My Visit to the US Treasury, Part 3
Going back to bank stress-testing for a moment, one interesting thing that a Treasury official said at the meeting was that unemployment did not have a big effect on foreclosures. Unemployment has a big effect on credit card defaults, but not foreclosures. I disagree.
As a multi-purpose quant, I have learned over the years that it is impossible to estimate an option curve/function when the variable in question has only been “in the money” or “out of the money.” (As an example, one can’t estimate the withdrawal function on deferred annuities because haven’t had a large sustained rise in interest rates since the product was created.) With mortgage debt, over the last 70 years, real estate values have never fallen enough to make default a reasonable choice until now. Thus in the past, when unemployment hit, one could sell, rather than default. As I have said before, foreclosure typically occurs when someone is inverted on their mortgage, and a life event happens: death, divorce, disability, disaster, disemployment, change in financing terms, or deciding that it is worthless (and doing a strategic default).
But now residential real estate values have fallen. When someone loses their job, the option to default becomes real. Do a short sale, and give the bank a hit.
With stress-testing, the devil is in the details. How do you turn unemployment, housing prices, etc., into losses tailored for each individual company? Different underwriting standards can make quite a difference in the results. I would have been more than happy to dig through detailed stress testing models. That was my job once.
When the Treasury announced the stress-testing results, it was at a time when the gloom was thick. It was a positive to the market that the government would not require huge amounts of extra capital, and in most cases, no extra capital. Thus the market rallied.
With many simple asset classes that were under stress, the Fed and Treasury offered guarantees that would enable them to easily survive the panic. Absent the guarantees, most short assets would have been “money good,” but there would have been significant doubt for a brief time.
As I commented to a Treasury staffer after the meeting, with financing rates so cheap to buy financial debts, regardless of what kind, it is no surprise that corporate bond spreads have tightened, while there is still little lending to finance growth in the real economy. That is why there is such a gap between Wall Street and Main Street.
Main Street sees unemployment and low capacity utilization. Wall Street looks at bond spreads and P/Es. Those are not the same things. The current stimulus has emphasized healing the financial sector in an effort to avoid contagion and depression. It does not directly address slack in the real economy. The real economy funds the bailout of financials, but does not directly benefit. Thus the disconnect between Main Street and Wall Street.
Many financial measures and companies have rebounded, but little expansion has occurred in the real economy. Even with companies that have done bond offerings, they have often used the proceeds to bolster the balance sheet, rather than expand capacity. Safety first is the watchword.
Perhaps a change happens when companies with a lot of cash appear as takeover targets in a sluggish market. Easier to grow market share through acquisition rather than organically, and what’s better, their cash helps pay for the deal.
Housing Initiatives
It seems that the low end of the housing market has bottomed. Government programs have something to do with it. The tax credit has made a difference in the short run, as has the efforts of the Fed to support the mortgage markets through the purchase of RMBS.
Mortgage modifications are advertised by the Treasury, but the results are small. Away from that, I will say that successful modifications occur more likely when there is some degree of principal forgiveness.
Tonight, I will pick up on the risks of low interest rates in part 4.
Who was Invited?
I’ve been in touch with staffers at the Treasury. One of them gave me a list of the invitees. Here is the list of those invited that did not come:
Abnormal Returns
Alea
Barry Ritholtz
Clusterstock
Free Exchange at The Economist
Paul Kedrosky
Andrew Leonard
Calculated Risk
Yglesias
Megan McArdle
Mike Konczal
Baseline Scenario
Mish
The Audit at Columbia Journalism Review
Credit Slips
Prudent Investor
Brad Delong
Felix Salmon
If you were in the Treasury’s shoes, who else would you have invited? E-mail me, or put it in the comments. Tomorrow I will mention who I thought would have been good additional guests.
