Mark Sunshine

Why Krugman's Analysis of Economists Is Wrong, Part II

Bob,

You are correct. I focused on only one externality in housing. I should have been clearer. I am trying to use the three examples as illustrative examples and not as an exclusive list.

I think that the change from the US being a liability society to a limited liability society makes the economic models wrong because their inputs are wrong.

There are many other externalities as well (in addition to limited liability) that economists ignore.

The point is that the models are great but they have little to do with reality.

Thanks for reading and taking the time to comment.


On Sep 09 12:51 PM bob adamson wrote:

> Mr. Sunshine transmutes Krugman’s focus on one sort of externality
> (environmental and social costs) to a focus on another (over indebtedness
> promoted by the spread of opportunities to exploit limited liability).
> Mr. Sunshine then further narrows his focus to over indebtedness
> in the residential housing market caused by the fact mortgagors are
> not required to give a personal guarantee for their loan. What has
> he proved, however?
>
> Clearly, the fact that mortgagors at all income levels (not just
> the poor from visible minorities as was for too much of the 2002
> to 2008 period the conventional wisdom) can walk away from their
> obligations once the mortgage principal exceeds their equity increases
> the downward pressure on the housing market in down times and therefore
> is a drag on lenders and the derivative markets based on mortgages
> (just as the converse applied while the real estate housing market
> was booming). In short, the lack of a requirement to personally guarantee
> a mortgage loan acts as one of several multiplier factors increasing
> volatility in the housing market and in industries associated with
> that market (including banking and trading in secularized mortgage
> debt and derivatives based thereon). Granting that Mr. Sunshine has
> focused on one element leading to the current economic situation,
> is it not so that other elements were of even more importance and
> that he has artificially reduced the important concept of externality
> to one element (the effect of limited liability, primarily for residential
> mortgagors).
>
> Taking his example of the mortgage market, wasn’t the real ‘limited
> liability accelerator’, to coin a phrase, the fact that investment
> banks were prepared to buy unsound mortgages, bundle them into derivative
> equities and derivatives based on such derivatives etc. and that
> a lack of regulatory oversight and transparency allowed this junk
> to the tune of 20+ trillion dollars to be sold world wide. Wasn’t
> there by 2005 a veritable black hole of demand for residential mortgages
> (few questions asked about the security backing those mortgages)
> to feed this derivatives escalator market? In short, hasn’t Mr. Sunshine
> focused on a relatively small aspect of the metastasis of toxic waste
> (the financial variety) which, in turn, is a small element of the
> limited liability issue (not really discussed in the blog or here)
> which is only one facet of externality as discussed by Krugman?

Mark Sunshine on U.S. vs. the world: "I strongly believe that we have the best system, government, population and natural advantages in the world... I haven't seen a lot of people make a lot of money betting against the USA over the course of a generation."Peter Schiff's retort: "We HAD the best system."

Harry, I apologize for not being clear in ,my previous writing. The reference that you are pointing to was an on line conversation/debate and at the time I was typing as fast as I could.

The qualifier about "over a generation" was only meant to acknowledge that in the short run the US stock market goes up and sometimes it goes down, but over time the US is the best bet in world.

In the debate with Peter when I typed the statement you are referring to I tried to qualify it so that Peter wouldn't be able to reply with a trading range retort.

But I want to be clear, there isn't any place else in the world that I think has a better economic system or government than the US. I think we are all lucky to live and work here and when the chips are down the US is the best that world has to offer. We have the most dynamic society and a system that self corrects itself. The US is the model most of the rest of the world. And, for the part of the world where we aren't the model I think that the other systems and governments are far behind the US (and the standard of living and freedoms far behind the US).

All around the world it is the US that ordinary people turn to and ask for help and leadership.

I have traveling throughout most of the world and worked in many countries. While many other countries are great places to live, what makes the US special are things like the independent judiciary, predictable property rights (both real estate and UCC), unquestioned civil rights and no realistic fear of civil unrest or insurection that distinguish the US from other places. The news of the last two weeks in Iran is another example of what makes the US different. US elections (in particular the counting) are the fairest we can make them and if an election goes the wrong way or seems "fixed" there is a court system that will decide and the decision will be respected. Many other countries have some of the attributes of the US but few countries (if any) have a combination of these attributes.

People in the US take what we have for granted.

