An Early Effect of FinReg

Posted in Financial Markets, Politics and Policy at 11:19 am

The business press has been making noise about FinReg holding up a Ford bond issue.  The legislation opens up the possibility of holding Credit Rating Agencies accountable for defective ratings.  As a result, the CRAs are refusing to allow bond issuers to disclose ratings in prospectuses.


In response, the SEC has issued a statement that it will temporarily allow bond sales to go on without ratings.  This decision should be made permanent.

The above article asks two good questions:

  • Why does anyone still care what the rating agencies say, anyway?
  • If rating agencies now won’t let their ratings be included in offering documents, what’s the point of having them in the first place?

The second question gets to the heart of the matter.  The business press is acting silly when they “blame” FinReg for the situation.


Financial Reform Passes Senate

Posted in Politics and Policy at 5:21 pm

It passed the Senate 60-39, with the President expected to sign it as early as tomorrow.

Finance Reform Passes

For some reason, Baseline Scenario is hailing it as landmark and comparing it to the Sherman Antitrust Act, despite their earlier criticism.

I still rate it a C-, though it’s certainly better than doing nothing.


Income Distribution Changes

Posted in General Musings at 9:48 pm

Interesting stats on income distribution changes in the US:


See Table 5.

In 1980, the Top 50% earned 82.32% of all income compared to the Bottom 50%’s 17.68. By 2007, that was skewed to 87.74% and 12.26.

No surprise there, it’s well known that most of the income gains in the US over that period went to higher earners.

What is surprising is how small a sliver of the population actually saw an increase in income share.

Those in the “Between 26% and 50%” category went DOWN from 25.62% to 19.04%. So that huge gain made by the Top 50% must have come from the top 25%, since the other half of the top 50% actually lost out.

Top 25%
1980 – 56.70%
2007 – 68.71%

But wait, the “Between 11% and 25%” category ALSO went DOWN from 24.57% to 20.66%.

So ALL of the gains must have come only from the top 10%.

But wait, the “Between 6% and 10%” category ALSO went DOWN from 11.12% to 10.61%.

Thus, the ENTIRE gain made by the top 50% in reality came from the top 5%.

Let’s break that down further.

The “Between 2% and 5%” category went from 12.55% to 14.61%. That’s a gain, but just barely.

Almost the entire gain made by the top 50% in reality came from the top 1%.

The top 1% went from 8.46% to 22.83% of all income. Wow.

Let’s break that down further. Unfortunately, we only have data on the top 0.1% of income earners going back to 2001. But for that subset of the data, we can see that those in the “Between .1% and 1%” category went from 9.43% to 10.9%, which isn’t much. Extrapolating back to 1980, it looks like the top 0.1% went from around 3% of all income to around 12% in 2007.

In other words, almost all of the difference in income distribution can be accounted for by those in the top 0.1% of income earners.

For the record:

Top 5% = >$160k
Top 1% = >$410k
Top 0.1% = >$2.2 million

In summary, from 1980 to 2007 the share of income earned by the various percentiles changed as follows:

  • For the lowest 95% of the population (<$160k in income), meaning almost everyone, it went down.
  • For the next 4.9% of the population ($160k-$410k), it went up slightly.
  • For the top 0.1% of the population (>$2.2 million) it went way up.

On a related note, MarketWatch had a related release the other day:


Inflation adjusted median wages for both high school graduates and college graduates have fallen over the past 10 years.

Median weekly wages, when adjusted for inflation, fell slightly for both high school and college graduates from 2000 to 2009, according to a recent analysis by the Economic Policy Institute, a Washington think tank.

“The story is often told that college graduates have done well and everyone else has not. But that’s not true,” said Josh Bivens, an economist at EPI.

For high school graduates, median inflation-adjusted wages were $626 per week in 2009, compared with $629 in 2000, according to EPI. If you assume a worker gets paid for a full year, that adds up to $32,552 in 2009, down from $32,708 in 2000.

For college graduates, weekly wages were $1,025 in 2009, compared with $1,030 in 2000, according to EPI. Over one year, that works out to $53,300 last year, down from $53,560 in 2000.

A decade of stagnant median wages across the board, with virtually all gains in national income going to the top 1%.

Fed Paper On Shadow Banking

Posted in Economics, Financial Markets at 7:40 am

The NY Fed has a new staff paper entitled, “Shadow Banking” available.

Shadow Banking – NY Fed

This is a phenomenal read that documents the rise of the shadow banking system in minute detail.

Note that what has been published is just Part 1 (~70 pages) of what will ultimately be a 4 part paper (~230 pages).  Essentially, this is the executive summary of the paper, though it is quite detailed for such.

