mathgeek

Railroad Companies: Good, Better, Best

Nice article.

A couple minor points:

- The long term battle between trucks and train has gone something like this: Trucks are faster and more reliable, Trains (or intermodal services) are cheaper, particularly for longer hauls. (>500 miles). Over time, train service speed and reliability has improved, displacing trucks. This can be expected to continue.

- As one poster correctly points out both BNI and UNP have excellent access to PRB coal. I don't belive there is a true advantage of one over another, but the advantage over the eastern rails is real.

- For those who are asking about passenger rail... keep dreaming, the economics just doesn't work very well, except for shortish trips between congested urban centers (e.g. the NE corridor) where time "to and through" the airport makes up the majority of the travel time. Think about it this way: People's time is valuable; it makes more sense to move people by the fastest means possible (e.g. airplanes) while letting lower value stuff move by slower means such as trains.

How Are Those Banks Doing? Depends Who You Ask

Excellent article.

While it has become everyone's favorite sport to blame the bankers for everything bad in the world, I think this shows the dilemma they face.

Do you lend more? This reduces the capital cushion and makes it more likely you will fail the stress test. Banks have long been caught between conflicting pressures from Washington. (Lend more! Lend more cautiously! Lend more to lower income people! Keep your rates down! Keep more capital on hand! etc. etc.) TARP combined with the stress tests are merely a bit more blatently schizophrenic than usual.

I think that the insight that the stress test may be used to force banks to hold on to TARP funds longer is an excellent one... the question then becomes what is the government willing to do to try to force more of those funds to be lent? The real answer to that question may very well be nothing.... at least nothing beyond giving the media a few juicy soudbites about greedy bankers.

Why Chrysler Needs to Declare Bankruptcy

Felix, you are right on. While it is true that there is a strong association of dealers:

On Apr 24 02:22 PM Car Guy 1999 wrote:

> Ever heard of NADA? The automotive dealer's trade association is
> one of the oldest and strongest of all. Please reseach your subject
> before making blanket statements.

The problem is, that unlike the union, NADA can't enforce an agreement on its members, and unlike the bondholders, each dealer has wildly differently situated, and protected by one of 50 different sets of state franchise laws.

To those who wonder why this is a problem, there are two main reasons. The first is that closing down a whole model line requires payouts to dealers.... making the elimination of unprofitable brands prohibitively expensive. Further, excess numbers of marginal dealers hurts the amount of dealer-financed promotion, investments in service, and requires more inventory financing, all of which ultimately hurt the automakers.

Mark-to-Market vs. Mark-to-Model: What Ever Happened to Real Value?

Article adds nothing to the debate.

I think one nice way to test your conviction about mark to market is this - Since house prices were transacting in an open market, do you agree that house prices were totally appropritate and correct to use as a basis for lending at the peak of the so-called bubble? (And I say so-called, because if the most recent market price is really the only indication of value, there cannot be such a thing as a bubble)

There are a myriad of other issues with mark to market - for example, m2m instantly amortizes expected changes to a future cash flow to present earnings... kind of the opposite of the time matching that accounting is supposed to acheive...

And that leads to the ultimate question here... what exactly are you trying to acheive? If you think market to market makes it easier to evaluate a bank's real financial situation, you have either never done it or are a fool... and have no business trying to understand a bank balance sheet. On the other hand, if you are a trader or a hedgie who is trying to make a buck exploiting the extra volatility created by mark to market, it makes perfect sense.

Note to Nassim Taleb: You Can't Kill Off Black Swans

Mr. Taleb, in his second book is smart enough to at least acknowlege the core flaw with his ideas:

"Ok, so we can't know anything, what do we DO?"

He attemps to provide an answer, of course, but at least in my estimation was unconvincing. Here is a man who has come to recognize the inherent fragility of... basically everything... and has allowed it to paralyze any sort of course of action. But act, we must.

Why It's Better to Bail Out Borrowers than Banks

Felix, while I prefer to keep the details private, I was living fairly close to the fire in this chain of events... and it was all about psychology. Everyone, from market participants to the media was playing the game of "whose next?"

While Leman was alive, the focus was there. The moment Leman fell, the focus shifted to WaMu and Wachovia... and please remember... WaMu was wiped out in less than two weeks not by losses... but by panic deposit withdrawls. As soon as WaMu went under, the pressure shifted almost instantly to Wachovia and Morgan Stanley.

What the regulators realized they needed to do was to draw a line underneath the financial system and say, this far, and no further. That is why TARP funds were crammed down all of the largest banks... the government needed to make it clear that the government would not allow either speculative attacks nor a deposit runs to close any more major institutions.... Period.

