The Banque de France

There's a fascinating story in Thursday's Financial Times about the central bank of France and the role it may have played in the shenanigans leading up to the collapse of Lehman Brothers in Septemnber 2008.

Regular readers in the econoblogosphere will not need to be reminded that part of the Lehman decline-and-fall involved an instrument known (at first internally, now to the world!) as Repo 105.

Repo 105, and its cousin Repo 108, were transactions designed to remove certain assets from the balance sheet, usually for a period of less than two weeks. As the term suggests, these "repos" were quite similar to standard repurchase deals, used to secure short-term financing. There was just one big difference ... Lehman did not account for Repo 105 transactions as financing transactions, but instead treated them as true sales.

Here's the intriguing part. Nobody can do a Repo, or a "Repo 105" for that matter, alone. There has to be a counter-party.

The FT tells us Thursday, "In the final months ... the French central bank was often on the other side of the bank's deals, taking collateral in the process." We know what was in it for Lehman. They could lessen the degree to which they (seemed) over-leveraged during key snapshot periods. But what was in it for the Banque de France?

The FT's Henny Sender seems baffled.

There Ain't No Such Thing As A Free Lunch

The title phrase of this blog entry is often abbreviatred TANSTAAFL in libertarian circles. Those aren't initials, buddy. That's an acronym, pronounced "tan-staff-ill."

Anyway, it is a profound truth. I was once arguing about health care policy with a Canadian who was trying to instruct the ignorant Yankee on this subject. She said that of course health care in Canada isn't a free lunch. It does get paid for obviously -- doctors don't work for free -- hospitals don't construct themselves. So since there is no such thing as a "free lunch" anyway, there is nothing to be concerned about. Right?

I told her that she had entirely misunderstood the significance of TANSTAAFL. The point isn't "the free lunch is like Big Foot. Big Foot doesn't exist, so he won't come and hurt you." The significance of TANSTAFFL is a warning, not a bit of re-assurance.

The warning is precisely that some people sometimes deceive themselves into believing that they see a free lunch, or that they see Big Foot for that matter. The coddling of such deceptions can do real harm. The danger is not Big Foot but the delusion.

Anyway, this column in the Chicago Sun Times Monday made much the same point using that Independence weekend favorite beverage -- lemonade. When that old symbol of childish enthusiasm and entrepreneurship, the lemonade stand, is turned into a lesson that good (material) things are "free," things are in a sorry state indeed.

Philosopher's World Cup

Spain has defeated Germany, setting up a Spain-versus-Holland match for the World Cup Championship.

Here is something else that Spain has going for it of late.

Anyway, Spain defeated Germany 1 - 0, which as my sister reminded me is probably a tribute to the great Spanish philosophers Maimonides and Averroes. Or, would be, if this were the Philosopher's Cup familiar to Monty Python fans.

Maimonides will try to guide you right if you are "perplexed" by the rules of the sport, or even the question of whether to call it soccer.

Averroes is your guy if you suspect that we are all thre same beneath the skin. He'll use the one-and-only "active intellect" as he maneuvers past the opposition.

They'll have to contend with the tough Dutch, who recently defeated Uruguay, due of course to the midfield of Spinoza and Brouwer, with Erasmus I think tending goal.

This Supreme Court Term

The U.S. Supreme Court has wrapped up another term -- John Paul Stevens' last.

There were several remarkable decisions this year, and I'll pass them in quick review, in no particular order.

JONES v. HARRIS ASSOCIATES concerns mutual funds, and the fees they can charge without violating their fiduciary obligation to their investors. Nobody is sure how it will affect actual mutual fund operations, but there is a general consensus that it is important.

In terms of the standard to be applied, the respondent and the petitioner in the case before SCOTUS agreed. They both wanted the court to endorse for the first time a standard laid down by the second circuit in 1982, in Gartenberg v. Merrill Lynch. The standard since then has been that to be guilty of a breach of fiduciary obligation "the adviser-manager must charge a fee that is so disproportionately large that it bears no reasonable relationship to the services rendered and could not have been the product of arm’s length bargaining.”

The matter got to SCOTUS this year because the seventh circuit disagreed with Gartenberg. The seventh circuit then (despite a dissent by Judge Posner) refused to rehear the case en banc.

The original panel's justification for blocking Gartenberg lawsuits was that allowing trial courts to second-guess market rates is a bad idea, and that mutual fund managers can only be said to have violated their duty if it can be shown that they had lied to their directors. Posner's own inclinations are laissez-faire, so I find it impressive that he thought this wrong, that some sort of objective reasonableness standard, as with Gartenberg, is appropriate.

SCOTUS agreed with Posner and embraced Gartenberg rather than the Seventh Circuit approach, and it remanded for further proceedings. Still, it is not clear how big a difference this will prove to make. Will it encourage some disgruntled investors to sue their managers to get their fees back, now that it is clear they can at least get their foot inside the courthouse door? Yes, probably.

