Bluematter.

That's US debt held by the public tracked in real time since 1993, and it stands at 9,017,482,214,669.27 as of two days ago.

The Chinese seem to be holding about 10% of that, although the true figure may be somewhat higher - according to the table, the per capita holdings of Luxembourg stand at an astounding $200,000.

Markets play a simple yet crucial role: they price (or 'rate') assets, so as to ensure societal resources are allocated efficiently.

Markets do this better than any other institution yet devised because people need to put their money where their mouth is; it is not enough to say 'I think Greece will default' - if you are going to have an influence on the price, you have to be willing to take the risk of losing money if your opinion turns out to be wrong, and you would only do that if you have confidence in your information and analysis. That way, the price of different assets, including sovereign debt, is determined by the people with the best information (or, as is the case when it comes to extremely deep and liquid markets such as sovereign debt, the best ability to process the information that is freely available to all).

So, it is a serious perversion of this basic principle when the credit ratings agencies spend 60,000 dollars a year (that's the annual wage of a junior analyst) on analyzing Greek debt while investing exactly $0 on it, yet the effect they have on the price of that debt is equivalent to their controlling billions in funds. What the hell does it mean to 'rate debt'? Isn't this what the market is supposed to be doing by setting the price?

This state of affairs is so striking that I have to repeat this again. Markets work because people put their money on the line: ratings agencies don't. Furthermore, information on sovereign debt is abundant and the agencies have no informational advantage whatsoever (not to mention an appalling ratings record). Giving dodgy ratings to obscure CDOs is one thing, but rating sovereign debt should have had no effect on its price - information is aplenty.

I'm trying to work out a model as to why real market participants (you know, the ones with money on the line) don't completely discount the agencies' credit ratings of sovereign debt. Where I've got to so far implies that ratings agencies can only have a destructive effect, leading the market away from the efficient price: since the ratings do not reveal any new information (as I said, info on sovereign debt is abundant), the only reason they can move the price of debt is because they give an opportunity to smart money to profit at the expense of dumb money - money that is too stupid to rate sovereign debt independently, or is restricted from investing in debt below a particular rating.

I repeat: this is seriously messed up. Do the credit agencies have access to superior information on Greek debt compared to everyone (indeed anyone) else? No. Does the $60,000/ year S&P team analyzing Greek debt have such amazingly better insights than the collective might of analysts of hundreds of funds and banks across the globe? Hell no. Then why in the name of all that is folly does what S&P say affects the price of sovereign debt to such an extent?

And let me repeat a crucial point in case it wasn't made clear (a lot of repetition in this post, but this is what happens when your blogger starts getting a distinct feeling that either he has gone crazy or the rest of the world has). Don't try arguing that even if the credit ratings agencies don't have their money on the line they have their reputation to worry about - in case you just arrived on our beautiful planet from somewhere in the outer universe, they seriously messed up with CDOs with no effect whatsoever on their credibility and their ability to make money (there is a word for companies that can provide a crappy service and stay in business: they are called monopolies).

All in all, credit rating agencies have a destructive influence. They facilitate speculation at the expense of market efficiency, creating or reinforcing herd effects where market participants try to outfox the 'bigger idiots' rather than aim for the efficient price, seriously distorting the essential role of the market in accurately pricing assets. They risk nothing when pontificating on the value of different assets, and they add nothing real to the stock of available information - just a focal point for speculation. Furthermore, they are so embedded in the system - with funds having restrictions in their constitution restricting what they can invest in depending on its credit rating - that it's difficult to see a way forward.

We can start by pointing out the absurdity of the situation.

Just needed to say this.

The market reflects my feelings exactly.

Tim Harford is outclassed by none when it comes to expressing important ideas simply yet forcefully:

I have been as guilty as anyone of being fascinated by behavioural economics. But the financial system did not fail because of some psychological trait, but because it was riddled with damaging incentives that were hard to spot because the system was complex and changing quickly.

In other words, let's get over evil bankers and the belief that moralizing will change the world, and let's focus on incentives.

Read the whole article, which discusses changing British thinking and practice on counter-insurgency in Afghanistan.

And yes, rightsizing is a real word, apparently.

The blame-it-on-Lehman story leads to a dangerous complacency. If we can persuade ourselves that the fault was just one policy mistake, forced on the feds by silly legal restrictions and not enough bailout power, everything can go back to the cozy way it was before.

This is a convenient story for large banks that dominate the lobbying and communication effort. And it absolves the Fed and Treasury of facing up to their long string of policy mistakes.