And, for better or worse, it worked. Almost overnight, speculation about who would be the next to go ended and that phase of the crisis ended. Now, its not at all clear that WaMu or Lehman share or bondholders were treated fairly... why let them hang while protecting Citigroup, for example? But the decisions were not made on principle, they were made in response to a chain of events, and by the time WaMu and Wachovia were gone, the Fed realized that they had to stop what had basically become a rolling bank run, and consistancy of policy was far less important than changing the psychology... and at the point, the train had already left the station on bailing out borrowers. The Fed needed to credibly back the remaining financial institutions, and they did.

Mark to Market: Time of Death 8:45AM, April 2, 2009

Here is the question I have for all of the people who think mark-to-firesale is a great idea:

Who would ever be willing to intermediate between liquid assets (deposits) and illiquid assets? What is basically being suggested is that any entity that wants to hold illiquid assets has to hold enough equity to withstand the lowest possible market value over the entire lifetime of that asset... which means the worst case NPV plus an undefinable and possibly infinite liquidity premium. What exactly is the benefit of a rule like this, if in fact the objective is to invest in illiquid assets and hold them to term?

Hedge funds and other asset managers are the worst forms of hypocrites about this issue (in large part because they can and do exploit illiquidity to make profitable short bets) How about we make a deal. I'll agree that everything should always be marked to market, if hedge funds, private equity funds, and everyone else agrees to post 100% collateral for their loans, in the form of US Treasuries.

The idea that mark-to-market provides a form of transparency is also disingenuos at best. All it really tells you is that a company is holding asset class X, which in the current environment has an impaired value made up of an unknown amount of actual value loss, plus some unknown liquidity premium. Anyone who thinks this actually helps to understand a balance sheet doesn't know what they are talking about. At the very best... and this is not likely... but at the very best it might give you some clues as to underlying asset classes and structures that are not otherwised disclosed. Its far more likely that it will be distorted by the need to find odball comparable trades in an illiquid market.

The only people who really support mark to market accounting are academic accounting geeks who place highly abstract theoretical concerns over any pragmatic considerations, hedge funds and other traders who have been able to exploit the problems m2m creates to reap huge profits, and idiots who don't know any better.

Which are you?

Generational Demographics: Can Young Adults Save the Markets?

Don't know what Tobias Levkovich was smoking... but peak savings period is late 40s.... not late 20s....

How to Not Pay the AIG Bonuses

What is going to have to happen is that someone is going to have to just say no and not pay the money. Someone will sue... and they will win. Congress might legislate, but the Supreme Court would inevitably uphold the contract.

The bottom line is, public outrage... even justified outrage... doesn't give anyone a license to walk away from contracts.

The real devil here is the nature of AIG's business. If AIG could be put into bankruptcy, all of those contracts would vanish. The problem is that because of the specific importance of ratings to AIGs products, bankruptcy hasn't been an option.

The FDIC can (and has) used its specific legal powers to accomplish this with banks. Perhaps the question we should really ask is why the government... both the outraged Congress and New York State... never chose to create a sensible legal regulatory structure for insurance companies.

Defending Financial Journalists - and Bloggers

The problem, Felix, is that too many of those same journalists... including bloggers... are all too happy to blame regulators, bankers, CEO's, and boards for not predicting the future.

I believe that the critics need to be held to an equal standard. The fact is, circa 2004, very very few saw this coming... except of course those who have been predicting disasters of various sorts 20 out of the last 20 years.

Even Nouriel Roubini, who has become famous for predicting the outlines of the crisis gave his famous talk in September, 2006. By that time, a significant portion of the subprime and alt-a paper that started the snowball rolling had already been originated... Washington Mutual... often the poster child of bad lending practices... sold most of its 2006 production to reduce exposure in early 2007.

Were their clear signs of trouble? Absolutely. Should leaders of banks done a better job of managing risk? Emphatically yes. Were regulatory flaws part of the problem? Definitely. But, too often bloggers and journalists make uncritical use of 20/20 hindsight to bash decisionmakers, this theater is of no use execpt possibly those who value entertainment above insight.

Fixing Finance: Incubating New Banks

This is dissapointing Technodrivel, and it reads like a pitch for Webvan circa 1997. (Those silly grocery stores, they just don't *get* technology!)

