notions of wealth in recent years. And the richest among them are redefining those notions once again. Their unprecedented and growing affluence underscores the gaping inequality between the millions of Americans facing stagnating wages and rising home foreclosures and an agile financial elite that seems to thrive in good times and bad. Such profits may also prompt more calls for regulation of the industry…”
Hedge fund managers get billion-dollar paydays
By Jenny Anderson
Wednesday, April 16, 2008
· G8 finance ministers meet on the issues relating to hedge funds but fail to address the issues.
G8 finance ministers met on the issue of the lack of supervision of hedge funds but they failed to address the issue. (When?, Source?)
Hedge funds that die are not included in the index, and since the mortality rate among hedge funds is higher than among mutual funds, it produces a greater gap between the returns reported in the indices versus those earned by a typical investor. There are about 9000 funds. Half of them have a life span of three years. About one out of ten goes bust.
· Distortion of returns reported to hedge funds versus the typical investor
– associated with the higher mortality rate of hedge funds. Also the reporting for hedge funds is voluntary and they tend not to report bad results.
· Lack of auditing.
They represent a relatively small share of total financial assets but their relative share has increased significantly.
· Substantial leverage
Hedge funds have the ability to take on substantial leverage.
· Large potential impact on financial market conditions
The substantial leverage of hedge funds magnifies the potential impact on financial market conditions.
· Hedge funds play a large (inappropriate) role as an insurer for regulated institutions
"Hedge funds have become an important source of protection to regulated institutions by being large sellers of credit insurance in the rapidly growing market for credit default swaps . But highly-leveraged and unregulated hedge funds are not the ideal type of insurer!"
· Hedge funds are receiving money from Australian superannuation funds.
Because of the current great doubt experienced by the two major political parties about the virtues of the fiduciary habits of ordinary workers, they feel compelled to take their savings away. The money is placed in pension funds for their old age. Workers are not allowed to withdraw this money and especially they are not permitted any control over the way in which these dollars are invested. (Meanwhile we'll continue to tout the virtues of a 'free market' system).
..Superannuation fund trustees have traditionally not invested in hedge funds both because of the infancy of the hedge fund market in Australia and because of the legal obligations described above. Rather,superannuation trustees have tended to prefer to invest in fixed interest investments, cash, government bonds and property investment trusts.
Hedge funds have not been favoured areas of investment principally because of perceptions concerning:
• the volatility of returns;
• level of regulation;
• the perceived lack of transparency of hedge funds ;
• levels of management fees; and
• additional risks associated with the use of derivatives by hedge fund managers.
In order to make such investments, superannuation trustees need to give careful consideration to the legal restrictions imposed in the form of general trustee duties and the investment parameters imposed by their trust deed, investment plan and the SIS Act.
However, despite this traditional reluctance to invest in hedge funds, superannuation trustees in Australia are now starting to use hedge funds to diversify their investments. Hedge fund investment is providing superannuation trustees with a way of counter-balancing the decline in returns on investments in traditional products. Those trustees are also attracted by the relative low correlation between the performance of some hedge funds and that of the equity markets more generally. There is also a considerable degree of liquidity with hedge funds, something that real estate or other structured assets may not offer. Finally, the introduction of hedge funds for retail investors has made the product apparently more mainstream and therefore, for trustees, possibly less likely to result in fund member concern..."
Australia: Some Legal Issues relating to Superannuation Trustees as Hedge Fund Investors
By Tessa Hoser and Katherine Henzell, Blake Dawson Waldron
1 December 2002.
· One third of hedge fund capital comes from pension funds
One third of hedge fund capital comes from pension funds. “Pension funds reusing hedge fund investment to diversify their own risks, but a situation where almost one-third of the capital for institutions on the cutting edge of financial risks comes from institutions whose first priority is safe investments certainly bears watching”.
Rodrigo Rato, IMF Managing Director
· The insurance provided by hedge funds lacks integrity.
1. How can you collect on an insurance contract when no-one can agree on the amount of the losses??
2. Both the buyer and seller of CDS may trade their obligation in the OTC market. There is nothing to prevent the insurer from offloading his obligation to an unqualified or unreliable party, in the process irreparably damaging the value of the insurance originally purchased.
