Oxford economist Paul Collier is the author of the wonderful book The Bottom Billion: Why the Poorest Countries are Failing and What Can Be Done About It. And today Paul offers an insightful examination of the economic logic of the Stern Report et al. Excerpt:
…Personally, I doubt whether the utilitarian calculus is the right ethical framework in which to think about global warming. It gives us numerical answers, but it just does not feel as though the calculus captures my concerns. Take the valuation of the future: are we radically undervaluing the interests of future people?
Of course, we cannot tell how the future will feel, but one simple test is to ask ourselves how we feel about the past – are we angry that our great-grandparents did not live more frugally so that we would now be richer? Personally, of all the things I would have liked my great-grandparents to do differently, this is not one of them. However, you may feel differently.
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It is fairly obvious that adequately compensating the future for letting it fry is likely to be a more expensive undertaking than curbing our carbon emissions. Remember that future people are likely to be much richer than we are, and so what they would regard as fair compensation would be prodigious. Note how, if obligation rather than utility is to be our ethical guide, the fact that the future is likely to be richer is an argument to curb our emissions, not an argument for neglect.
Ultimately, in a democracy our policy decision rules must rest on ethical principles that are widely shared by citizens. I suspect that most people feel that they should reduce carbon emissions, but the key issue is why? Is their motivation better captured by the utilitarian calculus used by economists, or by a sense of custodial obligation towards our natural legacy, of which carbon is but one instance?
Meredith Whitney, the bank stock analyst whose forecasts have been most accurate, said her best idea was to short Ciitgroup, last week, even at super depressed levels.
Isn’t it a bit late to short Citi? More excellent analysis from Yves Smith. An excerpt:
While I agree that the stress test scenarios are not dire enough (and others, see here and here share that view). Even the anodyne New York Times casts doubts:
But analysts say the administration’s worst projections, which it describes as unlikely, are not much more dire than what many private forecasters already expect.
According to the new Treasury Department guidelines, the banks would have to assume that the economy contracts by 3.3 percent this year and remains almost flat in 2010. They would also have to assume that housing prices fall another 22 percent this year and that unemployment would shoot to 8.9 percent this year and hit 10.3 percent in 2010.
“I don’t think they are harsh enough,” said David Hendler, an analyst at CreditSights, who said the dire projection was itself too optimistic about the growth that would be generated from President Obama’s stimulus program. “That would be a pleasant outcome, but you have to plan for the worst.”
Noam Scheiber at New Republic:
The FT has a great piece sorting through how much the banks’ mortgage-related assets might be worth. The answer for the particular assets it looked at: not much. The highest-grade stuff came in at about 32 cents on the dollar; the mid-level stuff at about 5 cents.
As Paul Krugman points out, people who think the banks can recover without something drastic like nationalization believe the banks are fundamentally solvent, just victims of a short-term market panic. Or, as Krugman puts it, that an “’irrational despondence’ [has] led to an undervaluation of these assets, and that if we can just calm things down and get cash flowing again all will be well.” But if the FT piece is right, it’s hard to believe those assets will ever be worth anything near what the banks say they’re worth, which means the hole in their balance sheets isn’t going away.
As another illustration of this, consider an example I got from Orin Kramer, a hedge fund manager and prominent Obama supporter. Kramer has a friend who recently bid on a bundle of home-equity loans the government was auctioning off (presumably after having seized a bank that owned them). The homeowners in this case weren’t subprime deadbeats but people with solid credit histories who were scrupulously making their payments. Still, the friend was the highest bidder at a measly 14 cents on the dollar—and, Kramer says, “I have another friend who claims he overbid.” (The government decided not to sell because it didn’t like the price.)
This might sound like a classic “irrational despondence” issue—only 14 cents on the dollar for a bundle of perfectly upstanding loans? But there’s one big problem, as Kramer points out: None of the homes have any equity left in them. Thanks to the cratering housing market, these people’s first mortgages exceed the value of their homes, which makes them good candidates to simply stop paying (both the original mortgage and the home equity loan).
Of course, if nothing else, this example illustrates how critical the Obama administration’s housing plan is—both for homeowners and the banks. One provision helps underwater homeowners refinance, so they can at least lower their monthly payments. (You’re much more likely to walk away from your home if you have zero equity and an unaffordable mortgage, as opposed to just zero equity.) The plan could create a floor under the value of all the mortgage-backed assets, though it’s unlikely to give them much of a boost.
Paul J Davies at Financial Times has some elements of the train wreck:
Almost half of all the complex credit products ever built out of slices of other securitised bonds have now defaulted, according to analysts, and the proportion rises to more than two-thirds among deals created at the peak of the cycle.
The defaults have affected more than $300bn worth of these collateralised debt obligations, which were built from bits of other asset backed securities (ABS) such as mortgage bonds, other CDOs and structured bonds, or derivatives of any of these, according to analysts at Wachovia and Morgan Stanley.
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The way these complex and risky transactions were exploited at the peak of the bubble can be seen in data from analysts at Wachovia, who reckon that 47.6 per cent of all CDOs of ABS by volume issued since the market substantively began in 2002 have now hit an event of default.
By their records, the first three years of the market saw less than 100 deals sold per year and less than 10 per cent of those have defaulted. The number of deals done rose to 133 in 2005, less than 20 per cent of which defaulted, and 89 in just the first half of 2006, about one-third of which have defaulted.
However, the real peak of the market saw 147 deals done in the second half of 2006 and 172 done in the first half of 2007 – of which 68 per cent and 76.2 per cent, respectively, have now defaulted.
[...]
