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Where have I heard this before:
Oakland City Council members may have privately bandied
about the possibility of the city filing for bankruptcy, an unusually rare
event in U.S. history. But none says it's likely, and Mayor Ron Dellums virtually
ruled it out Tuesday.
"Bankruptcy is not a strategy that has been seriously
considered, nor is it being pursued at this point," he said in a statement.
Full story here. At least the mayor qualifies his answer, unlike GM's prior management.
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As a person who still considers Los Angeles home, I often find myself reading the Los Angeles Times webpage. Yesterday I saw that Los Angeles County's recent note offering got a lower than expected credit-rating, in part because of the State's financial problems. A county official quoted in the article explained that S&P had based the rating on a "worst case scenario." My initial response was, are they doing that now?
Several people have asked me whether California might not follow GM into bankruptcy court. The easy answer to that is "no," since states, unlike cities and counties, can't file under the federal Bankruptcy Code.
But the financial press has also picked up on the issue and noted that California might be forced to default at some point this year if it becomes impossible to continually refinance its outstanding debt. In a recent Bloomberg column, Kevin Hassett breathlessly proclaims that "California leads nation to bond default abyss." He goes on to trace the problem to California's high corporate and personal income taxes, and then makes the entirely predictable argument that this shows that federal taxes should not be raised either.
Of course this ignores the fact that California has high corporate and personal taxes because its property taxes are extremely low. Proposition 13 instituted a kind of rent control scheme for property taxes in the late 1970s that caps increases in property taxes save for when the property is sold. In a state like California where property values increased much more rapidly than inflation over the past few decades, and the state population has been rapidly increasing, this provided a windfall to generally older, long-time homeowners, that the legislature made up by increases in other taxes.
But what about the basic question of a California default. Could it happen? Certainly. It has happened before.
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The Efficient Capital Markets Hypothesis (sometimes just called the Efficient Markets Hypothesis) states that liquid markets quickly absorb information, so that it is essentially impossible for an average investor to make excess profits trading on public information. Share prices are thus the best indication of the value of a company, because they reflect the consensus view of all available information.
If there ever was a market that might live up to the theory, you’d think it would be the New York Stock Exchange, especially with regard to trading in blue chip stocks like General Motors. After all, this is a very big company traded on a very liquid market.
Yet a few days ago I observed — in the pages of the Wall Street Journal — that GM shares appeared to be overpriced by a factor of 30. Did that effect share prices? Don’t be silly. I’m just a bankruptcy professor; what do I know about chapter 11?
And again there was a good deal of befuddlement today when GM’s share price started going up after the announcement that the company had reached something of a truce with a large group of bondholders. The new announcement didn’t change the reality that the shareholders will likely receive nothing in the GM chapter 11 case.
How much would you pay for something that will have no value in a few months? As of the close of the market today, the surprising answer was apparently $1.12.
By talking with my non-lawyer friends (all 2 of them), I’ve come to the conclusion that there are a variety of factors at work here. First, sophisticated investors are essentially unable to engage in significant shorting of GM shares right now because the cost of borrowing the shares is quite high. Second, some retail holders might be resistant to selling their shares if the commission on the sale will exceed the sale proceeds. Not an entirely rational, but plausible.
In addition, trading by people who don’t understand the Bankruptcy Code is probably all going in one direction (i.e., toward buying GM) — the ECMH presumes that such noise is random and cancels out. There also may be some buying happening to close out whatever short positions do exist. All these factors could conspire to prop up GM’s share price.
On the other hand, shouldn’t most investors — especially retail investors — be selling GM to lock in their tax losses? If there ceases to be a market in GM stock, these shareholders might not be able to realize their loss until the conclusion of GM’s chapter 11 case — which could be a long time after the §363 sale. The present value of a tax loss today (or this year) is higher than the same tax loss two or three years from now.
In short, the market in GM’s stock is rather clearly not efficient.
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One reason I’ve often thought that the benefits of moving credit derivatives to a central clearing house/exchange model have been oversold turns on the ability to move trades offshore. This is highlighted in an excellent article in today’s FT, in which a trader states that if the US and EU regulations become too tough, trading will move to “Switzerland and Singapore.”
Why not require disclosure of derivative-related information, regardless of the jurisdiction where the trading takes place? For example, the SEC could require all reporting companies to disclose (a) any counterparties who make up more than 5% of the reporting company’s derivative portfolio and (b) any reference entities or asset classes that are the subject of more than 5% of the company’s credit derivative portfolio. Specific trading strategies and positions need not be disclosed; the foregoing information would be sufficient to gauge whether the company was engaged in appropriate risk management (i.e., making sure that it was not getting all of its credit protection from AIG).
If the reporting obligation extended to the reporting company and all affiliates, such a rule could provide an important check on the “Switzerland and Singapore” strategy — at least so long as the US and the EU have subtaintially deeper capital markets than either of those nice, but small, jurisdicitons.