Perhaps you have some truly innovative ideas for the banking industry, or perhaps you don't... but if one were to base their opinion on this article, its unclear you understand the business at the most basic of levels. (You know, borrowing, lending, transaction processing... that sort of thing)

And its too bad, because, you do seem to have a solid grasp... it just doesn't show here. As you said so well in past articles... actually coming up with new and better ways to serve customers is hard.

Why Capping Pay Is Likely to Work

Anandakos,

I think that you, like Felix and so many of the people on SA have what I like to call an Eddie Lampert problem. In short, because you are intelligent, and in some cases, have made a lot of money making big directional bets on firms, you severely underestimate what it takes to run a large company. Perhaps Dilbert's pointy haired boss put it better: Anything I don't understand must be simple.

Insiders at Sears discuss a raft of basic problems that any halfway competent retail executive knows how to fix, but are destroying Sears. Bankers keep ATMs running, service millions of loans, run a network of retail stores (we call branches) larger than most large retail companies... not to mention trying to manage exposure to vast currency, interest rate, and other markets. If you really think any joe off the street... even one that is intelligent, hardworking, and can manage an enterprise of this level of complexity well... frankly... you know not of what you speak.

Yet, here we go saying that every bank executive in America (really the world) was incompetent and should be fired. Great rhetoric, horrible basis for decision making. First of all, think a minute about what you are saying... Everyone was incompetent? Really? ALL of them? How is that even possible... surely some should be competent, if only by chance. Or, is it a more reasonable and realistic assumption to belive that something extradordinary happened in the environment that no reasonable person would have anticipated? Is it more reasonable to understand the pressures and constraints of regulated banks (and despite the other favorite talking point of the day, banks are regulated... heavily)... which led inevitibly to business models allowing banks to remain competitive with unregulated entities. But then, thats a lot less fun than making jokes about how these people expected to get paid a lot of money to destroy the industry.

Its a bit of a strech, but blaming banking executives for this crisis is not really so far from blaming a drought on the incompetence of farmers.

I am not saying that compensation is not out of hand in many cases. But, as a general rule, executives at major banks are paid a fraction of what they could earn at private equity firms, hedge funds, and other money management jobs, or in fact at private investment banking firms... it is no accident that Goldman wants out of these restrictions as quickly as possible.

Ultimately, regardless of moral indignation, the question has to be about consequences. Its seems many of the people on SA are happy to gamble putting these huge, complex, and immensely important institutions in the hands of people without adequate experience... To which all I can say is... sincerely... I wish us all the best of luck, we're going to need it.















On Feb 04 12:13 PM Anandakos wrote:

>
> Think,
>
> I believe you are making a fundamental mistake about what banks are
> and should be. Because banks drank the Wall Street Kool-Aid they
> abandoned their traditional role and adopted the behavior of investment
> banks (leverage!). The regulators were drinking too, so they allowed
> them to act like investment banks, even encouraging them.
>
> This was a disastrous error, and like the last time it was allowed
> in the 1920's, led to exactly the same sort of excesses. The so-called
> "talent" you want to reward subsumed the depository function into
> large casino capitalist enterprises and poisoned the well for all
> and sundry.
>
> Depository banks should be free from political interference -- we
> don't want the kind they have in China and Japan. But also they should
> be strictly regulated and prevented from engaging in behavior that
> can eviscerate their capital adequacy. Such institutions would not
> and should not make a gazillions of dollars in profit. So they don't
> need the sort of buccaneer "leadership" that unlimited compensation
> attracts.
>
> Those folks have a perfectly valid place in American capitalism:
> as entrepreneurs, private equity managers, and venture capitalists.
> But they should not run depository institutions because their gambling
> ways put the government's insurance programs at risk. Let them reap
> huge gains and suffer huge losses on their own, without the taxpayer's
> implicit, explicit, or fantasy backing. And caveat investor when
> dealing with them.
>
> Banks serve the vital function of providing credit to businesses
> and citizens, and obviously they need to make a profit to increase
> their regulatory capital allowing greater loan making capability.
> But they should NEVER engage in non-depository activities. They also
> need to be forbidden from becoming "too big to fail". The only real
> value I can see in Wells-Fargo and Bank of America having become
> truly "national" banks is that people can visit an ATM in a different
> state without having to pay a fee.
>
> Thus they will not need enormously compensated CEO's. There are plenty
> of people running local banks and credit unions profitably for low
> six figure salaries who are completely capable of running larger
> enterprises so long as the "financial engineering" element of the
> mega-banks are not present. Let them.
>
> By the way, credit unions offer the same fee-free "foreign" ATM access
> through their national co-op. Smaller banks could do the same thing
> if they wanted to offer the service to their customers.
>
> On Feb 04 11:23 AM Think! wrote:

The Detour Around Banking Disaster: How We Lost the Roadmap

Where is the part where they say that mortgage lending is too risky? Where do they predict a nationwide housing decline of 20%+?