I think that people all around the world pretty much want the same things: to have a job and a family, to live in safety and not in fear. I think that people around the world are much more similar than they are different and generally I am an optomist. However, the US is a very special place and while I disagree with many things we do as a country I try not to forget the benefits that I have and not the issues that I disagree with.

I don't think we are losing freedom or liberty. Quite the contrary.

As for wealth, the economy runs in cycles and this isn't a good part of the cycle.

While I think that we are going to recover I do think that the level of per capita wealth that was enjoyed in 2006 probably won't be realized again until 2016 or later. However, that loss of wealth doesn't mean that we are poor as a country and isn't the fault of the current administration who is trying to fix it (it may not even be the fault of the prior administration).

I wouldn't bet against the US at any time but I don't want my statement to be taken out of context which is why I qualified it.

I hope this clears up the confusion and I apologize for not being clearer a few days ago.

On Jun 18 02:11 PM Harry Tuttle wrote:

> As usual, these statements failed once the qualifiers are analyzed.
> "over a generation" is the key.
>
> Many people have made money betting against the US in previous generations.

Securitization Accounting Rules Changing, But Interagency Action Necessary

Gtarras,

Thanks for your comments. I think you are "right on the money".

I am not totally current in the Basel rules as they apply to this area. They are very technical and very detailed. But my impression is that they fostered the orphan subs of the european ABSCP operations.

Do you agree?

Securitization Accounting Rules Changing, But Interagency Action Necessary

levin70

I appreciate your comments. Perhaps I should have been a little clearer. I taught accounting at the college level and spent 25+ years (starting in the early 1980's) acting as a securitization lawyer, banker and issuer. I won two IDD Deal of the Year Awards for innovative securitizations and have literally executed thousands of these transactions. I have testified in well known trials on substantive consolidation matters (as an expert). The company that I am currently the President of is a frequent issuer of securitizations (even during 2008 and 2009).

I am as good an expert as they come on securitization and if I have a tough time understanding securitization accounting rules the average investor (who doesn't have my training and experience) doesn't stand a chance. I may not be the smartest guy or the best accountant but my level of training can't be the standard to understand the accounting on trillions of dollars of financings and their impact on issuers.

If you were to accuse me of hubris it would be for thinking that if I can't easily figure something like out FAS 140 and FIN 46 it is too complicated for the average investor.

I believe that the majority of CFO's, CEO's and CPA's that rely upon FAS 140 and FIN 46 don't have a clue what the rules say or how to correctly apply them. I have found that when I question the application of those accounting rules I most often get fuzzy and inconsistent answers that indicate that management and the auditors don't understand it any better than I do.

The reason that I don't understand the rules is that they are incomprehensible and inconsistently applied. They were a response to the Enron (and other) problems and weren't well thought out. I assume that is the same reason others don't understand.

And, because the rules of the last 5 or 6 years were overly complicated and inconsistently applied, transparency hasn't been achieved.

Also, I know that the SEC has the power to sign off on public company financial accounting standards (I am a securities lawyer after all). However, it has been many years since the SEC has exerted that authority in any meaningful way. And, while the SEC has technical authority to change FASB pronouncements, their authority doens't extend to regulatory accounting principals (those are the rules that apply to banks and other depositories for figuring out whether or not they meet capital adequacy standards) or statutory accounting principals (those are the similar rules that apply to insurance companies). Without conforming changes to those regulatory and statutory rules havoc may ensue among regulated institutions. Also, it would be nice if the SEC used its authority to reign in FASB so that the amendments to FAS 140 and FIN 46 make sense.

I realize it is a little unusual for someone to actually admit that they have trouble understanding something like FAS 140 or FIN 46. After all, by making that admission I have opened myself up to ridicule. But I feel comfortable that my level of expertise and record of accomplishment is extensive enough that it will stand up to examination and most readers will hopefully realize that my statements are not frivolous. However, I accept that there are some readers who will reject what I have written and accuse me of incompetence.

Levin70, thanks for reading and I hope you reconsider your position.



On May 28 12:30 PM levin70 wrote:

> "I don’t know what this all means because I never understood the
> old rules and don’t know what the new rules will do to financial
> reporting."
>
> Mark - its nice you own up to knowing nothing about the subject.
> However, given that fact, I find your desire to write the President
> about your ideas on how to fix a problem about a subject you know
> nothing about, pure hubris. Btw, the SEC, one of the "intergovenmental"
> agencies you want in the decision making process, is actually required
> to sign off on the new standard, as the SEC oversees all FASB pronouncements
> as they relates to US reporting companies.
>
> Please try harder

Why Has the Securitization Market Dried Up?