We don't pretend that we could have done any better. That's the point: A system with so much power vested in so few people, with so few rules, in which crises are managed with 2 a.m. conference calls, cannot possibly do better no matter how good the people at the top. Repeating the Lehman story lets us all ignore the fact that this system cannot go on.

Cochrane and Zingales on the lessons of Lehman.

"People are wondering why Goldman is making such bumper profits... What they don't realize is how little competition there is left in certain areas...

Lots of banks just want to get rid of 'funny' assets at whatever price to please their freaked-out shareholders. Goldman operates under no such constraint, and there's no end to golden opportunities to make money."

In 20 years time, the concensus amongst economic historians will be that the prime reason behind the Almost-Depression was central bankers' reluctance to pursue aggressive enough monetary policy, either by generating some inflation so that real interest rates can come down, or by other means.

They will argue that a few percentage points additional inflation would have worked wonders in softening the recession, and they will dismiss arguments that long-term central bank credibility would have suffered as a result. They will marvel at how anyone could have let below target inflation (let alone deflation) take hold, and they will label as disingenuous claims that the tools available to central bankers and policy makers at the time were insufficient to generate the required degree of inflation at will.

They will comment extensively on the shocking lack of international co-ordination, both amongst central banks and governments. Finally, they will have some rude things to say about using fiscal policy, with all its adverse effects on public finances, when a small tax on monetary assets (i.e. inflation) could have done a better job, and much more neatly.

In other words, the consensus in 20 years' time will be what Scott Sumner is already saying today.

A humorous short film about career prospects in finance.

Volkswagen’s shares more than doubled on Monday after Porsche moved to cement its control of Europe’s biggest carmaker and hedge funds, rushing to cover short positions, were forced to buy stock from a shrinking pool of shares in free float.

VW shares rose 147 per cent after Porsche unexpectedly disclosed that through the use of derivatives it had increased its stake in VW from 35 to 74.1 per cent, sparking outcry among investors, analysts and corporate governance experts.

Shares in VW closed up €309.15 at €520, giving it a market capitalisation of €153bn, more than all the other US and European carmakers put together.

The FT has the full story, hat tip MR.

Merv is surprised a hedge fund hadn't pulled this one over other hedge funds in the past (although granted, it would need to be on something smaller than VW). I am surprised too, but who knows - maybe someone somewhere has just updated their bag of tricks.

Does any reader know what happens if you have borrowed shares to short and *can't* give them back?

Postscript: There's something about the commentary on the financial crisis that reminds me of sports interviews; firstly, the lack of content and repetition of cliches, secondly the use of language:

“This was supposed to be a very low-risk trade and it’s a nuclear bomb which has gone off in people’s faces,” said one hedge fund manager.

If it's a nuclear bomb it doesn't need to go off in your face, and if it goes off in your face it doesn't have to be nuclear.

Facts about the financial crisis:

1. Interbank borrowing and lending rates have risen to unprecedented levels relative to U.S. Treasury Bills.
2. Several major financial institutions have failed.

Myths about the financial crisis:

1. Bank lending to nonfinancial corporations and individuals has declined sharply.
2. Interbank lending is essentially nonexistent.
3. Commercial paper issuance by nonfinancial corporations has declined sharply and rates have risen to unprecedented levels.
4. Banks play a large role in channeling funds from savers to borrowers.

All four debunked in 2 pages of text and a collection of graphs. Required reading, ht Alex Tabarrok.

Lehman's Richard Fuld makes the case for a long-dated compensation system.

Addendum: And this, ladies and gentlemen, is what passes for journalism.

In case you missed it, Friday saw a hell of a meeting:

The intense discussions reportedly saw US Treasury Secretary Henry Paulson literally down on one knee, begging Ms Pelosi to help push through the bail-out package.

It looks like economists may have had something to do with the plan bein' stalled and all:

Republican Senator Richard Shelby moments ago on CNN explaining why the tentative deal reached earlier today is bunk:

"If 200 of our economists say the plan is flawed we should listen to them."

Here's the statement by the actually 192 economists.


And last but not least, Greg Mankiw's smart friend discovers a free lunch - go no further than point 1.

I was wondering about that. Zubin Jelveh has the answer:

[...] There are roughly $14 trillion in outstanding residential and commercial mortgages and five percent is also roughly the loss rate on those categories, he added. Five percent of $14 trillion is = $700 billion.

Nice.

"It's not science," Bernanke said.

