Capitol Capitalist

See here for the introduction to the ZBI.

I’m rearranging the top of the ZBI again.  Litigation taking the length of time it does, though, it will be three years before I’m able to say “I told you so.”  The good thing about all this happening in slow motion, though, is that maybe it gives the authorities on both sides of the Atlantic time to organize a coordinated international rescue/resolution regime before something large and hairy and international collapses all over the system.  Oh, but I forgot which authorities we were dealing with there.  So go ahead and panic, then.  I’ve panicked so much over the last year I have run out of capital letters.

1. Bank provisioning. Somewhere out there, a junior associate at a plaintiffs’ law firm is putting together the papers that will finally lead to the disassembly of some of the world’s largest banks.  There are several categories of litigation arising from the financial crisis.  There’s the assembly and sale of the troubled securities, which has led to settlements among many of the banks and investors and is being litigated in several venues, although the SEC can’t seem to get a break on its settlements (which of course means continued exposure for the settling banks).  There are the suits arising from the processing of the assets in the securities which was where I originally thought provisioning was inadequate.  And then there’s the “fauxclosure” issue.  Add to these a whole new category of lawsuits.  The recent disclosures by the Fed of exactly what they lent to whom and when in the crisis may lead to more lawsuits from investors who purchased bank shares in the massive capital-raisings of 2009.  The claim would be, of course, that not including the words “WE ARE ON LIFE SUPPORT FROM THE FED”  in the Risk Factors and the Management’s Discussion and Analysis, in 18-point type in flashing red letters, possibly with glitter, amounts to an omission of information necessary to make the disclosures in the prospectus not misleading.  Current rating: 9  zombie bears.
2. Europe. I’m downgrading the EU threat.  While the leaders of the European bits of Europe agreed to form an ever-closer union, the  ECB acted like a central bank and gave away free monies.  Yay Eurocrats!  Before this week if you needed Euros you’d be needing a special Argentine Euro-sniffing dog to find Euros.  Now you get Euros!  And you get Euros! Free(ish) Euros for everyone!   Current rating:  7 zombie bears.
   
3. Actuaries and pensions. So I ran across the budget manager of our town at a Christmas party, poor guy.  He admitted that an assumed growth rate of 7.5% on the pension fund was pushing it a bit, although on a 30-year timeframe it may all come good and they were looking at alternative investments, and all that.  More importantly, a commission of local worthies had recommended changes to our pension system, which were going to be followed.  (One of the great things about being in the DC area is that you have bona fide national experts living in your town and willing to do stuff pro bono publico.)  And until the fund is fully funded, which I personally think is a generation away, we live in a prosperous town with money in the General Fund.  So our firemen are fine.  In some other towns, not so fine.  Current rating: 5 zombie bears.
4. Populist rage and financial illiteracy. Current rating: 4  zombie bears.
5. Math/Algorithms. Gillian Tett in the FT says the Flash Crash could return with a vengeance.  And she’s right.  The SEC and Treasury’s OFR need battalions of really serious mathematicians on staff, who understand super-complex systems.  Tett cites this study by Dave Cliff and Linda Northrop, which we all need to read.   Although I don’t recommend doing it on New Year’s Day.  Current rating: somewhere between one and an infinite number of zombie bears; variable.
6. Hackers. Current rating: 8 sleeping (?) zombie bears; stable.
7. Cross-border equity custody. Current rating:  one lonely zombie bear.
   
8. Bitcoin or something like it. Current rating:  one zombie bear and stable.
9. Megabank’s Boring Transactions Division. Current rating: no zombie bears for now.
10. Commercial Real Estate. Current rating: no zombie bears; we are still pretending they aren’t there.

See here for the introduction to the ZBI.

The markets are clearly not getting it, so let’s look at where we are in zombie movie terms.  See, all the major indices got all excited about the fact that the various central banks are going to work together to provide liquidity.  That’s like the townsfolk cheering because the mayor has called in the Army to deal with the zombies and the Army brought its Armageddon machines that might destroy the world BECAUSE THE ZOMBIE THREAT WAS SO DIRE.  REALLY BAD.  SERIOUSLY, CHEERING IS THE WRONG RESPONSE HERE.  The correct response is to go to your local tavern, down several zombie bear cocktails and hope that the Vogons will be here soon.

Actually, the real correct response would actually be (a) cocktail, (b) leverage EFSF, (c) ringfence the PIIGS and probably France, (d) another cocktail, (e) provide massive liquidity to eurobanks (so this is actually happening a bit), and (f) work out what the frack you are going to do when one of the big banks actually fails.  As Ed Greene at Cleary Gottlieb is pointing out [hope I will get something to link to for you soon; he is spot on on this topic], on the US side we have authority to resolve but not rescue,  and in some of the European countries we have some rescue/resolution legislation adopted but it varies from place to place, and we have NO process in place to coordinate the international chaos that will ensue when something large and hairy and international goes down.  And something large and hairy and international WILL fail.

1. Europe. The single scariest sentence ever,  from last week’s Economist: “The only institution that can provide immediate relief is the ECB.”   Cos the ECB isn’t going to save us, is it?  On account of it’s not really a proper central bank and only a real central bank could do what needs to be done now.  Which is buy French bonds.  (And the bonds of all the dominoes that fall before France.)   Dean Baker says the Fed should take over this role and you’ve gotta admit that someone has to.  (So is Europe really trying to prove that they are less capable of doing stuff than the SuperCommittee?  It’s not a contest.)  Current rating:  10 zombie bears.  When it really wouldn’t be that difficult to get to 2 bears.  Really.
   
