Chrysler

Chrysler has filed for Chapter 11 bankruptcy. The government had tried to sit down with the bondholders to work out a deal. Basically Chrysler owes creditors a lot of money which it can not pay back. If they went into bankruptcy, the thinking went, the creditors would lose much more than if they forgave some of the debt. J.P.Morgan Chase and other banks have complied with the governments negotiations. However some hedge-funds refused to take the markdowns and that led to the Chapter 11 filing.

So why did the hedge-funds resist? When they lent money to Chrysler, they basically went out and bought a lot of insurance, the now infamous CDS. So if Chrysler goes bankrupt the hedge-funds will get paid from the CDSs which they most probably bought from ... take a guess ... AIG. So Obama indeed has cause to be pissed. This is an unfortunate misalignment of interests and the taxpayers are in the hook for it.

I think that the primary person responsible for this situation is Paulson for not forcing a haircut on AIG. Basically, in distressed times lender and borrower (for example troubled homeowner and mortgage lender) work out a deal, debt forgiveness and such. The Obama administration had similar plans for Chrysler. But in the last administration, Paulson made sure that all of AIGs clients got paid in full. The biggest beneficiary? ... Goldman Sachs, Paulson's old bank. So once AIG started paying out in full, they'll now have to payup these hedge-funds as well and the whole process has become a moral hazard. Read more!

The Current Economic Situation

The history of this economic crisis can be found in several places, but This American Life has the best introductory material, a fascinating narration on the housing bubble, the worsening economy and now bank solvency. Here's my earlier write-up on the bailout (mainly TARP). Finally, from my favorite blog, financial crisis for beginners.

So what's going on now? Before diving into the micro-details let's think of the macro picture. Early last year Krugman warned about the coming currency crisis. Has it finally arrived? Basically Chang the Chinese plumber is having second thoughts about financing Joe the plumber's quarter million dollar American dream. So basically the United States is hostage to all prospective investors who are needed to fill the current account deficit which will keep increasing in the near future. In this light, GM and other industries are dispensable, but the finance industry which ties together all these global investors is not.

This is the backdrop of the AIG story. Not only are they involved in these toxic CDSs, but also regular institutions are deeply exposed to AIG through non-toxic regular insurance. Thus collapse of AIG basically brings down the financial system, and with it confidence in U.S. leadership and destination of global capital.

Here is an extremely detailed look at bank solvency and a contradictory view of Krugman. Bottom line is all these experts are speculating, and it's still hazy who might be right and if the latest Geithner "plan" and the accompanying rally (Dow up 500pts) is any indication for actual recovery.

Nationalization seems to be the option of choice from liberals like Krugman to libertarians like Greenspan, while an anathema to the Obama administration. Here's a discussion on the just announced Geithner "plan", but following the hoopla over AIG bonuses and performance of Congress many are having second thoughts about nationalization. The speculation is that this is what was politically possible, if this fails then the administration will have sufficient momentum for nationalization (looking at Congress whether that's a good idea or not is a different question).

Will have a separate post on executive compensation.

Read more!

G30 Advocates Nationalization

The group of 30 is a group of most respected economists from all around the world. Members include Krugman, Volcker, Summers and Geithner. According to it's latest report Volcker urges

1. limiting the size of banks to prevent the "too big to fail" quality.
2. monitoring executive pay
3. regulating hedge funds.
   

With the situation with BofA one can see where this is going. Read more!

Krugman: Conscience of a Liberal

Krugman's book for the most part was an exciting as any of his columns, somewhere in the middle the section on the rise of the movement conservatism was somewhat boring since this has been rehashed several times in the press and elsewhere ad nauseam for the last several years. A few points were eye opening for me.

• The central claim of Krugman is : The middle class in the United States did not evolve automatically as the economy matured, but was created through government policy and intervention, by Roosevelt and the New Deal.
  
• The second claim is : The inequality of wages in the United States is not a result of technological advancements but of government policy.
  

Let's discuss the points below the fold.

• in progress ...


• Similar levels of technology in other western nations from Canada to France did not result in similar degrees of disparity, only Britain with similar policies during Thatcher saw spikes in inequality.


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Geithner

So Geithner for Treasury, it's an interesting choice, but also looks like Summers will be replacing Bernanke in 2010. The Dow suddenly got a 500 point bounce, who are these idiots? One would have to believe that it's only the interregnum and uncertainty which are killing the market. (other observations on the market below the fold)

Meanwhile, Merrill-BofA deal spread is widening, i.e. the "market" or what is left of it is betting against the merger going through under current terms. Which reminds me, I have to remember to vote. This is probably a consequence of TARP. Since Paulson abandoned the original plan of providing relief to the troubled assets, the valuation has changed. However, it's extremely difficult to believe in the wisdom of the market right now; the deal spread could simply be impacted by fund redemption. Also most of the arbitrage players on whom the market depends to close the gap, are out of business, so efficient market theory doesn't apply. Consequences of this deal not going through could be significant, not only for Merrill & Co. but essentially most of the TARP investments would also blow up in smoke as Merrill's debt brings down the remaining players. The market is simply broken right now. [For anyone who cares, all this is from public sources, I have no insider knowledge :(]

In other news, Hillary accepts state. What's annoying to me are the huge number of leaks and rumors which are spreading since the election starting with Emanuel. No-drama Obama is being dragged into the Clinton culture. But then Geithner's appointment was of course orchestrated to have the bounce. One thing that's going around is that you don't hire someone you can't fire. But I think Obama can always lure Hillary to the Supreme Court. All people complaining about too many Clintonites in the administration needs to think that anyone in the Democratic party with any talent had to be associated with the Clintons somehow, they have simply dominated the party for the last sixteen years.

Team of Rivals is shaping up (I wonder how much money Goodwin is making off this, not that I mind; the press simply creates an idea and milks it for all its worth). But when will the liberals get any appointment?

Read more!

Bailout

We met at the Wall St atrium for the discussion on the bailout. At the discussion I learnt one interesting thing. It seems its better for the auto companies to go into chapter 11 bankruptcy, and then get some money for retooling. This will allow them to restructure the management as well as renegotiate with the Unions. Overall my thinking is, even if they get the money, I don't see what the next game plan is. On the other hand if the finance industry gets a bailout, why not the auto industry? (nothing extra below fold) Read more!