Merle Hazard is the world’s leading (and only) country singer who sings about the financial crisis.
Merle released his latest yesterday, “Bailout”:
Merle’s production values have improved, so business must be good.
My personal favorite continues to be “Inflation or Deflation”:
The Citigroup pricing anomaly may be in its final days (earlier posts here and here).
Investors must submit their offers to exchange preferred shares for common shares by this Friday (which may require contacting your broker several days earlier). The common shares will then be delivered to investors on July 30.
The pricing gap between the common and preferred shares remains large (about 10% at the close on Monday), but has narrowed as the exchange date has drawn near.
It thus seems an appropriate time to reflect on what, if anything, the Citigroup anomaly illustrates about economics and finance more broadly. Happily, this week’s Economist carries a quote from Dick Thaler (previously quoted in my post about Catherine Zeta-Jones) that summarizes the lesson perfectly:
Mr Thaler concedes that in some ways the events of the past couple of years have strengthened the [Efficient Markets Hypothesis]. The hypothesis has two parts, he says: the “no-free-lunch part and the price-is-right part, and if anything the first part has been strengthened as we have learned that some investment strategies are riskier than they look and it really is difficult to beat the market.” The idea that the market price is the right price, however, has been badly dented.
To me, the Citigroup anomaly illustrates the strength of the “no-free-lunch” part of the EMH, and the limitations of the “price-is-right” part. Continue reading “Citigroup & Efficient Markets”
Neil Barofsky, the Special Inspector General for the Troubled Asset Relief Program (affectionately known as SIGTARP), is making headlines with his estimate that the government has provided “potential support totaling more than $23.7 trillion” in fighting the financial crisis. That estimate will be officially released on Tuesday morning in the SIGTARP’s latest quarterly report (you can find an early copy here – ht WSJ).
As the media are already noting (e.g., WSJ and Yahoo), there are many reasons to believe that the $23.7 trillion figure is overstated. For example, as noted in the footnote to the table above, the figure “may include overlapping agency liabilities … and unfunded initiatives [and] … does not account for collateral pledged.” In other words, there may be double-counting, some of the programs won’t happen or are already winding down, and the estimates assume that any collateral is worthless. For example, to get to $5.5 trillion in potential losses on Fannie Mae and Freddie Mac (part of the $7.2 trillion Other category), you would have to assume that all GSE-backed mortgages default and that all houses backing them are worthless.
In short, the SIGTARP estimate is a way upper-bound on likely Federal support to the financial support. That fact shouldn’t detract, however, from the importance of the rest of this report.
Good news on the TARP warrant front today (previous installments here and here).
First off, Reuters reports that:
JPMorgan Chase & Co, seeking to completely extricate itself from a federal bailout program, has asked the government to auction warrants to buy the bank’s stock, after the Treasury Department demanded too high a price for the bank to buy them back.
This is great news. Treasury should be driving a hard bargain. And JP Morgan should allow private investors to compete to buy the warrants — maybe that will allow JPM to use its capital for better purposes. As an economist, I also welcome the opportunity to find out the market price of the warrants, so we can compare it to what all the modelers have been estimating.
Next question: How do I bid? I hope Treasury does this in a way that lets small investors participate, much as they can in Treasury bond auctions.
Meanwhile, the Congressional Oversight Panel released a report on the warrants. The Panel suggests, albeit with major caveats, that some initial warrant repurchases were done too cheaply:
Continue reading “TARP Warrants: Auctions and the Oversight Panel”
As I’ve noted in a series of posts (here’s the most recent), there’s an anomaly in the pricing of Citigroup securities. Several issues of Citi’s preferred stock are scheduled to convert into common by the end of the month. Yet the common stock has been trading at a significant premium to the preferred in recent months. As I type this, for example, the common is trading at roughly a 14% premium to the preferred common, even though the conversion is just a few weeks away.
As best I can tell, the only explanation for this pricing anomaly is that Citigroup common stock is very difficult to sell short. So arbitrageurs can’t bid the spread down to levels that would be normal for such a deal.
This anomaly intrigues me for two reasons. First, it appears to be a blatant rejection of strong versions of the efficient markets hypothesis. However, as I will discuss in a later post, the market for Citigroup securities is actually ruthlessly efficient in many ways. As a result, it’s extremely difficult to profit from the anomaly. Sharp financial types have already bid other prices — most notably those for Citi options — to a level where obvious profit opportunities don’t exist.
Second, the anomaly is a big dangling carrot for big-money types to get creative. Markets always try to find ways around imperfections like the limits on short-selling. So I’ve been wondering what creativity would come out of the woodwork. Well, today I got an answer.
Summary: Both Citigroup and Berkshire Hathaway continue to violate the law of one price.
Citigroup
In previous posts (this is the most recent), I’ve pointed out that there are three ways you can purchase common shares of Citigroup:
Simple: Buy shares of common stock.
Preferred: Buy shares of preferred stock that will convert into common.
Synthetic: Use call and put options to replicate the financial returns of owning common stock.
In a perfect world, these three approaches would give nearly identical prices. That’s the law of one price.
Over the past few months, however, Citi securities have been breaking that law. Investors who have been buying common shares have been significantly overpaying relative to the values implied by the prices of the preferred stock and options.
How much is TARP costing American taxpayers? We know that Congress originally authorized up to $700 billion in TARP investments. And we know that $439 billion has been committed to various programs. But how much of that money are taxpayers likely to see again? And to what extent will they be compensated for making those investments?
The Congressional Budget Office took a crack at answering those questions in a report released last night. The headline finding is CBO’s estimate that subsidies in the TARP program are $159 billion. Taxpayers put up $439 billion and, in return, now own assets (including recent repayments) worth $280 billion.
The following chart shows the estimated value of the TARP portfolio (dark red) and subsidies (light red) across the major TARP programs:
Key insights from the chart: Continue reading “The Subsidies in TARP”
Catherine Zeta-Jones has an important message for policymakers who want to help consumers make better financial decisions.
Really.
Let’s go to the video:
I should emphasize that the message is not that economists are bow-tie-wearing geeks who should be sprayed with garden hoses. That may be true, but it isn’t CZJ’s message to policymakers.
No, the special message of the T-Mobile ad is that … Continue reading “Catherine Zeta-Jones & Consumer Finance”
Wednesday was a rare day in Washington: the Federal government was actually cash-flow positive.
The reason, of course, is that ten major banks repaid $68 billion in TARP money. Smaller banks had previously repaid about $2 billion, so Wednesday’s action lifted total repayments to $70 billion, almost 30% of TARP support to individual banks.
As noted in my previous post on TARP, that means that two firms — Citigroup and Bank of America — now account for the majority of outstanding TARP support to banks. Citigroup has received $50 billion in three transactions, and B of A has received $45 billion in two transactions. Investments in all other banks now total “only” $79 billion.
The TARP continues to grab headlines, so I thought it would be useful to summarize how the TARP money has been used to date.
As you may recall, the Troubled Asset Relief Program (TARP) created a pool of $700 billion that the Treasury Secretary could use to stabilize the financial sector. The following chart summarizes the TARP transactions that have already occurred (dark blue) and any additional funds that Treasury has announced for each program (grayish):
As the chart illustrates, Treasury has announced plans for about $645 billion of the TARP money, of which $435 billion has been committed to specific transactions. But the most interesting facts involve the specific programs:
