Felix Salmon

Usury: It’s a bad idea to give banks an incentive to drown individuals in debt.

The injustice of pricing tea in dollars: Always good to see the denomination fallacy applied to something other than oil.

Pension insurer shifted to stocks: At the top of the market. More billions of dollars of losses for the government.

H-1B Visa Window Opens Amid Recession: The quota will still run out in a matter of days, starting tomorrow.

As the annual scramble for H1-B visas kicks tomorrow, an interesting wrinkle has appeared in the usual proceedings. Here’s an email sent to foreign employees by Wells Fargo:

“Due to the fact that we have and will be displacing numerous U.S. citizens in your same positions Wells Fargo has decided to enforce a policy that prohibits lines of businesses to file visa sponsorships for foreign nationals that would hold positions that could otherwise be held by qualified U.S. citizens.”
“As a recipient of these funds we feel as a company we could not justify to our political officials the need to provide sponsorship,” the email added.

The rule that H1-B visas can only be issued for jobs where no US qualified citizen can be found to perform the role is a rule which is honored almost entirely in the breach. Everybody pays lip-service to it, and there’s quite a trade in job advertisements for positions which have already been filled by a foreigner but which need to be advertised all the same so that the necessary visa can be obtained.

Still, it does make perfect sense that Wells Fargo is disinclined to perpetuate such deceptions in the wake of receiving $25 billion of TARP funds. If you’ve just fired a bunch of US citizens doing the same job, it’s not very easy to claim with a straight face that no US citizens can be found to do it. And so when an employee’s H1-B visa expires after three years, the normally-automatic renewal process has now turned into something much more drastic for foreign Wells employees.

Those employees will now automatically be out of status as soon as their present visas expire, and will very likely have to leave the country. Now remember that these are skilled and valuable employees who have deliberately been kept on by Wells in the face of layoffs, precisely because they presumably contribute in important ways to the bank. But never mind all that — there’s no way that Wells Fargo is going to be caught in yet another media gotcha moment.

Interestingly, Goldman Sachs remains defiant:

Goldman Sachs, another TARP recipient, is renewing existing H-1B visas and continues to offer jobs to foreign workers who need new temporary visas to join the investment bank.
“We will make offers to the best people regardless of where they live,” said Ed Canaday, a Goldman spokesman.

Good for them. But taking that position takes some cojones, in the present environment.

Allison Schrager of the Economist (who went to Edinburgh), Simon Constable of Dow Jones (St Andrews), and I (Glasgow) appeared on a panel at the British Consulate in New York Thursday, moderated by Nick Wapshott. My back-and-forth with Constable over natural sellers of CDS didn’t make the final edit, but here’s the stuff which did:

If you think the world is about to come to an end, you’re not likely to be particularly worried about saving money — in fact, you will probably be quite keen to spend it while you can. Even on houses:

Mr. Crowe investigated how changes in the index matched up with home prices and found that up to 90 percent of the difference in price changes between evangelical and non-evangelical areas could be correlated with the Rapture index.

Zubin Jelveh gets the credit for the find; it’s great to see him back in the blogosphere. The same research finds that house prices in predominantly-evangelical areas tend to be less volatile, because “unchecked greed and speculative frenzy are seen as undesirable in the evangelical community”, and because, as the abstract puts it, evangelicals “interpret otherwise negative events as containing positive news, dampening the response of house prices to shocks”.
By these lights, evangelicals should also be more disposed towards interest-only mortgages: there’s no point in paying down principal if you’re going to be Raptured in the near future.

Matthew Turner points me to this rather interesting datapoint from the IMF’s International Financial Statistics for Ecuador. The country’s has had 845,000 ounces of gold for as far back as the statistics go — until January 2009, when they jumped to 1.76 million ounces, and then February 2009, when they rose further to 1.93 million ounces. That’s an increase of 1.085 million ounces (or about 37 tons of gold) in the space of two months — which at present prices is worth almost exactly $1 billion.

Curiously, the national valuation of the gold reserves hasn’t risen much — from $734.7 million in December to just $804.2 million in February. Which implies that the huge jump in gold reserves might just be some kind of data-input error. But on the other hand, it coincides exactly with Ecuador’s decision to default on its foreign debt. Might the Ecuadorean central bank be trying to convert attachable assets into something it can safely store at home? And if the country’s gold reserves have soared this year, why hasn’t Ecuador’s valuation of those reserves increased proportionally? It’s all most peculiar.

Update: The IMF says that indeed this is “a simple data mistake that is being corrected”.