Should we be worried about that? I don't believe so. There has after all been no flood of mutual fee related lawsuits over the decades since Gartenberg, even in the 2d Circuit where that decision has been binding.

DOE v. REED denied a request by an organization, "Protect Marriage Washington," to keep the personal information of the signers of a petition private, affirming the constitutionality of a law in that state that requires disclosure in most cases (though allowing for ad hoc exemptions).

It was not a "clean win" for transparency, though. The decision allows PMW to ask the district court in Washington for an exemption from public disclosure.

The lead counsel for PMW said in a statement, "While we wish the Court had agreed with us and found that petition signers speaking on any issue should be protected from having personal information disclosed to the public, we are looking forward to returning to Washington and showing the Court that supporters of traditional marriage should have their personal information protected from disclosure."

SCOTUS voted for this result 8-1, with only Justice Thomas dissenting. Thomas would have held that "compelled disclosure of signed referendum and initiative petitions" is unconstitutional because it chills citizen participation in democratic assembly and speech.

I have no sympathy for the whole protect-traditional-marriage cause, but Thomas' decision seems right to me. I am cynical enough to wonder whether he would have written just this decision had it been a gay rights group on the other side of this issue that was asking for anonymity.

CITIZENS UNITED v. FEDERAL ELECTION COMM'N struck down decisions on what various affected parties, including for-profit corporations, may say during the course of a campaign. Much has been said and written on this subject. I won't add a lot to it.

I will note that this was the decision that provoked President Obama to criticize the Justices during the State of the Union address. The presence of the Justices at the SOTU speech has long been considered a non-controversial formal gesture, which allows for the presence of the top level of all three branches of our federal government in the same room at the same time. But Obama chose to make it an opportunity for face-to-face confrontation.

Justice Alito responded to that by mouthing the words "not true."

Stuffy people have bemoaned that exchange. I think both men acted appropriately. Let's be less stuffy and more honestly confrontational in our politics! It may help us learn to get beyond politics, and beyond the myth of sovereignty -- though I'm sure that idea was far from both of their minds at that YouTube-able moment.

BERGHUIS v. THOMPKINS is the latest example of SCOTUS' long entanglement in the specifics of police interrogation rules. Specifically, two officers of the state police of Michigan interrogated suspect Thompkins, after informing him of his Miranda rights.

For three hours he remained silent, although he did not first say "I invoke my right to remain silent" or "I want a lawyer" or anything of that sort. After 2 hours and three quarters, the police did manage to get him to speak, in a highly incriminating way.

By a 5-4 vote, SCOTUS allowed the statement. "Police are not required to rewarn suspects from time to time. Thompkins’s answer to Helgert’s question about praying to God for forgiveness for shooting the victim was sufficient to show a course of conduct indicating waiver," says Justice Kennedy.

I think Sotomayor, writing for the four dissenters, has the better of the argument, though, and will give her the last word here.

"I cannot agree with the Court’s much broader ruling that a suspect must clearly invoke his right to silence by speaking. Taken together with the Court’s reformulation of the prosecution’s burden of proof as to waiver, today’s novel clear-statement rule for invocation invites police to question a suspect at length—notwithstanding his persistent refusal to answer questions—in the hope of eventually obtaining a single inculpatory response which will suffice to prove waiver of rights. Such a result bears little semblance to the “fully effective” prophylaxis, 384 U. S., at 444, that Miranda requires."

SKILLING v. UNITED STATES granted a partial victory to former Enron CEO Jeffrey Skilling. More important, it trimmed back the overly luxuriant prosecutorial interpretations of the "honest services" statute.

I've discussed this one at length on my other blog, and I'll just link you to that.

Here's another discussion of the case.

BILSKI v. KAPPOS is the much-anticipated decision on "business method" patents and on the machine-or-transformation test of what is or isn't patentable.

Here, too, I have said much on the subject on my other blog, so I will say very little on this one. The good guys won.

To grant this opinion would give Bilski and his partner, Rand Warsaw, a license to file patent-infringement lawsuits in a wide variety of cases of routine commodity hedging, simply because they have reduced to paper a sort of algorithm for that common process. It is a bit like describing the flapping of wings in the hope of suing the birds -- businesses have been hedging their commodity price exposure for as long as anyone can remember.

Still, it is not clear what the court is saying about business method patents as a rule.

I do think Elena Kagan, as our solicitor general, submitted a fine brief in defense of the patent office's refusal to grant Bilski and Warsaw their requested monopoly. Those who are complaining that her experience does not qualify her as a Supreme Courty Justice might want to consider how vastly sup[erior that brief is in its reasoning to any of the three opinions the litigation produced (authored by Justices Kennedy, Breyer, and Stevens.)