I would be interested to learn if anyone can shed light on a potential problem in financial markets larger by at least an order of magnitude greater than subprime + CDO s sold to the SIV s and other institutions that hold them. Dr. Roubini has put numbers on subprime and alt-A plus CDO s, of about 1.5 trillion, and we don't have good estimates yet for auto loan and credit card securitized debt. Dwarfing these numbers is the 30 to 40 trillion dollar (or more) value of credit default swaps (CDS) outstanding. These swaps are essentially insurance policies between 2 parties. The FIRST buyer, presumably, is one with an asset (bond or securitized debt) to hedge. The FIRST seller, presumably, is a party known to the buyer who is financially able to provide the contracted protection in the event being insured (default) in return for the fee collected. But if both sides of this equation may TRADE their obligation in the OTC market, what is to prevent the INSURER from offloading his obligation to an UNQUALIFIED party, damaging irreparably the value of insurance originally purchased. If the insured has no control over the assignment to a third party of the obligation, of what value is the insurance. You may recall that in the DELPHI automotive bankruptcy, with 2 billion in bonds outstanding, there were over 20 billion in CDS outstanding. If the presumed solvency of unregulated insurance providers has enabled careless debt instrument purchases, watch out.
Written by RHK on 2007-11-06 08:01:26
3. The Over the Counter (OTC) trade is opaque and allows for the creation of fictionalised capital.
· There’s been a dramatic acceleration in number and type of derivative instruments.
(But current accounting and regulatory practice – as of December 2007 - allow for the creation of huge amounts of imaginary capital that is opaque and not subject to appropriate credit ratings. With the possibility of firms upping their trade in derivatives to hide the day of reckoning that comes with insolvency. See the linked article on credit default swaps.)
Hedge funds (holding Russian corporate bonds with ‘put options’) are demanding either full payment of debt or much higher interest rates; up to 16% during 2008.
· The total number of hedge funds has grown dramatically.
In 2007 there existed about 9000 funds. Half of them have a life span of three years. About one out of ten goes bust.
· Hedge funds are ‘Program Trading outfits’. They make money by buying large baskets of stocks.
A hedge fund, like investment banks, are referred to as ‘Program Trading outfits’. They make money by buying large baskets of stocks and then will blow out of those positions when their computers are programmed to sell.
· The range of hedge fund returns is large and unprecedented.
· Hedge fund managers’ earnings are astronomical. are determined by the gains of their own capital in their funds and their share of their firm’s management and performance fees. Most funds charge a 5% management fee and a 44% performance fee)
Of the 200-plus funds that Permal invests in, the poorest performer in the year to date – from January through to November 15 – had reported a loss of 7 per cent, and the top performer had returned 70 per cent. [unsourced]
“…Combined, the top 50 hedge fund managers last year earned $29 billion. That figure represents the managers’ own pay and excludes the compensation of their employees. Five of the top 10, including Mr. Simons and Mr. Soros, were also at the top of the list for 2006….”
Wall Street Winners Get Billion-Dollar Paydays
By JENNY ANDERSON
Published: April 16, 2008
+
“Hedge fund managers, those masters of a secretive, sometimes volatile financial universe, are making money on a scale that once seemed unimaginable, even in Wall Street's rarefied realms. One manager, John Paulson, made $3.7 billion last year. He reaped that bounty, probably the richest in Wall Street history, by betting against certain mortgages and complex financial products that held them. Paulson, the founder of Paulson & Company, was not the only big winner. The hedge fund managers James Simons and George Soros each earned almost $3 billion last year, according to an annual ranking of top hedge fund earners by Institutional Investor's Alpha magazine, which comes out Wednesday. Hedge fund managers have redefined notions of wealth in recent years. And the richest among them are redefining those notions once again. Their unprecedented and growing affluence underscores the gaping inequality between the millions of Americans facing stagnating wages and rising home foreclosures and an agile financial elite that seems to thrive in good times and bad. Such profits may also prompt more calls for regulation of the industry…”
Hedge fund managers get billion-dollar paydays
By Jenny Anderson
Wednesday, April 16, 2008
· G8 finance ministers meet on the issues relating to hedge funds but fail to address the issues.
G8 finance ministers met on the issue of the lack of supervision of hedge funds but they failed to address the issue. (When?, Source?)
Wall Street Bonuses in 2008 – Disappointing or Shameful?
When I first heard that bonuses paid to Wall Street types dropped from around $33 billion in 2007 to only $18.4 billion, the Manhattan resident in me thought – “ouch, that’s going to hurt the already sagging aggregate demand around here”. Call me a Keynesian. The President had a different thought:
OK – we don’t reward incompetence and we don’t give income assistance during hard times to the very wealthy. I’m with you Mr. President!