Continuing Coverage
Here is a list of posts to date on the meeting:
Friday in Vegas (Kid Dynamite):
“A Sit Down With Senior Treasury Officials – Part I”Naked Capitalism:
“Curious Meeting at Treasury Department”The Aleph Blog:
“My Visit to the US Treasury, Part 1″
“My Visit to the US Treasury, Part 2″Across the Curve:
“Bond Market Open November 04 2009″Accrued Interest:
“Financial Regulation: How Would You Have It Work?”Michael Panzner
Treasury Officials Meet With Financial BloggersInterfluidity
Sympathy for the Treasury
That’s all for now. Until this evening and part 4.
November 5th, 200912:40 pm at
Two names that jump to mind are David Rosenberg (yes, I know, he’s not a blogger, but he is still a highly public, highly influential, and highly frequent commentator on economic affairs) and “Tyler Durden” from Zero Hedge. And yes, I know that Zero Hedge couldn’t have physically sent someone without blowing their cover, but they certainly could have preserved their anonymity by participating via conference call, Skype, etc.
Which raises two points of curiosity:
1) Did Treasury insist on your physical attendance (seems awfully low-tech)?
2) Was there a background check (that you know of) before gaining admission to the sanctum sanctorum?
November 5th, 20092:02 pm at
Bruce Krasting (who sometimes posts at Zero Hedge) would have been a good invite. I really like his ongoing articles on Fannie, Freddie, and the FHA.
November 5th, 20092:09 pm at
I’m very impressed by and proud of the bloggers who chose not to attend this meeting. I think it’s far more impressive to be able to turn down such an opportunity in the name of intellectual honesty than it is to have been at the event.
Kudos, particularly to CR, Mish, Barry, and Simon Johnson, for their independence. Thanks guys.
November 5th, 20092:28 pm at
Krugman would have been obvious though I am sure he would be too busy.
November 5th, 20092:47 pm at
@benedict – they asked for SS#’s and DOB’s before the visit.
@NDK – so are you suggesting that by attending the meeting, David and I somehow lost our independence? I cannot agree. At the very least, we gained insight and had access that others did not – it’s really hard to turn that into a negative.
You are probably picturing a meeting where they wined and dined us, carried our bags, and got us to come around to their viewpoint. Reality was almost the exact opposite – if the Treasury was expecting to convert a roomfull of bloggers, they failed in that effort, in my opinion
November 5th, 20092:52 pm at
Zero Hedge.
November 5th, 20093:32 pm at
Your points are as usual well thought out and lucidly expressed. It is a shame that the Treasury guys weren’t listening at the meeting–I have gathered the impression by reading most of the commentary that the Treasury guys wanted to say that they had had a meeting with some critical bloggers and exchanged dialogue with them (maybe at the behest of some higher ups?).
I’ve been at meetings like that–your counterparts were sauve, friendly, and polite and used those tricks that Steve Waldman detailed to try to make you feel like they cared about what you thought and would truly consider your opinions and advice. You leave the room feeling pretty good, but nothing was accomplished, other than the other side being able to say they held a meeting and putting whatever spin they want to on that. Of course, I wasn’t there, but that’s what it sounds like to me.
Please don’t take this as criticism of your attendance at the meeting–I would have gone too if I had been in your place. I just think you need to be able to remember that the charming people across the table can and will do the wrong things.
November 5th, 20095:51 pm at
Warren Mosler
November 6th, 20092:41 am at
Barry was out of town — I think he would have come. CR lives a long distance away, I think. Simon Johnson has access any time he wants. Mish, I don’t know.
Don’t be so sure of the motives of those who did or did not go. Aside from trivial friendly comments, what have any of us said that is a substantial change of view?
November 7th, 20094:24 am at
As I live in Austria it would have been a bit costly to attend the Treasury invitation. Additionally I will not travel to a country where immigration/DHS locks up people on arrival without giving a reason. As my blog is rather anti-US-government I am not going to take the risk to travel to the US only to get my first cavity search and be threatened with weapons. Friends of mine have been throuh this. One did not travel to Germany in 1939. One does not travel to the USA since 9/11.
November 7th, 20094:26 pm at
TPI — understood, sir. If you ever do get here, look me up.