2. Bank provisioning. Current rating: 9  zombie bears.
3. Actuaries and pensions. On a recent rainy day I spent some time looking at my own town’s budget, specifically its unfunded pension obligations.  The budget assumes a 7.5% annual return/discount rate, and a cash flow projection that predicts a 100% funding rate by 2018.  This is, of course, impossible.  Looking at “The Determinants of Actuarial Assumptions Under Pension Accounting Disclosures“, we see that for every 1% change in the discount rate a pension liability can change as much as 20%. [The actual book that proved this was printed in 1977 and I'm still waiting for the copy I bought used on Amazon.] So if you use a more reasonable 4-5% discount rate, my town’s obligations will be fully funded by, oh, say 2525.  And this is a AAA-rated municipality.  For now, the town will continue to fund the shortfall from the general fund, but we are in the lucky position of being in the DC area with modestly rising house prices and an employed populace.  Lots of other municipalities aren’t so lucky, and some won’t make it.  And the people who lose out (apart from bondholders) are the middle-class public servants who were relying on those pensions.  Long, slow, painful fail. Current rating: 5 zombie bears; rising.
4. Populist rage and financial illiteracy. Warren in Offshore has pointed out to me the role that ignorant financial journalism has played in fanning recent panics.  It’s probably even broader than that; people who have vehement views on things they know nothing about are in charge of some important stuff.  More on this to come. Current rating: 4  zombie bears.
5. Math/Algorithms. Current rating: somewhere between one and an infinite number of zombie bears; variable.
6. Hackers. I liked this “top ten threats” guide.  But if I followed it I wouldn’t be able to mention cats or cocktails.  Or even zombies. Current rating: 8 sleeping (?) zombie bears; stable.
7. Cross-border equity custody. Current rating:  one lonely zombie bear.
   
8. Bitcoin or something like it. Current rating:  one zombie bear and stable.
9. Megabank’s Boring Transactions Division. Current rating: no zombie bears for now.
10. Commercial Real Estate. Current rating: no zombie bears; we are still pretending they aren’t there.

See here for the introduction to the ZBI.

Oh noes!  The Almighty (or at least his vicar on Earth) is in favor of a financial transactions tax!

On the basis of this sort of ethical approach, it seems advisable to reflect, for example, on:a) taxation measures on financial transactions through fair but modulated rates with charges proportionate to the complexity of the operations, especially those made on the “secondary” market. Such taxation would be very useful in promoting global development and sustainability according to the principles of social justice and solidarity. It could also contribute to the creation of a world reserve fund to support the economies of the countries hit by crisis as well as the recovery of their monetary and financial system…

And not just the Big Guy but also the nurses.

Popes and nurses; I know when I’m outgunned.  The March in favor of FTT is on November 3.  Vanuatu here we come.

1. Europe. Everyone is on edge for the meeting tomorrow.  Will we have a massive confidence-building plan together with strict stress tests for the banks and a robust recapitalization program?  Oh we can dream, can’t we?  Current rating:  10 zombie bears.  When it really wouldn’t be that difficult to get to 2 bears.
   
2. Bank provisioning. Current rating: 9  zombie bears.
3. Populist rage. The message gets more coherent.  On the other hand the American Nazi Party (eewww) is encouraging their supporters to join the OWS protests and hand out flyers explaining the problem with the “judeo-capitalist” system.  (You didn’t think I would link to those people?)  And, as discussed above, the calls for a FTT get louder. Current rating: 6  zombie bears.
4. Math/Algorithms. Current rating: somewhere between one and an infinite number of zombie bears; variable.
5. Hackers. Current rating: 8 sleeping (?) zombie bears; stable.
   
6. Actuaries and pensions. Rhode Island’s actuaries pointed out that the assumption of 8.25% growth underpinning its pension calculations had only a 30% chance of happening.  So the assumption got decreased to 7.5% (over 7%? really?  is that in, like, dog years?) and a $7 billion pension shortfall turned into a $9 billion one.  Multiply this process by 50 states, etc.   The Economist discusses a study estimating a $4.4 trillion shortfall in public pensions.  Of course that’s over the life of the pensions in question, but it’s still almost real money (AND you know that some of these plans are still using ridiculous growth assumptions).  And then you have the problem of the companies who still have defined benefit plans, which are running at a deficit of only half a trillion or so.  Any directors of companies with defined benefit compensation plans who have not spent a load of time asking about their pension liabilities are not doing their job.  (Pay special attention to non-US companies with defined benefit plans.  The US GAAP reconciling footnote at the end of the financial statements of non-US companies registered with the SEC can be fascinating…)  [UPDATE: Cate Long at Reuters points out that the $2 billion extra shortfall in RI arises from applying private sector rules to public pension accounting, not from changing the assumptions.  The NYT story might be inaccurate in this respect, but surely the deeper story is that private sector accounting rules give you a better indication of whether your local retired cop is going to get all his pension or not.  Also the RI Treasurer's report says that meeting the revised assumption for growth is unlikely.]  Current rating: 3 zombie bears; rising.
7. Cross-border equity custody. Current rating:  one lonely zombie bear.
   
8. Bitcoin or something like it. Current rating:  one zombie bear and stable.
9. Megabank’s Boring Transactions Division. Current rating: no zombie bears for now.
10. Commercial Real Estate. Current rating: no zombie bears; we are still pretending they aren’t there.