Latest from Matt Taibbi and other links

Thanks to Barry Ritholtz, I came across this latest by Matt Taibbi (famous for his description of Goldman Sachs as vampire squid) on how the present democratic administration sold out to Wall Street. I have not read it. But, thought I should flag it. It should be interesting.

I was there in CNBC studios in Singapore when Greek PM was interviewed by CNBC – LIVE and Exclusive – in Europe. He admitted to corruption from top to bottom. I did not find it that sensational or candid. Many politicians in India have said so. It is one thing to make general statements like that. It is another ….

I must confess to being impressed by the resilience of spending and confidence of the American consumer. Whether they are all sustainable or healthy remain matters of debate, however. But, one must admit that one had not anticipated it. Rising asset prices does that. M/s. Greenspan and Bernanke must be chuckling. For them, it has always been a case of asset prices, confidence and liquidity. Nothing about fundamental imbalances. In the short-term, the wind is blowing in their favour.

The strength in the dollar is welcome for it pulls up the currency from the edge of the cliff. But, if it is in anticipation of some yield being made available on the currency by the country’s central bank, then investors are going to be disappointed. The Fed won’t satisfy their desires. Why? Read the previous paragraph.

Nonetheless, it is this feeling of some one being hauled back from the edge of the precipice that is creating the odd combination of confidence in recovery, higher yield expectation, yet stronger stock markets, strong dollar and weaker oil (which should be boosted by expectation of better growth but is being offset by the return of (temporary) confidence in the dollar). It is all about the decline in risk  premium.

If risk premium was high before, then how did risky assets manage to do so well this year? It was smothered by the tsunami of easy money, proprietary trading and short covering.

If you had not read this piece in Bloomberg on how Dubaiworld and Nakheel got all those loans, you should read it. It is a good piece of journalism.

Off to Dubai today and then on to India for the end-of-the-year holidays. On 14th December, Nakheel’s debt/coupon payment falls due. I will be there in Dubai. It should be interesting.

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Immelt, Black and Derman

Alastair Darling’s one-off bonus windfall tax seems theoretically sound, to me. People can quibble with the floor above which the tax is applicable but the principle is sound. Emanuel Derman wrote about it a while ago. I had blogged it here. He reckoned that since bankers were bailed out by taxpayers, he felt that it was appropriate that bankers should share the upside with them. In other words, he said that bankers should write call options to the public. Since they would  not do it themselves,  Darling has done it for them.  He had set a good precedent. France is following. American bankers and central bankers must be nervous.

Jeffrey Immelt has sought to distance himself from the bankers,as John Gapper puts it in FT. All good things must begin somewhere. America, for it to retain its superpowerdom, has to begin its  introspection. It is late. But, never too late, I guess.

Emanuel Derman had spoken about Fischer Black recently. I read the speech. Looks like I have to read it more than once, to understand. Very interesting guy – I mean, Derman. Parts of the speech felt like I was reading Hindu philosophy:

Every thing you can think of exists, and everything that exists can be thought of.

That reminds me of the following lines of Tamil poet Bharatiyar: “Kaanbavellam Maraiyumendraal, Marainthathellam Kaanbomandro?”

Back from ‘bubbles’

I have not posted in a long time. It was not meant to be this way. It just happened. Let me break the stalemate with a post on bubbles. Nothing original. It just so happens to be the topic on which I spoke in Mumbai over the weekend. The Indian Alumni Association of the Asian Institute of Management in Manila hosted a panel discussion on ‘Are bubbles necessarily bad?’.

As good friend Nitin Pai – who was in the audience  – rephrased it, the more appropriate question was whether we preferred capitalism with bubbles or socialism. He posed this question to the keynote and valedictory speaker, Mr. Mani Shankar Aiyar. To which, Mr. Aiyar responded, that he preferred capitalism without bubbles. That ideal world, of course, does not exist because bubbles are inherent to human nature. Of course, in an economy organised along socialistic lines, perhaps, there would be a bubble in totalitarian controls. Bubbles have to manifest somewhere, somehow.

There was no speaker to defend bubbles. In the course of my research for this speech, I found that even those who defended the bubbles on account of the risk-taking and innovation (journalist Daniel Gros and Professor Didier Sornette, to name just two) that initially engendered had done so before the latest crisis hit us in 2008. Since then, they have softpedalled. It is difficult to find some one explicitly state that they favour bubbles. No policymaker, not even the American ones, want to be seen in bed with bubbles!

So, whether or not we welcome or like bubbles, the problem is that bubbles not founded on any scientific discovery, technological advancement seem to cause more damage and very little residual positive effects that are now attributed to the Internet and TMT bubbles. Financial capitalism has engendered mostly harmful bubbles and ever since financial sector came to dominate the economic landscape, bubbles have not only become more frequent, they have also become more global and hence, more pervasive in their harmful effects. No wonder even its champions have become more muted.

It was refreshing to see an American policymaker display an attitude of ‘mea culpa’ on their handling of bubbles and their aftermath. I am referring to the recent speech of the President of the New York Fed, Bill Dudley. Just for the record, Bill Dudley is formerly from Goldman Sachs. The full speech is here and the key extracts from the speech on bubbles are given below:

For one, the crisis is provoking a reevaluation of our views on how to respond to asset bubbles. For years, central bank orthodoxy has been that you cannot identify asset bubbles very well. Thus, the strategy has been to move aggressively to clean up such bubbles after they have burst.

I think our level of confidence in that approach has been considerably reduced in the wake of the crisis that we have just experienced. The costs of cleaning up after the fact have been immense.

But make no mistake—developing an effective, more proactive approach is not easy. Among the important questions that need to be answered:

  1. How does one identify bubbles—which I’ll define here as persistent large deviations in asset prices from their fundamental value—in real time?
  2. What instruments can be used to limit the development of bubbles and/or allow bubbles to deflate in non-catastrophic ways that will not damage the economy in other ways?

Turning to the first issue, identifying asset bubbles in real time is difficult. However, identifying variables that often are associated with asset bubbles—especially credit asset bubbles—may be less daunting. To take one recent example, there was a tremendous increase in financial leverage in the U.S. financial system over the period from 2003 to 2007, particularly in the nonbank financial sector. This sharp rise in leverage was observable. Presumably, this rise in leverage also raised the risks of a financial asset bubble and the impact of this bubble on housing certainly raised the stakes for the real economy if such a bubble were to burst. This suggests that limiting the overall increase in leverage throughout the system could have reduced the risk of a bubble and the consequences if the bubble were to burst.

Turning to the second issue of how to limit and/or deflate bubbles in an orderly fashion, the fact that increases in leverage are often associated with financial asset bubbles suggests that limiting increases in leverage may help to prevent bubbles from being created in the first place. This again suggests that there is a role for supervision and regulation in the bubble prevention process. For example, it might be appropriate for the Federal Reserve—working with functional regulators such as the SEC (Securities Exchange Commission)—to monitor and limit the buildup in leverage at the major securities firms and the leverage extended from these firms to their clients and counterparties.

Whether there is a role for monetary policy to limit asset bubbles is a more difficult question. On the one hand, monetary policy is a blunt tool for use in preventing bubbles because monetary policy actions also have important consequences for real economic activity, employment and inflation. On the other hand, however, there is evidence that monetary policy does have an impact on desired leverage through its impact on the shape of the yield curve. A tighter monetary policy, by flattening the yield curve, may limit the buildup in leverage.1

Whether it would be more effective to limit leverage directly by regulatory and supervisory means or via monetary policy is still an open question. But it is becoming increasingly clear that a totally hands off approach is problematic. [More here]