Monthly Archives: April 2010

Nick Rowe on the Eurozone

Nick Rowe has written an excellent post on the Euro money supply. Here is a long excerpt:

Only the European Central Bank has enough money to fix the Eurozone problem; because it can print it. What’s ironic is that what they call “The Nuclear Option” is what first year economics textbooks describe as the normal way that central banks increase the money supply. We call it “Open Market Operations”. Print money and use it to buy Eurozone government bonds.


Eurozone commercial banks hold Eurozone government bonds as assets. With the drop in those bonds’ values, many commercial banks (inside and outside the Eurozone) will become insolvent. There will be (and already are) runs on those banks, as depositors seek to transfer their deposits to safer banks, if any can be found, or withdraw currency, if they can’t.

The first year textbook says this fall in bank deposits will cause a fall in the money supply, and that this fall in the money supply will cause a recession. And the general fear of financial assets will also cause an increase in the demand for money which will exacerbate the problem of a declining supply. And the solution is for the central bank to do whatever it takes to increase the money supply by however much it takes to eliminate the excess demand for money.

I don’t see how the ECB will do this, if it can’t buy bonds, can’t lend to insolvent banks, and can’t lend against junk bond colateral.

Instead, the ECB will point to its nice low interest rate target and say “Look how loose monetary policy is!”. And it will be low, because the only people who can borrow at that rate won’t need to, and all those who desperately want to borrow at that rate won’t be allowed to.

The fall in the Euro money supply will cause a worsening Eurozone recession. As I, Scott Sumner, Bill Woolsey, (and others) have been saying all along, central banks’ nominal interest rate targets are not a good measure of the stance of monetary policy.

Assorted Links

  • Arnold Kling on financial reform — I don’t like his call to break up the big banks. The problem with “too big to fail” isn’t the “big” part.

    Also, check on his post on “predatory” lending.

  • Stephen Williamson on the new Fed Governors — he expresses my sentiment quite well.
  • David Beckworth has a round-up of commentary on the Eurozone crisis.

Quote of the Day

“Here’s the problem. Once we start thinking of large financial institutions as too-big-to-fail institutions with oversight by a systemic regulator, it is tempting to start thinking of these institutions as public rather than private.”

Stephen Williamson


Last Friday, April 16 I was awarded the Samuel Levin Award for the best research paper by a graduate student in our department. The award was presented by the late Professor Levin’s daughter. The video is below:

More on GM

In my previous post I pointed out that GM’s claim that they paid back their loan to the government is true, but perhaps a bit misrepresented. This prompted the following response (via email) from GM spokesperson Tom Wilkinson:

Hey Josh,

Regarding the GM loan payback, what is happening here is what happens in bankruptcy. The major creditors (UST, EDC, UAW, VEBA, old GM) exchanged debt in the old company for a combination of debt and equity in the new. (All of this is detailed in Note 2 of our 2009 10-K, available on the SEC EDGAR or GM Investor site.) These new owners also provide liquidity so the new company can operate long enough to get on its feet and generate positive cash flow, and eventually, profits. Since we getting back on our feet faster than expected, we can pay off the loan portion of this funding ahead of time, with interest. This is a good thing for us and for our stockholders.

I understand why some pundits and politicians might want to make an issue of this. But if you are training as an economist and plan to cover business, you might want to go back and review the basics of bankruptcy.


Now, I will be the first to admit that I am not an expert on bankruptcy. I am not a lawyer or a business leader, I am a macroeconomist. HOWEVER, I do actually read things before hastily writing a post. Thus, allow me to explain the inner workings of what is actually happening with GM and thus defend myself from accusations that I am uninformed.

According to a report by the Office of the Special Inspector General For the Troubled Asset Relief Program (TARP), GM was given $49.5 billion dollars in accordance with the TARP program. Roughly $19 billion of this disbursement was given prior to bankruptcy and the remaining funds were dispersed during bankruptcy. What’s more (p. 5), “As of November 18, 2009, GM had used about $35.8 billion (72 percent) of the TARP funds…” The document then details how this money was spent. I won’t bore you on the details, but most of the money was spent to cover operating costs.