Andrew Ross Sorkin takes aim at GM’s bondholders today:

Not three hours after the president spoke on Monday I received an e-mail message from a group representing G.M. bondholders — people who are likely to have an enormous influence over the future of the Detroit carmakers…
By the end of the e-mail message, they were complaining that they were “very disappointed that the government and company have had virtually no real dialogue with bondholders while designing the proposed restructuring plan.
The e-mail message came from the same group that two weeks ago grumbled that “G.M. bondholders have been asked to make deeper cuts than other stakeholders,” and threatened to send G.M. into bankruptcy…
I called Gabe Roth, the spokesman listed at the bottom of the message, and asked if I could speak with some of the bondholders the committee represents. The answer: “No. We’re not making them available.”
I followed up by asking which investors were members of this ad hoc committee. “We’re not making that public,” Mr. Roth said.
I reminded Mr. Roth that government money was at stake, and that we taxpayers might end up bailing out the bondholders. Doesn’t the public have a right to know whom they are negotiating with — or against? He demurred.

Sorkin does mention that Pimco is one of GM’s largest bondholders; what he doesn’t mention is that as recently as January, the head of Pimco, Bill Gross, was saying this, as he unilaterally withdrew from the GM negotiating committee:

“We have the interests of our clients more at heart than the interests of particular corporations or even the government, I guess, so it’s best that we simply look at the situation from afar as opposed to from inside.”

When Pimco’s GM’s largest bondholders behave like that, is it any surprise that they haven’t had much in the way of “real dialogue” over the restructuring plan? After all, it’s not as though their demands would come as any surprise: they want more money. And if they want to, they can force GM into bankruptcy — which is a pretty likely outcome in any event. But so long as they’re moaning from behind a cloak of anonymity, there’s really no reason to give them any sympathy at all — they’re asking for a government bailout just as much as GM’s management is, but they have a much weaker case for getting one.

Mike at Rortybomb finds some empirical research on what happens to loan rates when banks get bigger and more consolidated. The results make intuitive sense: as competition falls, loan rates go up. The exception is loans which can be securitized, like auto loans: those rates can fall as economies of scale improve.

The lesson here is that we should keep banks small, while encouraging securitization — which of course itself helps in reducing the size of banks’ balance sheets. Bank competition is good for consumers; big banks are bad for consumers. It’s worth remembering that, as we construct a new regulatory regime.

Why size matters: Steve Waldman is a fan of banks getting smaller.

In Market Cap, Google Now Bigger Than GE

The Taiwanese war against tax evasion: Clever.

The Government Crackdown on Peer-to-Peer Lending: I think it should be regulated by someone. If not the SEC, then who?

One thing drilled into every MBA student is that sunk costs are irrelevant, while opportunity costs are paramount. Which is a lesson this year’s graduating class will put to good use. Let’s say that in any given year, there’s a graduating MBA who has the choice between creating a green-energy start-up, on the one hand, or joining Goldman Sachs, on the other. Normally, the start-up loses, because the opportunity cost of going that route — all that foregone Goldman remuneration — is enormous: it probably has a present value of a good $10 million.

Today, however, the opportunity cost of starting your own company is tiny: if no one on Wall Street is hiring, then you literally have nothing to lose. To be sure, it’s not pleasant trying to make your way in the world with no steady paycheck and hundreds of thousands of dollars of student-loan liabilities. But those loans are sunk costs: there’s nothing you can do about them, and so there’s no point stressing about them overmuch. The art of any career decision is to make the best possible choice given the decision set available, rather than to kvetch about not having graduated a few years earlier, when MBAs were hot commodities.

Paul Oyer puts it another way:

There is a deep pool of potential investment bankers in any given Stanford MBA class. During the time these people are in school, factors beyond their control sort them into or out of banking upon graduation.

Never has this been truer than today: I’d wager that in any given MBA class, a very high proportion took the class with the intention of going into banking, and a much tinier proportion will actually do so.

The ones who don’t go into banking might be upset about their bad fortune, but I’m not sure they should be: there’s a case to be made that they actually dodged a bullet here. Given the choice, what would you rather be: a freshly-minted MBA with thousand of possible career paths ahead of you, or an MBA of vintage 2004 who got snapped up by a subprime mortgage origination desk and who now has an all-but-unemployable skillset?

For those of us who aren’t and never were in business school, however, the big question is what this all means for the economy. Will the best and the brightest now enter the real world, as opposed to the bizarre parallel reality of Wall Street, and put their skills to good and productive use? Or, conversely, will a cohort of finance MBAs infect the real world with their outdated and dangerous ideas about modern portfolio theory and whatnot, causing formerly well-run companies to follow the trajectory of Lehman Brothers or AIG?