Update: Rudy Guiliani goes Keynesian on this story too:
Memo to self – in the future, check out what Josh Marshall has to say before blogging on these types of issues:
President Obama branded Wall Street bankers “shameful” on Thursday for giving themselves nearly $20 billion in bonuses as the economy was deteriorating and the government was spending billions to bail out some of the nation’s most prominent financial institutions. “There will be time for them to make profits, and there will be time for them to get bonuses”
OK – we don’t reward incompetence and we don’t give income assistance during hard times to the very wealthy. I’m with you Mr. President!
Update: Rudy Guiliani goes Keynesian on this story too:
Bonuses for Wall Street fat cats are easy political fodder in uncertain economic times, but former New York Mayor Rudy Giuliani said Friday cutting corporate bonuses means slashing jobs in the Big Apple. "If you somehow take that bonus out of the economy, it really will create unemployment," he said on CNN's "American Morning." "It means less spending in restaurants, less spending in department stores, so everything has an impact."
Memo to self – in the future, check out what Josh Marshall has to say before blogging on these types of issues:
As a resident of New York City, I think it's probably true that those dollars do do a decent amount for New York City economy, in the form of tax dollars and supporting local businesses -- though I would question its relative efficiency in stimulus terms. (And that's in large part because it's a lot of money in a fairly restricted geographic area.) But the government support that keeps these firms afloat doesn't just come from New York City, does it? This is the definition of trickle down -- give huge amounts of money to a small number of individuals, most of which will be socked away but a relatively small percentage of which will be spent on luxury goods. Amazing that this goof was once the GOP frontrunner for president.
Thursday, January 29, 2009
Stimulus Pork
Senator Max Baucus got $26 billion for private equity companies -- the vultures that buy companies, load them up with debt, collect exorbitant fees, and then try to sell them to the unsuspecting public.
Senator Robert Byrd is getting $4.6 billion for clean coal. "Clean, carbon-neutral coal can be a 'green' energy," Byrd said.
What the hell other crap is out there?
http://www.commondreams.org/headline/2009/01/28-2
Drucker, Jesse and Peter Lattman. 2009. "Senate Provision Would Let Buyout Firms Defer Taxes on Canceled Debt." Wall Street Journal (28 January).
http://online.wsj.com/article/SB123310671578422199.html?mod=todays_us_page_one
"Senate Finance Committee Chairman Max Baucus included language in the tax portion of the proposed stimulus package that would allow companies to defer income taxes triggered when they repurchase their own troubled debt at a discount. That would benefit a wide array of companies and industries, but would be a particular windfall to private-equity firms, which acquire companies using piles of debt in hopes of producing large profits for their investors. Amid the economic downturn, many of these deals have run into trouble and the firms are seeking to refinance them."
"The Joint Committee on Taxation estimates the proposal would cost the government roughly $26 billion over the next three years."
"A study by Boston Consulting Group found that, of 328 private-equity portfolio companies, roughly 60% had debt trading at levels considered "distressed"."
"To stave off default, private-equity executives have made reduction of their companies' debt a top priority. The companies are asking investors to swap their bonds for ones with lower values and longer maturities and also seeking to settle debt with cash. However, reducing debt levels can result in a big tax bill. For example, if a company issues $1 billion in debt, but later runs into trouble and exchanges it for new debt worth $600 million -- or buys it back for $600 million -- the remaining $400 million in cash is taxable income."
Senator Robert Byrd is getting $4.6 billion for clean coal. "Clean, carbon-neutral coal can be a 'green' energy," Byrd said.
What the hell other crap is out there?
http://www.commondreams.org/headline/2009/01/28-2
Drucker, Jesse and Peter Lattman. 2009. "Senate Provision Would Let Buyout Firms Defer Taxes on Canceled Debt." Wall Street Journal (28 January).
http://online.wsj.com/article/SB123310671578422199.html?mod=todays_us_page_one
"Senate Finance Committee Chairman Max Baucus included language in the tax portion of the proposed stimulus package that would allow companies to defer income taxes triggered when they repurchase their own troubled debt at a discount. That would benefit a wide array of companies and industries, but would be a particular windfall to private-equity firms, which acquire companies using piles of debt in hopes of producing large profits for their investors. Amid the economic downturn, many of these deals have run into trouble and the firms are seeking to refinance them."
"The Joint Committee on Taxation estimates the proposal would cost the government roughly $26 billion over the next three years."
"A study by Boston Consulting Group found that, of 328 private-equity portfolio companies, roughly 60% had debt trading at levels considered "distressed"."