Thanks for the shout out.

I totally agree with what you wrote.

The securitization market needs to restart for the economy to really recover BUT it must restart on a safe and sound basis. I should have been clear in my last article.

Securitizations existed since the mid-1980's and were a great investment and fund raising vehicle for the vast majority of that time.

For securitizations to exist common sense credit underwriting and administration must exist and the abuses that you discussed in your article can't happen again. But, for more than 20 years the market was safe and sound so there is no reason to think that it can't be restored again.

Mark-to-Market: The Bogeyman of the 1930s Is Back

I appreciate the comments that everyone is making to this article. I really didn’t intend to start a firestorm as much as write a nice short piece supporting the great work of Wesbury and Stein.

However, now that the debate has started I guess I shoudl weigh in…I disagree with everyone who thinks that mark to market accounting is a small problem or of limited application. And, yes, for those of you who think I have lost my memory or sanity I have not. I do remember lower of cost or market accounting, vividly in fact. However, it is the intersection of the expansion of mark to market accounting and the capital markets (or lack thereof in the current market) that is killing the banking sector.

And, I noticed that not a single comment related to 141R which went effective on 1/1/09 and effectively expanded mark to market accounting to all financial assets of all banks. Now, I know that 141R only applies in a merger situation but the effect of that rule is to make all bank management teams run their institutions as if they are constantly applying 141R to their portfolios. 141R is just starting to infiltrate through the banking system but give it a little time…it will infect all banking decisions in short order.

I also didn’t happen to notice anyone discussing the ability of companies to manufacture earnings by pretending that they aren’t going to repay their liabilities and marking them to market. Two of the bigger abusers of that part of the rule were Lehman and Bear (RIP for both of them). As I recall Merrill was pretty big in that game of pretend as well.

I hope the debate continues and that FASB, the Administration, the SEC and/or Congress fix this rule.
Obviously, bad assets are just plain old bad and shouldn’t be treated as anything other than bad. Accounting rules shouldn’t be used to make bad assets look good or delay the recognition of credit losses.

But by the same token the efficient market’s thesis (which underpins mark to market accounting) has severe limitations and if misapplied (as I believe the current version of mark to market accounting is doing) creates terrible distortions. The market isn’t all knowing and always correct and that is because the market often doesn’t have real information about the real borrowers behind the loans that are being priced, the market doesn’t have the time to digest the information and the market just isn’t liquid enough to price all the different loans that exist (it isn’t liquid enough to effectively price all of the publically traded companies that exist).

Thanks for reading and thanks for commenting.

Tangible Common Equity: How Much Is Enough?

Bill,

I am in favor of all of your suggestions. The converstion of Morgan and Goldman were desperation measures. Now the Fed needs to regulate them as bank holding companies and make sure that they have adequate amounts of equity and are safe and sound. I don't see a lot of evidence of that happening but then again I can't prove that it isn't happening behind closed doors. Being a bank holding company and getting Federal help has benefits but there are responsibilities as well and the Fed should be making sure that these institutions hold up their end of the bargain.

As for ratios requiring permenant capital, shockingly there are some but for some reason on a holding company level no one seems to care (not the markets, not the regulators, not the media).

I am a reasonably frequent guest on FOX and Bloomberg and for months in 2008 only talked about TCE (and was either ignored or made fun of). But, by when analyizing banks and whether or not they are risky everyone should start by looking at TCE ratios. Those ratios don't say whether or not there is a good business, whether or not they are making money, or whether or not one should invest, but the TCE ratio is a good proxy for balance sheet risk. If everyone starts with TCE they will find that they are able to predict what happens to the banks almost as well as Meridith Whitney.

As an aside and in respose to another comment, risk weighted assets are important but it still all starts with TCE ratios. As an example, assume a bank is totally core deposit funded and only buys Treasuries (i.e., no funding or credit risk). The bank still needs to have adequate TCE because of market risk (yes, off the run Treasuries have some market risk) and interest rate risk (the interest rate risk can be high if the Treasuries are Treasury strips, high coupon or low coupon and even on the run Treasuries have interest rate risk). Same with Freddie/Fannie pass throughs - lots of market and interest rate risk. And, the bank has operating risk, i.e., the risk that managment makes a mistake and doesn't hedge market risk or interest rate risk well or has a law suit or other problem. All of these risks require TCE. Running a bank on 20 to 1 leverage makes no sense to me even if the bank has 0% credit risk.