To put it another way: what did this year’s MBAs really learn during their course? Was it much the same thing as their predecessors, or did the magnitude and severity of the financial and economic crash teach them a few home truths which will come in useful going forwards? I fear that the answer is largely the former: it’s hard enough just keeping up with your coursework, without trying hard at the same time to unlearn a large part of the compulsory curriculum. And certainly anybody I’ve ever talked to who’s taught a classroom full of would-be quants has told me that they tend to concentrate on formulas and algorithms to the point at which they can’t even perform a basic smell test on results, let alone look at those algorithms critically and decide to discard them.

But the optimist in me says that if there isn’t any demand for financial whizzbangery any more, then maybe the supply of it will wither quite quickly. And that today’s MBAs might yet add more value than you might think.

Will Ortel, a journalism student at the College of Idaho in Caldwell, Idaho, sent me a few questions about financial literacy for a project he’s doing. They’re good questions, so I’m blogging the answers:

Financial education for the layman is a shambles normally organized towards paying bills on time and managing credit cards. This prompts most Idahoans to think "who is this guy" when I explain what a CDS contract is or how short selling works. Is detailed financial knowledge something that most Americans should have? What is it about financial understanding that makes it distinct from engineering or psychological understanding?

I’m very happy that someone who knows what a CDS contract is or how short selling works is attending journalism school — the world of journalism desperately needs financially-literate reporters. On the other hand, there’s absolutely no need for most Americans to understand these things — any more than they need to understand what makes an airplane fly, or how beta blockers work.

Some people are interested in the world of finance, especially now, when troubles on Wall Street seem to be the proximate cause of the worst macroeconomic recession in living memory. So journalists who can clearly and accurately explain such things are to be treasured. But it’s no weakness not to understand how banks’ balance sheets are constructed, or even what a balance sheet is. People need a certain level of psychological understanding to perform their daily duties, which is why life with autism can be so very hard. And some basic personal-finance literacy is a good thing too. But beyond that, there’s no reason people should be expected to understand the mechanics of Wall Street unless they particularly want to. In that sense, yes, it’s much like engineering.

Coming from the standpoint of protecting small investors from hazy information that they might receive, could you support conceptually the establishment of a test to see who was capable of trading individual stocks and bonds (as distinct from vanilla mutual funds)? Can you think of anything that you would want to put on such a test?

It’s true that individual stocks are incredibly risky things which most people should avoid — much riskier than most hedge funds, which most individuals are not allowed to invest in. But I don’t think there’s much evidence that financially-sophisticated individuals make for better investors. If anything, they suffer from overconfidence bias, think that they have some kind of an edge, and make even bigger bets as a result. Giving people a financial-sophistication test might even be counterproductive in that sense: Americans would barge into the markets armed with their "qualification" to trade stocks, and then proceed to lose a fortune.

The much-heralded blog era has begotten the rise of personal financial journalism, perhaps typified by yourself. To what extent do you think that econobloggers parsing news for lay readers will catch on? Do you see yourself as parsing news for lay readers or providing insightful (and occasionally hilarious) commentary to moderately informed dorks (like me) around the country?

I like the idea of "personal financial journalism" meaning "financial journalism written with a personality" rather than "journalism about personal finance". Econoblogging is exploding right now: when I started the Economonitor blog at RGEmonitor.com in September 2006, one person could pretty much keep on top of most of it. Today, that’s unthinkable, I discover great new blogs constantly, and the best of them can become extremely popular and influential very quickly indeed.

That said, I don’t think that most of them are necessarily aiming at what you call "lay readers": a blog is naturally very conversational, and one tends to like to converse the most with people at more or less one’s own level. So you won’t find too many blogs spelling out what a basis point is, or explaining that bond prices move in the opposite direction to yields. So count most of us in with the "commentary for moderately informed dorks" crowd, I think. For lay readers, sites like The Big Money might be a better bet.

If the audience of a news organization with high overhead demands a Jim Cramer or Ben Stein figure, how can that organization deliver a more responsible figure instead and stay solvent? How would you characterize my optimism that the nature of financial journalism might improve?

Well, I’m on the record as liking Suze Orman: just because you’re a financial celebrity doesn’t mean you’re as idiotic as Ben Stein. And I’m not sure how hiring Ben Stein is likely to improve any news organization’s solvency — he doesn’t come cheap.

But one good thing about the internet is that people can become brands without having to be on the television. And since appearing on TV is a great way of becoming incredibly stupid, then with any luck the age of the internet will usher in a new generation of finance pundits who have made their name by the quality of their ideas rather than the recognizability of their faces.