There are two main reasons people don't want government interfering in private markets:

1. The rule of law. No-one can be referee and player at the same time, and government officials should not be allowed to use their discretion to benefit one player over another.

With the Paulson plan, not only will there be discretionary action on a vast scale, but it also looks like there will be a minimal degree of accountability. This is not specific to the current plan however: any 'solution to the crisis' requires discretionary, arbitrary actions by the Treasury and Fed.

2. Government is inefficient. It is likely to make a mess of things and waste taxpayer money, so if something can be handled by the private sector it should be.

What I find funny with the Paulson plan is that instead of doing something to address this worry, it actually guarantees that taxpayers' money will be wasted. The fund is limited to buying worthless securities, so it doesn't even allow the possibility the taxpayer might turn a profit or even minimise the loss. It boils down to preferring to lose money instead of running a risk of losing money.

And what makes this even more remarkable is that the current environment is the best possible for government to actually make money by investing in financial markets. Following standard commentary, the biggest problem right now is not that there are gigantic losses in the system, but rather a lack of liquidity and a lack of trust. Government is the unique institution right now that enjoys an abundance of both, and in any economic system whoever controls the scarce resource is amply rewarded.

A plan along those lines, albeit one which I think could be improved, is described here. The Economist blogger's reaction is telling:

I get the feeling that a bigger hurdle to the latter plan than any real concern would be a gut Congressional reaction against the government taking equity stakes in a broad array of American corporations.

The Zingales plan also has much to recommend it, although it wouldn't be my first best option.

For my take on the long-term solution to the problems in the finance industry, tune in later this week.

Many (other) serious people think the Paulson plan sucks: see Naked Capitalism, Politico, and of course Tyler Cowen and Greg Mankiw.

It is enough to say that for 6 of the last 13 years, the Secretary of Treasury was a Goldman Sachs alumnus. But, as financial experts, this silence is also our responsibility. Just as it is difficult to find a doctor willing to testify against another doctor in a malpractice suit, no matter how egregious the case, finance experts in both political parties are too friendly to the industry they study and work in.

This is from the the truly excellent 2-page essay by Luigi Zingales on why the Paulson plan sucks. He is right: no matter how easily you can switch your hats around, you may find it difficult to be harsh to the people and companies you spent your career with. Did Margaret Thatcher hail from a long line of coal-miners?

Old Manchester United shirt:

New Manchester United shirt, to reflect change of sponsor:


And from the same loyal reader, I have no idea if this is true but it still is hillarious:

Bloomberg reports that Lehman's Brothers' Canary Wharf landlord prudently insured the firm's rent in case Lehman ever had difficulty paying up. It looked dodgy there for a moment, though, as the policy was taken out with AIG...

Thanks to Stef for sending me this.

Empires came crumbling down, blood flowed on the trading floors and the real economy quickly headed for the Great Depression mark II. The collapse of Lehman Brothers led to a true Black Week, as predicted by numerous self-serving bankers.

Only it didn't.

The Dow fell from 11260 four days ago to 11060 yesterday - that's 200 points, or 1.8%. When future dictionaries define 'disaster', they will not be displaying this picture by means of example:

(Source: Yahoo finance)

Now, the worse is not necessarily over, and markets might yet crash as a direct result of this week's events. There is still a not-so-reassuringly-low probability this blogger will have to eat his words in the not so distant future. But so far it looks like Lehman's demise caused no more than a shrug.

It really is impressive how quickly the lessons of Bear Stearns were not only understood but also put to action by the bankers (be sinister and wait long enough, and the Treasury will give you a bank for free.) Yet, it is even more impressive how the government put an end to the emerging orthodoxy.

A proud week for everyone fighting on the taxpayer's side. Public officials, I salute you!

A while back I wrote:

Banks are not, and cannot, be plc's in the same way that other companies are. The social value of a steelmaker can only fall as far down as zero, while the social value of a bank can be much, much lower than that.

Avinash Persaud at Vox EU proposes a solution:

The third pillar [of financial regulation reform] is requiring banks to pay an insurance premium to tax payers against the risk that the tax payer will be required to bail them out. If such a market could be created, it would not only incentivise good banking and push the focus of regulation away from process to outcomes, but it would provide an incentive for banks to be less systemic. Today, banks have an incentive to be more systemic as a bail out is then guaranteed. The right response to Citibank’s routine failure to anticipate its credit risks is not for it to keep on getting bigger so that it can remain too big to fail, but for it to whither away under rising insurance premiums paid to tax payers.