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Slate has a put up a map that animates first job growth and then scary job losses from January 2007 to February 2009. It's worth a look, although the sea of red at the end might cause some sleepless nights. Very few data presentations are perfect, and I do have one quibble with this one. The map shows the absolute number of job losses such that higher populations areas appear to be doing worse. Thus, the eastern part of the United States appears to have been hit the hardest, although it is also the part of the country that is more densely populated relative to the rest. In the same vein, note that southern California and the San Francisco Bay area come across as the worst hit western regions, but these are two of the largest U.S. population centers.
All in all, it's a great piece of data visualization. We've been hearing about job losses to the point where we're almost numb. This map brings those stories alive. Hat tip and thanks to my colleague, Andy Morriss, for pointing the way to this map.
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The fact that wealth is rapidly declining deserves public policy attention. Wealth serves critical functions in the U.S. economy that relies heavily on individual initiative. It is primarily an insurance against a range of economic risks. The more such insurance exists for the typical family, the less a family has to worry about their basic necessities and the more they can focus on longer-term economic growth. A family that has the basics covered can take more chances by sending their kids to college and letting them choose a degree that suits their abilities. Also, family members can more easily switch jobs to match their particular skills. And, a family with enough wealth is in a better position to let their creative side take hold and start a business. The entire economy wins from letting people gain more skills and apply those skills most effectively in their job or by starting a business.
Recommending what the government should and should not do about rebuilding family wealth has become as ubiquitous as real estate ads in the mid-2000s and dot-com IPO discussions in the late 1990s. Here are just a few principles that will likely guide the reform debate.
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Here is another example from the list of “things that we saw coming, but nobody cared.” Credit card companies are suffering from record default rates. In the fourth quarter of 2008, credit card companies charged off – declared as uncollectible – a whopping 6.3 percent of their debt. Aside from a fluke spike in the data in the first quarter of 2002, this was the largest charge-off rate since the Federal Reserve began collecting these data in 1980.
Interestingly, these record setting losses for credit card lenders come after the punitive changes to the bankruptcy code were supposed to weed out the “deadbeat” borrowers and lead to lower default rates. Apparently, things did not work out as planned.
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Ahh, retirement – so many possibilities, so little time! Turns out that for millions of Americans the dream of a secure retirement was just a dream. From 2007 to 2008, total retirement wealth in private and public sector pension plans and retirement savings plans dropped by $2.8 trillion (in 2008 dollars).
Not all retirement plans are created equal, though. Data from the Fed show that holding gains and losses – changes in asset values minus contributions – relative to initial asset values tend to be higher for traditional pension plans than for retirement savings plans, such as 401(k) plans. Holding gains are typically used as an approximation of rates of return for these data.
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Here’s a news flash: The housing market is bad. Actually, it is really bad, historically, woefully bad. And, the bad news won’t stop coming. Housing wealth is dropping precipitously, families own ever smaller shares of their own homes, and home owners are falling behind in their mortgages in record numbers.
According to data from the Federal Reserve, housing wealth has taken a nose dive for two years. In December 2006, housing values reached a peak of $18.9 trillion (in 2008 dollars). By December 2008, they had fallen by $3.9 trillion to $15.1 trillion.
This reflects a historically fast depreciation of housing wealth. Over the past two years, real housing wealth dropped by 20.5%, a record for any two-year period since 1952. In fact, before this crisis occurred, there had never been a two-year period when real housing value fell by more than six percent.
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A trillion here, a trillion there and all of a sudden you are talking real money. We are getting used to the “T” word. Over the past year and half – from the middle of 2007 through the end of 2008, when the crisis unfolded – the crisis in the housing market and in the stock market has cost American families a total of $15 trillion in 2008 dollars.
It makes sense, though, to put the loss of personal wealth in perspective. In these 18 months, approximately 27 million times the average family’s wealth — $566,000 in 2008 dollars. Put differently, equivalent of the average family’s net worth disappeared every 1.8 seconds in those 18 months.
In fact, this was the sharpest relative wealth decline in more than fifty years. Over the 18 months since the crisis began, inflation-adjusted personal wealth has fallen by 22.8%. This was the fastest such decline since the Federal Reserve started to collect the information in 1952. The quickest 18-month wealth decline before this crisis was 12.0% for the period from March 1973 to September 1974. We are shattering speed records that nobody ever wanted to break.
Didn’t families build up enough of a buffer because of the bull market in the housing and the stock markets? Apparently not. Family wealth is a buffer for emergencies, insurance for when sources of income like wages disappear, e.g. because of retirement, and a tool to invest in one’s own future through education or starting a business. Hence, it is important to compare current wealth to current income. In the fourth quarter of 2008, the ratio of wealth to after-tax income stood at 483.3%, its lowest level since March 1995. It’s as if the stock market boom of the 1990s and the housing boom of the 2000s never happened.
At the end of the day, though, these declines matter because they leave families in a very precarious situation. Over the years, we have asked families to shoulder an ever greater economic burden. Health insurance coverage and the quality of health insurance have dropped, “do-it-yourself” savings plans have taken the place of traditional pensions, changes to financial aid and rapidly rising tuition costs have meant more and larger student loans, Social Security benefits have already been trimmed, and a whole host of social programs have been cut. Personal wealth today takes on a completely different meaning than it did for previous generations. The money that a family sets aside has to go a lot further than it used to. That’s why the trillions in lost wealth are especially scary.