The much-maligned Gawker Media, it’s worth noting, dispenses a pretty large amount of generally-excellent financial advice on such sites as Consumerist*, Lifehacker, and Jezebel. All of it is vastly more useful than anything you’ll get from Cramer or Stein. So the trend is in the right direction. Stein adds no value for the New York Times, so eventually he’ll be dropped. It’s just sad that it has taken so long.

*Update: As Gari points out in the comments, Consumerist is now part of Consumer Reports, not Gawker Media. I should know.

I got an interesting response from one reader to my post on whether healthy banks should be able to give back TARP funds. Here it is, with permission; the short version is basically "no".

The TARP preferred shares were extended to the major banks last year with a 5% dividend for the first 3 years, stepping up to 9% after the third anniversary. As orginially written, TARP preferred could only be repaid with the proceeds of equity issuances during the first 3 years. Apparently a clause slipped into the stimulus package gives the Treasury Secretary the option to waive that requirement. I think that TARP money should only be allowed to be repaid if fresh equity is raised from the market, and preferably in the form of common stock.

Let’s look at Goldman as an example of a bank that has expressed a desire to repay TARP funding. A few relevant facts:

1) At $100, Goldman has a $46 billion market cap. Assuming no placement discount, Goldman would have to issue 22% of new common shares to repay TARP, effectively telling the market that GS common shares at $100 are a cheaper form of capital than a preferred yielding 5%.

2) Use of proceeds of the equity deal should be properly disclosed as allowing insiders to enrich themselves with higher compensation without government scrutiny. Beyond that, there is no reason to accelerate repayment within the initial 3 years.

3) Based on the terms Buffett extracted on his preferred, GS could not issue 5% prefs today. Again, how could you justfiy paying a higher dividend on a new pref? Other than to facilitate executive looting, I cannot think of a reason.

4) If Geithner waives the equity issuance, where will the money have come from? According to Bloomberg, Goldman has issued about $22 billion of government-guaranteed debt this year. Given the fungibility of money, couldn’t one argue that the government has allowed Goldman to issue debt so that it could buy back its equity and weaken its balance sheet during a crisis? If markets dip again and Goldman needs help, what would we do?

5) Alternatively, one could argue that Goldman is taking its AIG proceeds to buy back TARP preferreds. I know that their CFO said they didn’t need the AIG bailout given their hedges. At the risk of sounding like Maxine Waters, Blankfein (current CEO) reportedly advised Paulson (prior CEO) during the AIG bailout process. To avoid the appearance of a conflict of interest, perhaps Goldman should voluntarily disgorge its AIG hedge profits since the government made them whole on their contracts (based on Blankfein’s counsel).

6) If Goldman escapes the TARP program’s scrutiny after a waiver, they will have a competitive advantage in recruiting, and other, potentially weaker banks would seek the same waiver. It would set off an arms race to repay TARP preferreds, weakening the balance sheets of large banks. And the primary reason would be to allow executive looting to resume without scrutiny. Again, if we dip again what does Treasury do?

7) Goldman is now a bank holding company but I see little evidence of a stable deposit base or other implementation of a bank holding company business plan. Shouldn’t we evaluate that before we allow them to weaken their equity base?

8) Shouldn’t we have a regulatory structure in place before we allow banks to reduce their capital cushion?

I am a portfolio manager following emerging markets stocks. I have no dog in this fight other than being a participant in equity markets and an American taxpayer.

This all makes perfect sense to me, and can be applied mutatis mutandis to any other bank thinking of paying back its TARP funds too. The government recapitalized the banks with TARP funds because the equity markets were closed. The equity markets are still closed. So for the time being, any talk of paying back TARP funds is surely premature.

I’m a huge fan of OpenTable, and I’ve always imagined that restaurants are, too. They don’t need to spend hours on the phone telling people what’s free and what’s not, special instructions don’t get garbled, and it’s very easy to cross-reference the diner to previous visits. But apparently Raoul’s didn’t get the memo:

I can no longercontinue putting off talking about the back room. I’d prefer it didn’t exist, since I love the rest of Raoul’s. Actually, I’d prefer the ma√Ætre d’ didn’t exist, either.
On my second visit, with tables empty everywhere in the front and middle rooms, he instructed the hostess to take us to the garden. I begged him: Please don’t.
He looked down at us in the French style, and said, “You made your reservation online.” Indeed, my friend had used OpenTable, listed on the restaurant’s website. The ma√Ætre d’ informed us that OpenTable had assigned us to the back room, and that was that. As we were led away, no happier than prisoners in leg irons, he sneered, “Next time you should call.”

