Monday, September 05, 2011

Betting on Banks

Warren Buffett made a big investment in Bank of America a couple weeks ago. The PE based on estimates of next year's earnings is about 4, which suggests it is really cheap. Unfortunately, there's a catch.

Our government is going after the banks, suing them for losses on loans guaranteed by Fannie and Freddie. As Dick Bove notes, this would be the tip of the iceberg:
The price tag is unlimited. Basically, we can look at Fannie Mae and Freddie Mac and say they've lost $33 billion, supposedly, as a result of buying these bad mortgages, and therefore, those losses should be put back to the banking system. But in essence, if we establish the precedent that anyone can sue a bank if they get a mortgage that doesn't work out, and there were $5 trillion of mortgages that were securitized through this Fannie-Freddie system over the past number of years. I have no idea how many people would sue, nor how much the courts are willing to give back to these companies and take away from the banks. It's a very, very negative development.

So, if the government wins this case, it would establish a fact that other investors could use, and given the size of the mortgage market, basically wipe the banks out. Meanwhile, Obama has been castigating 'fat cat bankers' for not lending more. Bove thinks banks are a good buy because the government will realize it is making a mistake: ruining the banking sector would not help the economy, we don't have enough money to recapitalize it after giving it to the trial lawyers.

The government is basically behaving like a child, wanting inconsistent things. That's understandible, because the government is not a unified whole, rather, a collective with many parochial interests. The rumored call for selective stimulus through targeted tax breaks for 'innovative' businesses, and the constant demand for closing corporate loopholes, is inconsistent. Today's loophole is yesterday's targeted tax break. So is the idea that for labor, temporarily reducing payroll taxes is a good idea, but that same administration has pushed for increasing the minimum wage.

Bove is betting that the FHA will have the wisdom to drop the lawsuit because winning would be a tragedy for the economy, and I bet Buffett also has this kind of faith. It's an interesting gamble.

Personally, I think the quicker bad ideas fail the better. Obamacare is really poisonous because it kicks in slowly and front loads revenues, so by the time everyone notices it is a bad idea and very expensive (say 2014), it will be impossible to prove what provisions and who is at fault (the new President, or Congress, will be to blame). Let the FHA win its lawsuit asap, crash the economy, and then our legislators may understand that without a vibrant business sector, they have no taxes to distribute.


Blixa said...

Surely increasing the minimum wage is consistent with reducing the payroll taxes. Both, on balance, should go towards increasing aggregate demand. The impact of the minimum wage is a bit controversial, though empirical evidence seems to hint strongly at a positive effect.

And so does common sense. Imagine you're a well-off person who's used to buy a $2 coffee every morning on your way to work. A hike of the minimum wage of the barista puts that coffee to $2.20. What do you do? Skip coffee every alternate Friday so as to keep your coffee budget constant, or just ignore it and save 20 cents a day less than you did before? In the meantime the low-wage barista, who now gets your 20 cents a day, will be more likely to spend it, as they are likely to be on a tight budget with less slack for savings.

B. A. said...

Gee Blixa, seems that the 20 extra cents for a coffee you are talking about were just "saved" before and did absolutely nothing for the economy, but now they increase aggregate demand. How about if they were lent to some corporation (say via the bond market) that could create jobs without the need for state intervention?

Blixa said...

If the private sector in aggregate did put enough of their (net) savings to productive investments, we wouldn't be in the mess we're in in the first place. People, for some reason, don't buy (enough) corporate bonds or equity with their current savings. In boom times, putting up the minimum wage could indeed be an unwise idea.

Besides corporate bonds are not always investment, e.g. when Google issues bonds to increase their cash pile, it doesn't help.

Basically the private sector loves government paper too much, and government intervention is needed to tame the private sector's excessive unwillingness to invest in themselves.

Mercury said...

"Personally, I think the quicker bad ideas fail the better."

And that's why everyone needs to vote Obama in 2012. The sooner the inevitable collapse comes, the better.

D said...

Payroll Tax Impact

That blog maintains excellent quantitative analysis of the political paralysis that exists today, including the minimum wage topic.

The key structural changes that should be made to stimulate capital formation in the US are:

1) 0% LT capital gains tax
2) 0 employer payroll tax contribution
3) eliminate the 501c3 and convert the existing 501c3 into traditional corporate structures.