Thinking about Population

When the phrase "population theory" comes to mind, so inevitably, does the name Thomas Malthus, the author of the single most influential essay on the subject. Indeed, Malthus is to essays on population what Melville is to novels about whaling.

But what of the more than two centuries of subsequent debate? Which other names should one know to get up to speed? Well, first, there is Edwin Cannan.

In 1888 he wrote, in Elementary Political Economy: "[A]t any given time the population which can exist on a given extent of land, consistent with tha attainment of the greatest productiveness of industry possible at the time, is definite."

"Is definite"??? What the heck kind of a predicate for such a long convoluted subject is that?? A very indefinite one. Nonetheless, one gets his drift. There presumably is some "best case" at any one time, given the technology and capital accumulation and all other pertinet factors at that time, that can be stated in a given number of people per square mile.

One might also mention Henry George, the land-tax theorist, who addressed population issues. Here is the relevant chapter of Progress and Poverty. George didn't involve himself with trying to determine the optimum level of population. He is certain that the earth could support everyone there is, and everyone that is likely soon to arrive, were social conditions such as to allow it. His refutation of some of the Malthusian arguments is salutary.

Finally, I'll link you to a recent philosophical discussion. Gustav Arrhenius has used population theory to illustate moral issues, "what we ought to do in situations when our actions affect future generations. More specifically, I shall focus on the moral problems involved when our actions affect who’s going to live, their number and their-well being."

Cassano testified

Now THIS is the one for which people have been waiting! Well ... wonks of a certain sort.

On Wednesday, June 30, the Financial Crisis Inquiry Commission finally heard from Joseph Cassano on his role in American International Group (AIG) in the period leading up to the financial crisis of 2008.

Joseph Cassano, who ran a sort of high-risk prop desk within AIG, known as "Financial Products" or AIG FP, is often credited/debited with setting off the 2008 crisis. Indeed, Cassano wears the biggest black hat in Michael Lewis' book, The Big Short.

Describing a period beginning in late 2004, Lewis writes: "The 'consumer loan' piles that Wall Street firms, led by Goldman Sachs, asked AIG FP to insure, went from being 2 percent subprime mortgages to being 95 percent subprime mortgages. In a matter of months AIG FP, in effect, bought $50 billion in triple-B rated subprime mortgage bonds by insuring them against default. And yet no one said anything about it -- not AIG CEO Martin Sullivan, not the head of AIG FP, Joe Cassano ....The deals, by all accounts, were simply rubber stamped inside AIG FP, and then again by AIG brass."

AIG FP stopped writing such deals in late 2005 -- except for those that were still "in the pipeline."

The news out of the hearing room Wednesday, though, was that Cassano was notably unapologetic. You can read his written submission to the committee for yourself, of course here.

To use the appropriate jargon, AIG FP was writing CDS' on CDOs. Or: it was writing credit default swaps on collateralized debt obligations. Or, as Lewis summarized it in the passage above, it was -- through a chain of instruments by which it hid the risk from itself -- implicitly buying bundled-up subprime mortgages.

Even in retrospect, after the blow-up, Cassano shows a touching faith in the ability of his quants in this statement. "You have asked about the way in which we calculated fair market value for our portfolio. This was, to be sure, a challenging, first-of-its-kind process at AIG-FP, but I believe we developed a reasonably strong analytic method for estimating fair value. We selected a model developed by Moody's (the Binomial Expansion Technique, or "BET") in September 2007. We customized it to provide the most accurate valuation estimate possible."

But of course, if Lewis is at all right than the damage had been done before September 2007. The plane hadn't crashed yet but it was on an auto-pilot course for the mountainside.

Cassano's back-and-forth with the committeemembers is more fun than his pre-hearing statement. Watch that here Go to FCIC Panel Two, and fast forward it to about 37:20, "We were working in an opaque market," and keep it running until he takes offense at the notion that he was making a "one sided bet."

That does seem to be what he was doing, umbrage notwithstanding,

Invention of Teflon

Today, July 1, is the anniversary of the day, in 1939, when Roy Plunkett filed a patent application for an extremely heat-tolerant no-stick stuff formally known as tetrafluoroethylene resin.

Less formally, it is known by its trade name: Teflon.

Plunkett was working then for DuPont's laboratory in Deepwater, New Jersey. The discovery is said to have been an accident, but no doubt chance favors the prepared.

It was not the only landmark in Plunkett's career. But mortals only get the chance to be remembered, at most, for one achievement. In Plunkett's case, the one is Teflon.

It is even more important as a metaphor than it is as a material. We had one recent President who was remembered, half-jokingly, as the "teflon President," and another who was known, in ironic reversal, as the "velcro President."

So here's to you, Mr. Plunkett. Like the White Line naval engineers who worked on The Titanic, you started with a set of practical workaday issues and ended up with a cosmic paradigm.