"To stave off default, private-equity executives have made reduction of their companies' debt a top priority. The companies are asking investors to swap their bonds for ones with lower values and longer maturities and also seeking to settle debt with cash. However, reducing debt levels can result in a big tax bill. For example, if a company issues $1 billion in debt, but later runs into trouble and exchanges it for new debt worth $600 million -- or buys it back for $600 million -- the remaining $400 million in cash is taxable income."
Stimulus Debate: Flakey Economics
Jeff Flake had a novel argument against increasing at least one form of additional government spending as Josh Marshall notes and rebuts:
Net income for both Ford and GM has recently been negative so does Congressman Flake think that if the American automobile manufacturers are somehow encouraged to hire more workers that this fails to constitute stimulus? In fact, a lot of companies currently have negative net income. According to Flake’s “logic”, the prospect for a recovery is really dismal!
Now he's explaining how capital spending on AMTRAK is also not stimulus because AMTRAK doesn't run a profit. Again, total non-sequitur. I think rail is something we should be spending a lot more on. But you can certainly disagree with that on policy terms. But you can't claim that that capital spending on rail stock and rail upgrades doesn't provide jobs. Of course it provides jobs. And whether Amtrak is profitable or not is completely beside the point.
Net income for both Ford and GM has recently been negative so does Congressman Flake think that if the American automobile manufacturers are somehow encouraged to hire more workers that this fails to constitute stimulus? In fact, a lot of companies currently have negative net income. According to Flake’s “logic”, the prospect for a recovery is really dismal!
Wednesday, January 28, 2009
Do House Republicans Understand Tax Policy and Consumption Demand?
I submit that Congressman Jeff Flake does not:
While I have been noting that Ricardian Equivalence would argue for the proposition that tax cuts do not increase aggregate demand while increases in government purchases would stimulate aggregate demand, we should recognize the role of borrowing constraints:
Flake seems to be arguing that households that do not face borrowing constraints would be more likely to consume a tax “cut” than those that do face borrowing constraints. This proposition is precisely the opposite of what economic theory would tell us. Then again – economic theory tells us that increases in tax cuts (especially tax cuts for rich households) have less bang for the buck than increases in government purchases. Are these House Republicans hoping for the lowest bang for the buck or are they really this stupid?
Rep. Flake (R) was just on CSPAN moments ago talking about tax cuts in the Stimulus Bill. And he just made the argument that a lot of tax cuts in the bill go to 'people who don't pay income taxes', i.e., they're tax rebates … There's a decent case that one-off tax rebates aren't as potent as spending in terms of pumping money back into the economy. The one from last year didn't seem to have much of a punch. But whether the money goes into the hands of people who do or do not pay income taxes is a completely irrelevant point in itself. It's only relevant to whether you can focus tax breaks on wealthier people -- a political point. What's more, since people who 'don't pay income taxes' are overwhelmingly people with low incomes, those people by definition spend more than those with higher incomes, if only because they have no choice. It's just a straight-up nonsensical statement.
While I have been noting that Ricardian Equivalence would argue for the proposition that tax cuts do not increase aggregate demand while increases in government purchases would stimulate aggregate demand, we should recognize the role of borrowing constraints:
If “strapped consumers” means those facing borrowing constraints, it is precisely these households that are more likely to consume rather than save a tax cut.
Flake seems to be arguing that households that do not face borrowing constraints would be more likely to consume a tax “cut” than those that do face borrowing constraints. This proposition is precisely the opposite of what economic theory would tell us. Then again – economic theory tells us that increases in tax cuts (especially tax cuts for rich households) have less bang for the buck than increases in government purchases. Are these House Republicans hoping for the lowest bang for the buck or are they really this stupid?
World Growth Collapses
Econbrowser provides a link to a just-released IMF survey that reports that in November, 2008, world industrial production went from growing at a positive amount to an annual rate of -15%, and world merchandise trade went from growing at a positive rate to nearly a -45% rate, a total collapse probably more dramatic than even during the Great Depression. The IMF has lowered its projection for aggregate world economic growth in 2009 from 2.4% to 0.5%, which if it comes to pass would be the lowest rate of world GDP growth since WW II. We are indeed in a massive world economic crisis of the first order.
More Less
Pass the stimulus - then help shorten the work week
New York Daily News
By Dean Baker
Wednesday, January 28th 2009, 4:00 AM
As job losses hemorrhage, the American economy is in desperate need of a stimulus. It is becoming increasingly clear that Congress must work rapidly to approve some version of President Obama's plan.
Then, Obama and the Congress should very quickly turn to taking a second, temporary step to create more jobs: creating incentives for companies to reduce the workweek and work year for many Americans.
The idea is not as radical as it sounds - and could prove very productive indeed for the American worker....
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