Raoul’s is an old-fashioned restaurant — that’s a large part of its charm. But if it doesn’t want diners to use OpenTable, it shouldn’t offer them the option.

I do occasionally wonder, though, what to do with my Dining Rewards Points. I somehow can’t see myself redeeming them on the website, waiting up to six weeks for delivery, taking a Dining Cheque to a restaurant, and then using it to pay for (some of) my meal. It would be great if I could somehow donate them to charity — help treat some non-profit workers to a very nice lunch every so often. But then I suppose more people would redeem them, and the business model might not work any more.

James Kwak wants to make US financial institutions smaller:

There are a few main things that made companies like AIG and Citigroup systematically important. One was interconnectedness: they did business with lots of counterparties. One was complexity: when push came to shove, the regulators were not able to assess the potential damage a failure could cause, and therefore erred on the side of bailing them out. But the big one was size, and this is why we call it Too Big To Fail. The companies in question were so big, and had so many liabilities, that they could cause a lot of damage if they suddenly defaulted on those liabilities…
Size can definitely go away, simply by setting a cap on the volume of assets any institution is allowed to hold (and doing something about off-balance sheet entities).

Kevin Drum is not convinced:

It still has the flavor of a solution that’s clear, simple, and wrong. After all, Bear Stearns was a quarter the size of Citigroup, and it was considered too big to fail. So just what would the limit be on bank size? $500 billion in assets? $200 billion? Can a country the size of the United States even have nationwide banks with limits like that? And what happens the next time around, when all these smallish banks overleverage themselves and collapse en masse? Are we any better off than we are with a few big banks failing?

I’m with James on this one. Two things are worth noting about Bear Stearns: first, it might have been small by Citigroup standards, but its balance sheet was still enormous. And secondly, it wasn’t considered too big to fail, it was considered too interconnected to fail, largely as a result of its role as a major CDS broker.

To get specific, I think that maybe $300 billion in assets would be a reasonable cap on bank size — there’s very little evidence that banks get any economies of scale beyond that in any case. If they want to be part of a global or even a national network that would be fine — I’m sure such networks would spring up quite naturally, much as they have in the airline industry. After all, the United States managed to go 200 years without any nationwide banks, it’s unclear why it desperately needs them now.

At the same time, the cap on the balance sheet of broker-dealers should be smaller still: the more interconnected you are, the lower the cap, to the point at which companies like the CME, which are far too interconnected to fail no matter how small their balance sheet, should be barred from issuing any liabilities at all.

As for what happens when lots of smallish banks overleverage themselves and collapse en masse, well, you get an S&L crisis. Which is fiscally painful, to be sure, but which can largely be avoided through good regulation and which more importantly doesn’t have anything like the systemic implications of the current meltdown. So yes, we’re better off with one of those than we would be with Citi and BofA both failing.

The problem is a practical one: how do we get there from here. There are no good and politically-feasible answers to that question. So in the real world, TBTF banks are here to stay. But that doesn’t mean we have to like it.

From the European parliament, of all places:

(Via MAI, although I’m late to this, it’s been viewed almost 2 million times on YouTube already.)

I’ve had my share of disagreements with Arnold Kling on the subject of credit default swaps in the past, but he has a good idea today:

Regulators and accountants could require firms that are net sellers of credit default swaps to translate those positions into bond holdings and put these synthetic bonds on their balance sheets. My guess is that had such a policy been in place in 2000, the CDS market would not have taken off.

My guess is that Kling’s guess is wrong: there were actually very few net sellers of CDS, and in any case for most of this decade the stock market seemed to think that ever-expanding financial balance sheets were a good thing, not a bad thing. But yes, definitely: if you’re a net seller of protection, then the notional amount of credit that you’re exposed to should be considered an asset on your balance sheet, just as it would be if you owned that credit in bond form.

It is conceivable that the the monolines — which were by far the largest publicly-listed net sellers of protection — might have thought twice about continuing their escapades in the CDS market if there would have been such an enormous effect on their balance sheet. Doing so would have brought them more into line with the buyers of synthetic CDOs, who were the other large net sellers of protection, and who invested up front all the money that they could possibly lose.

Kling’s other point is that it’s hard to buy long-dated derivatives on the big exchanges in Chicago: if you want something with a maturity of three years or longer, you need to buy it in the OTC markets. That’s true, but he’s wrong that "it is quite difficult to take a position of any size" in long-dated options: those OTC markets are huge, and in many cases substantially larger than the exchange-traded markets. And they seem to work pretty well, in the absence of massive players like AIG taking large net positions (on the order of hundreds of billions of dollars) in the market.