Regarding the $30.1 billion dispersed during the bankruptcy, a portion of the proceeds of this loan were placed in an escrow account. The escrow account was designed to ensure that the Treasury department could oversee the use of funds. The amount of funds in the escrow account totaled roughly $16.5 billion. GM used a portion of these funds, $2.8 billion, to resolve Delphi’s bankruptcy. This left a remaining balance in escrow of $13.7 billion. Further, as the report indicates (p. 6), “GM officials stated that they intend to seek release of additional escrow funds to repay its outstanding $6.7 billion loan to Treasury and $1.3 billion to the Canadian government.”

So what does all of this mean? Here is a simple breakdown of the disbursement:

  • GM received $49.5 billion — $14.5 billion pre-bankruptcy and $30.1 during bankruptcy.
  • Of the $30.1 billion, the $16.4 billion was placed in an escrow account.
  • $2.8 billion in the escrow account was used to resolve Delphi’s bankruptcy thus reducing the escrow account to $13.7 billion.

In exchange for the disbursement of $49.5 billion, the government received:

  • 60% stake in the new GM.
  • $7.1 billion in interest bearing debt ($0.4 billion was paid back in July 2009).
  • $2.1 billion of preferred stock.

Thus, the through TARP, the government gave GM $49.5 billion in exchange for a mixture of debt and equity. The government can therefore recoup its investment by selling shares of GM stock after the release of the IPO and through the repayment of the interest bearing bonds.

What GM has done is use the TARP money that was placed in escrow by the Treasury Department to repay the remaining interest bearing debt of $6.7 billion. Given that this money was not paid for with profits earned by the company it is effectively a debt-for-equity swap not a loan repayment. In other words, the Treasury approved the repayment of the loan with the escrow funds and the government therefore hopes to recover the remainder of their investment by selling common stock after GM’s initial public offering that is intended to take place this year. As I stated in my previous post, I am skeptical that the government will be able to fully recoup its initial investment through this process.

Thus, to re-iterate, GM did pay back its loan — sort of.

Did GM Pay Back Its Loan? Sort of.

The big news, especially around my neck of the woods:

The new, post-bankruptcy GM made a final $5.8 billion loan payment to the US and Canadian governments on Tuesday.

Two questions, however, emerge. How did they pay it back? What about the $50 billion bridge loan? First, the bridge loan:

The payments however do not include much higher loans made to the company under its former guise, being slowly wound down through the bankruptcy process.

The US government, which provided about $50 billion in emergency loans, holds a 60.8 percent stake in the new company and $2.1 billion in preferred stock. The Canadian government and a retiree health care trust also hold significant stakes.

The expectation seems to be that the government will recoup the $50 billion when the company goes public later this year. However, GM’s market cap has never been $50 billion (let alone 60% of it).

Now to the issue of how the money was repaid via Jamie Dupree of the Atlanta Journal Constitution:

General Motors will make a big splash in the news today by announcing that the automaker will repay several billion dollars loans from the federal government earlier than expected. But it’s not really coming out of the GM wallet.

The issue came up yesterday at a hearing with the special watchdog on the Wall Street Bailout, Neil Barofsky, who was asked several times about the GM repayment by Sen. Tom Carper (D-DE), who was looking for answers on how much money the feds might make from the controversial Wall Street Bailout.

“It’s good news in that they’re reducing their debt,” Barofsky said of the accelerated GM payments, “but they’re doing it by taking other available TARP money.”

In other words, GM is taking money from the Wall Street Bailout – the TARP money – and using that to pay off their loans ahead of schedule.

“It sounds like it’s kind of like taking money out of one pocket and putting in the other,” said Carper, who got a nod of agreement from Barofsky.

“The way that payment is going to be made is by drawing down on an equity facility of other TARP money.”

Translated – they are using bailout funds from the feds to pay off their loans.

This is not quite the good news suggested by the headlines.

UPDATE: I have written a follow-up post with precise details here.

Present or Past Tense?

I was in the middle of writing this morning when I wrote “monetarists emphasize” before instinctively changing it to “monetarists emphasized”. Should it be present or past tense? In other words, are there any monetarists left (besides myself and a few notable exceptions)?