Its easy to find people who said something that happened to be right after the fact... the trick is identifying who is saying the right things now.

The premise is that financial firms are currently insolvent. The question I ask is this: under what set of assumptions? If housing prices were to stabilize right now, I would guess very few if any are insolvent. If housing prices crash another 40% on a nationwide basis, pretty much every financial institution is insolvent.

Fundamentally, banks take short term, liquid funds and convert them into longer term, illiquid investments. It is a necessary feature of this role that short term, market pricing of long term illiquid investments will not correctly reflect their ultimate value.

The objective of government invention should be neither to protect nor to punish bank shareholders and executives... rather, the role should be to allow bank investments to play out over their natural time frames and prevent panic liquidations. The TARP program, implemented correctly, could acheive these objectives.

Eight Mistakes That Caused the Financial Crisis

I think Blinder is pretty close

Derivatives:

I think the problem is not some vague need for regulation, but rather to ensure that complex structures not be used to arbitrage away from basic princples... in other words, if it looks like a duck, and quacks like a duck, it should be subject to the same regulations as a duck... this point goes far beyond just derivatives per se, but a host of alternative structures (SIVs,auction rate securities... even money market funds) who's basic purpose is to avoid capital rules.

Leverage:

Excess leverage is clearly one of the greatest core causes... and for the most part it isn't leverage of commerical banks, but the leverage of a variety of other financial participants... particularly investment banks but also hedge funds and others... the real core banking problem is supplying excess leverage. Hedge funds can and should be able to lose as much as they want... of their own money. The most shocking regulatory failure will ultimately allowing banks to lend hedge funds 90% of their capital (or more) with relatively modest capital requirements for the lending bank.

Subprime:

I think painting subprime lending with such a broad brush is a mistake, and we lose sight of the core issue, which was that subprime and alt-a mortgage lending stopped worrying about capacity to repay. One of dark secrets of this business at its worse is that lenders were basically harvesting fees from people by repeatedly refinancing, eating away at equity in home... knowing that the borrower could not repay out of their income, but depending on the fact that they could... and did... refinance, over and over again. While not as cynical, it also allowed for mortgage originators to profit from house flipping at the hight of the boom... essentially providing bridge financing to house flippers, in the guise of a mortgage loan. The bottom line is, there is a good reason why capacity to repay is an important mortgage underwriting criteria... as the owners of these loans are re-discovering to their anguish.

Forclosures

Limiting forclosures was a missed opportunity, but perhaps not in the way suggested. Simple minded approaches would have either failed or created worse problems; Nonetheless, it is a fair point that there are structural issues that could have been addressed. There are structural reasons why mortgage servicers foreclose and sell (even at distressed prices) when it might be more economically rational to take a different action (work-out mortgage, convert to rental, etc.). This is mostly a case of what is rational in normal circumstances becoming collectively irrational, but with no system or structure in place, there is no way to change the "normal" course of action to something that makes more sense... especially since doing something different requires a re-negotiation of who bears how much of the economic loss that has occured.

Lehman

Yes.

TARP

It was a good decision to inject capital rather than buy bad assets... this creates a multiplier effect that gives more "bang for the buck"... it would have been ideal if this was done with stronger incentives to lend, however.

Hopefully the remainder of the TARP funds will be used effectively to buy up bad assets. The devil has always been in the details... what valuation to place on what the government buys, and given that the quantity of bad assets out there is far greater than the funds available... how to deterimine which assets to buy become sticky questions for which there are no easy answers... which is almost certainly part of the reason that the Bush administration chose to leave the inevitably controversial decisions to the Obama white house.

Evidence That Big Inflation Is Coming

Discussing money supply without considering credit is like discussing air without considering the presence of oxygen.

Of course the money supply (absent credit) is increasing at a massive rate... this is the Fed's desperate action to counteract the equally massive contraction in money supply that is credit driven... Let's all hope it works.

On the flip side, it is absolutely true that if credit were to reappear tomorrow at 2006 levels, everything the Fed is doing would be wildly inflationary... and in fact, if the economy normalizes, it will be difficult to unwind some of these manuvers quickly enough to prevent meaningful inflation but slowly enough to keep a recovery from stalling out. It is probably a wise observation that the Fed will probably err somewhat on the side of allowing a higher than average level of inflation for some period.