Thoughts on recent economic affairs

-The Fed paying interest on reserves has the same effect as the Fed selling securities through open market operations. Selling securities through OMO parks the cash at the Fed, out of the money supply. The Fed pays interest on those securities. With the new system, the Fed just pays interest on the cash directly, and since the FFR is so low institutions park their cash at the Fed instead at other institutions.

-Paulson and Bernanke are like the people in Jurassic Park who thought things would be fine once they got power back to the fences; but forgot that the velociraptors and T-Rexes were loose, shredding anything that moved.

Mark Cuban and insider trading

There is a great post here regarding the Cuban case by Stephen Bainbridge, William D. Warren Professor, UCLA School of Law; where Bainbridge makes a pretty good case that Cuban didn't have any legal obligation not to sell shares as he did. Bainbridge cites a Supreme Court decision regarding what individuals would have fiduciary obligations under the law in cases similar to Cuban's. Also, Professor Bainbridge has apparently written a book on insider trading(Securities Law: Insider Trading), so he seems to me to be a reasonably reliable authority and disinterested third party. The linked post is a great read. I'm convinced that Cuban could win his case.

In the Bainbridge post I linked, he cites this precedent that some might find interesting:

"The most relevant precedent here would be Walton v. Morgan Stanley & Co.,623 F.2d 796 (2d Cir.1980). Morgan Stanley represented a company considering acquiring Olinkraft Corporation in a friendly merger. During exploratory negotiations Olinkraft gave Morgan confidential information. Morgan’s client ultimately decided not to pursue the merger, but Morgan allegedly later passed the acquired information to another client planning a tender offer for Olinkraft. In addition, Morgan’s arbitrage department made purchases of Olinkraft stock for its own account. The Second Circuit held that Morgan was not a fiduciary of Olinkraft: “Put bluntly, although, according to the complaint, Olinkraft’s management placed its confidence in Morgan Stanley not to disclose the information, Morgan owed no duty to observe that confidence.” Although Walton was decided under state law, it has been cited approvingly in a number of federal insider trading opinions. Hence, I believe the cases finding liability based on a mere contractual duty of confidentiality are wrongly decided."

So JP Morgan was given a free pass for trading against a client...

U-6: The Real Unemployment Number

Double click on the image to zoom; you'll see that the total number of unemployed in the US is 4.6% higher than the headline unemployment number you'll see in the press.

Bankruptcy for Profit

I found an interesting link at NakedCap:

Looting: The Economic Underworld of Bankruptcy for Profit

George A. Akerlof University of California, Berkeley

National Bureau of Economic Research (NBER)

Paul M. Romer Stanford Graduate School of Business

National Bureau of Economic Research (NBER)April 1994

NBER Working Paper No. R1869

Abstract: During the 1980s, a number of unusual financial crises occurred. In Chile, for example, the financial sector collapsed, leaving the government with responsibility for extensive foreign debts. In the United States, large numbers of government-insured savings and loans became insolvent - and the government picked up the tab. In Dallas, Texas, real estate prices and construction continued to boom even after vacancies had skyrocketed, and the suffered a dramatic collapse. Also in the United States, the junk bond market, which fueled the takeover wave, had a similar boom and bust. In this paper, we use simple theory and direct evidence to highlight a common thread that runs through these four episodes. The theory suggests that this common thread may be relevant to other cases in which countries took on excessive foreign debt, governments had to bail out insolvent financial institutions, real estate prices increased dramatically and then fell, or new financial markets experienced a boom and bust. We describe the evidence, however, only for the cases of financial crisis in Chile, the thrift crisis in the United States, Dallas real estate and thrifts, and junk bonds. Our theoretical analysis shows that an economic underground can come to life if firms have an incentive to go broke for profit at society's expense (to loot) instead of to go for broke (to gamble on success). Bankruptcy for profit will occur if poor accounting, lax regulation, or low penalties for abuse give owners an incentive to pay themselves more than their firms are worth and then default on their debt obligations.

Sounds like a very apt description of what has been taking place. I see this as falling into the category of a problem in what economists call "agency theory". The interests of mgmt are not aligned with those of shareholders/bondholders. Investment banks should never have been public companies.

The credit crunch has gotten through to consumers

Interesting tidbit from Across the Curve:

"No interest in homes

...though consumers painted a relatively sunny picture about the outlook, they don’t seem inclined to pull the trigger on big ticket items any time soon. Home buying intentions collapsed to just 2.1% of those surveyed, the largest one-month decline since August 1990. Given the tightening in credit conditions in this space it is little wonder to us that pool of prospective buyers is getting thin, not to mention that home prices have sagged by 20% according to the latest Case Shiller numbers out earlier today. Moreover, folks are still not seeing real estate as a great place to sock their investments. According to the University of Michigan survey, only 2% of respondents think home prices are going higher.

Even more disturbing was that new car purchase intentions dropped to just 1.5% of all respondents – an all-time low. This is an ominous sign for those auto sales numbers due out tomorrow – consensus is expecting an almost unchanged print to 13.5 million units while we see sales coming in about 1 million below that mark and we would not be surprised to see sales dip below 12 million in the months ahead."

Those are low numbers, but make sense when very few have down payments ready to put down on these kinds of big purchases. One of the major automakers will have to shut down if those sales numbers pan out. There is far too much production capacity out there.