I anxiously await the publication of the remaining parts.


Financial Reform Bill calls for 68 Studies

Posted in Financial Markets, Politics and Policy at 8:15 pm

Wall St reform calls for 68 new studies

Instead of toughening up ethical and marketing standards for financial planners, Congress studies the issue in the financial overhaul bill. Instead of making it easier to sue lawyers, accountants and bankers who help commit securities fraud, Congress studies the issue.

The bill also studies, among other things: short selling, reverse mortgages, improved insurance regulation, private student loans, oversight of carbon markets and the “feasibility of requiring use of standardized algorithmic descriptions for financial derivatives.”

By way of comparison, the health care legislation only called for 40 studies.

The article goes on to state that most of the studies were the result of compromises – one side wanted to implement some new policy, the other side opposed it entirely, and the negotiated compromise was to conduct a study of the issue instead.

The nature of the studies and their followup also varies widely by issue:

Some studies are worse than others, congressional watchers say. Studies that don’t require any follow-up or deadlines can be dead ends.

A multi-agency study to combat mortgage foreclosure scams has no deadline nor follow-up rules. A study on executive compensation consultants and another on financial literacy among investors must meet deadlines, but doesn’t require Congress or regulators to act on the findings.

Much more useful is a study on financial firms’ hedge funds and trades made on banks’ own accounts. That study has a deadline and is followed up with mandates: regulators must limit so-called proprietary trades and bank ownership of hedge funds.

As noted in a previous post, the only saving grace is the hope that this reform legislation, assuming it passes, represents just the first in a series of ongoing legislation.


Eliot Spitzer on Financial Reform

Posted in Politics and Policy at 9:44 am

Eliot Spitzer has written a thoughtful analysis of the financial reform legislation for Slate.

How Washington Blew Its Chance To Bring Real Change To Wall Street

He reaches most of the same conclusions I did in my analysis, namely:

  1. The legislation mainly shuffles around existing regulators and leaves way too much to their discretion, and
  2. The good parts of the legislation (Volcker Rule and derivatives reform) were seriously watered down during the negotiation process

He also does a deep dive into the governing structure of the Federal Reserve, which is quite informative.

There are some real chestnuts in here:

The end result is an almost perfect illustration of not just how legislation is made but how politics works. Proponents of the bill continue to talk in grandiose terms of reform, but the actual terms of the bill provide continuity in both power and structure.


In traditional Washington fashion, under the current reregulation bill, there is a “compromise” that permits the illusion of reform but leaves the status quo intact.


And when you examine any of the so-called reforms, the same reality emerges. Virtually nothing has changed. Oh, the atmospherics are different, perhaps, and maybe a momentary lesson has been learned. But there is a reason bank stocks rose the day the final agreements on the financial regulatory bill were announced. The smart money knew which side had won.

Overall, an excellent read.


Hedge Fund Lending

Posted in Economics, Financial Markets, Politics and Policy at 10:12 am

The WSJ has an interesting article on hedge fund lending to non-financial firms, and the impact it has (detrimental) on the borrowers’ stock prices:


Companies that borrow money from hedge funds often see a sharp rise in bets against their shares before the loans or loan amendments are announced, new research shows, suggesting that fund managers or others privy to these deals may be illegally trading ahead of the announcements.

The sharp spike contrasts with little change in the short selling of companies that borrow money from banks, according to the research.

The academics found that the average company receiving a new loan from hedge funds saw a 74.8% spike in the volume of short sales during the five days preceding announcement of the new loan, as compared with the volume of short selling 60 days before the deal.

By contrast, 255 similar companies turning to banks for loans saw little change in the volume of short selling during the five days prior to the announcement of new loans.

This raises the obvious question of why hedge funds would trade against the stock of firms to whom they have loaned funds.

Why might a hedge fund bet against shares of a company while also lending it money? Traders say a fund might seek short-term gains from a potential tumble when word emerges that a company has turned to hedge funds for a high-rate loan, even if the fund is comfortable extending a loan because the company is likely to survive over the long haul. It also could be that some hedge funds are offered the chance to lend to a company, turn down the opportunity and then short the company’s shares.

The second explanation seems far more plausible to me.

Also, some data on the size of the Asset Based Lending Hedge Fund (ABL) market:


In 2007 and 2008 in particular, total asset-based loan volume outstanding was $545 and $590 billion, respectively, according to the Commercial Finance Association.

According to the HedgeFund.net database, ABL funds managed approximately US$15.6 billion in assets as of February 2009 compared to less than $1 billion in 2004.

Rapid growth and leverage out the wazoo, combined with near zero regulation.

It’s getting hard to argue that the financial crisis was not about the rise of the shadow banking system.