Transitional deficits can be patched by government borrowing/spending through additional QE measures if required to keep interest rates from going negative.

D said...

"The private sector loves government paper too much"

That is a fallacy! LOL

Do you own any treasuries? How many people do you know that own treasuries? What about in relation to their overall asset mix?

The fact is that central banks and money center banks are the primary investors in treasury paper because of its risk-weighting and the fact that it can't "default." It's BETTER because it is actually...better!

B. A. said...


I think it's the same argument, only hidden better this time :)

I suspect Google keeps the cash pile in bank accounts rather than some company safe, and it's banks that ultimately hoard it or make poor use of it by lending it to the government. I believe there is some truth in this. But you are saying that the best fix for this is for government to make companies pay that "extra" money as extra salaries, rather than allow them to save it in banks that ultimately hoard it or lend it to the government. Now Google and the banks may well have their reasons why they hold on to cash, but hell with that, let's either force them to spend it, or keep them from getting it! way to go.

If lending money to the government is a mis-use of resources that the government itself is concerned about, maybe the government should look for ways to spend and borrrow less? Banks are holding on to cash mainly to avoid the fate of those that didn't have it. It's a safety buffer against liquidity risk. Having less safety buffer means the bank will have to lend even less.

Even regardless of all these, increasing minimum wage has far reaching consequences. As long as buyers (both the guy who buys the coffee and the employee) are free to choose what they do with their money, they will ultimately buy whatever they need from whoever offers the best value for money, and that may well turn out to be a maker in Asia, which nobody can force to pay the same minimum wage. To me the real problem is efficiency against competitors. It's not something that economists can fix with redistribution schemes or anything else.

Blixa said...


So you're saying someone who lives in say New York is going to fly to Uganda every morning for breakfast because the coffee is $1 there? While the effect you describe is not as such incorrect in theory, it's not that relevant in practice because it only applies to tradable goods (and not services like the making of a cup of coffee in front of you) and all the low skill jobs that can be done anywhere have already moved elsewhere, because the Ugandan wages are already way below what a no-regulation low wage would be.

You can observe that by looking at countries with no minimum wage. In Germany there's no minimum wage for shit jobs, and the going rate is about $7/hour which already isn't competitive with the third world. All movable shit jobs have moved and those that remain are services that cannot be moved (cleaning, elderly care, barristas, digging up the street, etc). If Germany introduced a minimum wage it would just transfer a bit of wealth from the buyers of shit-jobs-intensive services to those who do them.

Blixa said...


For what it's worth, I hold almost half of my wealth in government paper of some sort or other, and have done so for a couple of years. I was 80%+ in equity before.

Of course it doesn't help on a macro level, which illustrates the problem: too many investors are making the same choice, because it's a rational one individually, and we need to be either collectively forced away, or at least convinced in some way or other that the private sector has better prospects.

B. A. said...


I guess we can think of the $7 per hour in Germany as the level where further immigration, legal or illegal, from Eastern Europe to Germany, to do low pay jobs, doesn't make economic sense any more. Impose a minimum wage and it will begin to make sense. You can't fly to Uganda to buy the coffee, but you can have the guy come over, live in the US and make it for you every day, legally or illegally. This, together with free competition for tradable goods, is why you have the problem of low pay for such jobs in the first place, I guess.

Assuming you have a way to make all immigrants stay in their poor countries and live their sorry lives there rather than have them come and compete with low pay americans, an increase of minimum salary is no guarantee of transfer of wealth overall. You can artificially set the price, but you can't control the amount that will be traded. Some people will prefer to make their own coffee at home.

Somehow I have the feeling you could argue this point of view a lot better than I do, if only you wanted to :D

Blixa said...


I do agree a minimum wage may increase immigration, and then?

We need people who spend money, it doesn't matter where they were born, it only matters that they spend and immigrants taking low skill work are likely to have a similar high propensity to spend as locally grown poor people.

And that it incidentally makes some poor people a little better off than otherwise, is all bonus, where they were born is also totally irrelevant. One person is as good as any other.

As for people making coffee at home, some will do of course, but the measure should be effective because most will not, that is I think on aggregate people would rather metaphorically speaking sell some treasuries than make coffee at home and keep the treasuries. If I'm wrong on that, the macro argument for the stimulus effect of the minimum wage does indeed fall down.