Yikes — 5% recovery rates? What does this report say about the valuation of big bank assets? More from banking consultant Yves Smith:
The Financial Times has been keeping tabs on the results, or perhaps more accurately, the lack thereof, of collateralized debt obligations. A couple of weeks ago, it highlighted research by Morgan Stanley and Wachovia that concluded that nearly half the CDOs made from asset backed securities [failed].
Today, Gillian Tett of the FT discusses research on CDOs by JP Morgan and Wachovia. I’m assuming that JP Morgan released an additional study (as opposed to the first article having mistakenly mentioned Morgan Stanley, as opposed to JP Morgan). Tett mentions not only the impressive level of failures, but also the horrid recovery rate.
From the Financial Times:
Just how much should a debt vehicle backed by subprime mortgage bonds be worth these days? Two years ago, most banks and insurance companies assumed the answer was close to 100 per cent of face value – or more…
But as the zeroes relating to writedowns multiply, a peculiar – and bitter – irony continues to hang over these numbers. Notwithstanding the fact that bankers used to promote CDOs as a tool to create more “complete” capital markets, very few of those instruments ever traded in a real market sense before the crisis – and fewer still have changed hands since then.
Thus, the “prices falls” that have blasted such terrible holes in the balance sheets of the banks have not been based on any real market numbers, but on models extrapolated from other measures such as the ABX, an index of mortgage derivatives…
But now, at long last, one shard of reality has just emerged to piece this gloom. In recent weeks, bankers at places such as JPMorgan Chase and Wachovia have been quietly sifting data ….
From late 2005 to the middle of 2007, around $450bn of CDO of ABS were issued, of which about one third were created from risky mortgage-backed bonds (known as mezzanine CDO of ABS) and much of the rest from safer tranches (high grade CDO of ABS.)
Out of that pile, around $305bn of the CDOs are now in a formal state of default, with the CDOs underwritten by Merrill Lynch accounting for the biggest pile of defaulted assets, followed by UBS and Citi.
The real shocker, though, is what has happened after those defaults. JPMorgan estimates that $102bn of CDOs has already been liquidated. The average recovery rate for super-senior tranches of debt – or the stuff that was supposed to be so ultra safe that it always carried a triple A tag – has been 32 per cent for the high grade CDOs. With mezzanine CDO’s, though, recovery rates on those AAA assets have been a mere 5 per cent.
I dare say this might be an extreme case. The subprime loans extended in 2006 and 2007 have suffered particularly high default rates and the CDOs that have already been liquidated are presumably the very worst of the pack.
Even so, I would hazard a guess that this is easily the worst outcome for any assets that have ever carried a “triple A” stamp. No wonder so many investors are now so utterly cynical about anything that bankers or rating agencies might say these days.
After all, when the ABX started taking a dramatically bearish tone 18 months ago, many banks claimed that it was ridiculous that they were writing their mortgage assets down to prices extrapolated from the ABX, since it was popularly claimed that the ABX overstated likely future loss. Even the Bank of England appeared to share that view.
But with the ABX now suggesting that triple A subprime mortgage assets are worth around 40 cents on the dollar (depending on the precise vintage), the message from that might almost be too optimistic in relation to some CDOs. So where does that leave the banks? In reality we will not know whether that horrific 95 per cent loss is unusual until the rest of the CDO of ABS are liquidated too. But for my part, I suspect that the saga strengthens the case for financiers now biting the bullet – and conducting some open auctions of this stuff, to get a bit of market price discovery….
After all, if an open auction ends up pricing mortgage-linked CDOs near zero, at least the capital hit to the banks and insurance companies will be clear; and if it is higher than zero, it might even cheer investors up.
Our sentiments exactly.
Wow is all I can say. Felix Salmon:
It’s pretty much impossible to get one’s head around the sheer enormity of the numbers in Barack Obama’s first budget. But it’s important to try, and one anonymous commenter has a very good point: the entire federal budget, as submitted by President Clinton in 1996 through 1999, was smaller than the budget deficit that Obama is proposing for next year.
Obama’s total budget is $3.6 trillion, which works out at $34,000 per household; median household income is about $50,000. Which basically means that for every dollar that a US household earns, the US government plans to spend 68 cents next year. And the ten-year T-bond still yields less than 3%. Extraordinary.
Here’s the latest analysis of United Overseas Bank. An excerpt from the introduction:
Based on the reversion to trend growth, we estimate conservatively that most key Asian countries face the prospects of an unprecedented 10%-20% decline in their exports in 2009. In a pessimistic scenario, the extent of exports slump could be as much as 20% to 40% this year.
Looking at individual countries, our full year real GDP forecast of -4% for Singapore has factored in a in a 24% drop in non-oil domestic exports (NODX) this year. Similarly for Taiwan, a similar 25% fall for Taiwan’s exports is built in to our recently revised -3.5% growth forecast. For China, we expect exports to slide by 18% this year.
On the UOB report Brad Setser commented
…Among other things, they noted that the credit/ housing/ consumption bubble in the West pulled Asian exports well above their long-term trend. I rather suspect artificially weak exchange rates also played a role, especially vis-a-vis Europe. The current export fall consequently represents a reversion to a more normal pattern of export growth.
Click on the thumbnail for the full size image.
NASA has announced the dates and terms for a key prize challenge.
SUMMARY: This notice is issued in accordance with 42 U.S.C. 2459f-1(d). The 2009 Power Beaming and Tether Challenges are now scheduled and teams that wish to compete may now register. The NASA Centennial Challenges Program is a program of prize contests to stimulate innovation and competition in space exploration and ongoing NASA mission areas. The 2009 Power Beaming Challenge is a prize contest designed to promote the development of new power distribution technologies. The 2009 Tether Challenge is a prize contest designed to develop very strong tether material for use in various structural applications. The Spaceward Foundation is administering both Challenges for NASA.
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