And, for the people reading this blog and accused me of trying to dump the stocks because I am short, I have neither a long or short position in the banks. For a lot of reasons relating to my employment and my wife's employment I don't own individual stocks and only own mutual funds that are generic in nature. And, I don't expect nasty comments from anyone on the fact that I am prohibited from owning stocks yet commented and wrote an article. The chart was meant to be "industry generic" not particularly company specific.

Tangible Common Equity: How Much Is Enough?

The author here,

Usually I don't respond to comments but this is an exception.

I am intimately aware of how bank preferred stock works.

A short primer is in order for those that have commented.

First, much of the preferred stock is "trust preferred stock" which is a hybrid. It is a form of tax deductable preferred stock that grants hybrid creditors rights to preferred shareholders.

Second, the vast majority of the rest of preferred stock is term perferred stock that has a fixed redemption date to it. Just like a bond it carries principal and interest payments requirments (although often it is a bullet principal payment). You may recall that TARP preferred stock is this type.

There is a third type of preferred stock which is prepetual preferred stock and I think this is what you are referring to in your comments. However, this is the most expensive type of preferred stock that is issued and over the life of the preferred stock the dividends equal many times the outstanding principal amount of the preferred stock. Because it was the most expensive type of preferred stock to issue it is the least issued. However, you are correct in saying that it is the closest to common equtiy (even if it still isn't common equity).

And, there are limits as to how much preferred stock can count in capital ratios because just like ice cream, a little is good but too much is bad. So, there are limits to how much preferred can count as Tier 1. Also, as you know preferred stock that is within 7 years of its redemption date has reduced availability to count as Tier 1.

Other forms of "capital" that banks are counting as capital includes holding company debt which of course if just plain old debt.

The reason that preferred stock can't count in unlimited amounts as capital is that preferred shareholders have the expectation that there will be dividends and most often principal payments. That is a form of decapitalizing banks and bank holding companies. If preferred stock agreements aren't honors the holders have rights (often not creditors rights but rights just the same) to change the course of the bank that has issued the preferred stock and get paid back or get the dividends paid. Banks are, therefore, loath not to honor the preferred stock requirments.

Recent experiences with institutions going bankrupt or failing and preferred stock not being honored is no different than other types of investment not being honored (i.e., unsecured debt). The issue with preferred stock isn't when the bank is broke but when the bank is in the process of going broke. Banks decapitalize all of the time to make preferred stock payments right up to the date of seizure which makes preferred stock, as a practical matter, similar to debt.

Preferred stock is equity but it isn't the same a common. Regulators know this, preferred shareholders should know it and banks certainly know it.

Pretending that preferred stock and sub debt are like common equity is the type of thinking that got the US and world into the current crisis. For 100+ years everyone knew that preferred stock wasn't the same as common equity. Suddenly in the last 5 years everyone thought that it was the same as common equity and guess what happened to the banking system in the last 5 years? Investors need to unlearn all of the great lessons of the last decade and remember the basics of finance, accounting and, in the case of banks, what makes a safe and sound bank.

As an aside, I apologize for any spelling errors in the above. Without spell check I tend to have a lot of typos.

Why TARP 2.0 Won't Be Much Better than TARP 1.0

The author here...

Altasman, in response to your question, definitly newly formed bond insurers can be privatized in a few years. Please take a look at a previous article that I wrote seekingalpha.com/artic.... This should be a money maker for the Treasury if they do it correctly (believe it or not).


Prudentinvestor, thanks for your comment. You make a good point and my article is deficient because I didn't make the issue that you raise clear. I am definitly talking about prudent lending standards. Not even a question. I am very much a "back to the basics" person. My experiences in life have taught me that it is always better to follow the rule book that worked for decades. My experiences especially apply to credit. Sorry for being unclear.

Thanks for reading.

10 Simple Investment Rules for the Very Wealthy

Dear Fool and His Money,

The author here,

I had the opportunity many times to invest in Madoff. I didn't because I followed my own rules.

In the case of Petters, the Petters group directly and indirectly attempted to get First Capital to lend to them. I made sure that First Capital (the company I am President of) refused to lend because I thought it was a fraud. Also, I got a number of my friends out of the Petters fund. I was outspoken and considered a little crazy on Petters.

So, as the say, I not only talked the talk but walked the walk.

Thanks for reading.

The Next Crisis Is on the Horizon

The author here....

A few answers to questions in the comments.

1. "Sunshine" really is my last name.
2. Application of tax law can be changed by Treasury without approval of Congress. For a recent example, the changes that the Treasury implemented in the NOL rules for banks was done without Congressional approval. There are a lot of technical ways for the Treasury to effectively raise taxes on Treasury securities and lower them for other types of lending. Stuff that wouldn't make sense for individuals but does work in the context of banking. For example, the application of certain types of interest income against NOL's would work and Treasury can do without Congressional approval. Another example is to change the ability to deduct loan losses and valuation reserves against certain types of income (like not allowing the deduction against interest income of Treasuries). Treasury can do that as well without Congressional approval.
3. Choices in the economy were always driven by the Fed and the Government. It is just a whole lot more obvious now that the Government is driving the economy (which I don't think is good).
4. There are pleanty of good quality borrowers and lots of opportunity to lend safely. But, what is taking place now is that good borrowers are getting left in the ditch. Simple things like trade finance transactions (which is low risk and really transactionally based) aren't getting funded and that is killing the economy. Hoarding is "death" to the economy. The liqudity trap is "death" to the economy. But, increasing money supply isn't the answer to the hoarding problem. Accelerating velocity is the answer and that is largely beyond Fed monetary policy.
5. The Fed isn't "sterlizing" which is why the money supply is growing so rapidly.

Thanks for reading and sorry for any typos in this comment.

Those Who Don't Learn from History...

Dear Mr. iThinkBig:

You have an interesting marketing challenge. I have a friend who is in a sort of similar business where they help companies work down their cost of banking services (not loans but things like wire transfers, transaction processing, merchant fees (not for credit but processing), returned check fees, etc.).

They only get paid if they save the client money and get the service done well. And, they have the same problem as you do in getting their clients to be honest and open up (and let my friend save them money and improve quality). There are marketing techniques that my friend employed with only limited success. It is a tough marketing model and mostly because the buyers of the service often have a conflict of interest (if they hire you and you do a great job it may adversly impact their job security by making it look like they weren't doing a good job before - so doing the right thing for the company often isn't the right thing for the individual).

I think that your move to integrating by buying brands is smart and intuitive.

Thanks for reading.

Mark Sunshine

10 Reasons I'm Glad To Be Doing Business in America

The author here...

weiwentg, the point of the post isn't that other countries don't have some (if not most) of the attributes of the U.S. Only that no other country has all 10 of the attributes. And, it is the combination of all 10 that makes the U.S. special.

I believe that other nations are great as well and have great workers and lots of attributes. My only point is that the "end isn't here" and the U.S. remains a very special place to live and work.

Thanks for reading and commenting on the blog.

Five Common-Sense Confidence Builders

The author here...I didn't mean to suggest that this is a democratic or republican issue. It is a competence issue. It is an American issue.

Mark-to-Market Accounting: Kill It Before It Eats Us Alive

The author here,

A few observations/comments.

First, from are article today in Bloomberg...."ABA, which has been lobbying policymakers and regulators for months, upped the ante recently as more and more banks told the association their accountants are advising them to use the fire-sale value."

I firmly believe that mark to market accounting is a self reinforcing race to the bottom of valuation and what the ABA said (eventhough it is a lobbying group and therefore we must be suspect) is correct.

Second, FAS 141r ("r" is for "restatement") will change the purchase accounting rules and extend mark to market accounting into non-financial assets and for all assets of all firms. What company is going to publish one set of financial statements only to have potential acquirers announce that if they purchase the company the financials will be massively restated as a result of mark to market accounting. Like the Blob, mark to market accounting will keep on growing, and growing and growing until it eats us alive.

Third, mark to market accounting is pretty much only endorsed by people that are "traders" and want "transparency" for ease of trading. While I don't have anythng against traders, the trading mentality has limitations and pushes everything and everyone into short term analysis. CEO's complained about how quarterly earnings releases were ruining their companies because they were too short term. Well, how much more short term is mark to market accounting?

Thanks for reading the article and thanks for taking the time to comment. Even if I don't agree with your position I appreciate that you took the time to read what I wrote.