Felix Salmon

House Passes Heavy Tax on Bonuses at Rescued Firms: It might be gesture politics, but it’s a sorely-needed gesture, a wake-up call to Wall Street.

Citigroup May Spend $10 Million for Executive Suite: They claim it’ll save them rent costs. But somehow I doubt they’re going to give up the third floor of 399 Park.

Deleveraging after Lehman—Evidence from Reduced Rehypothecation: The IMF reckons that "since end-2007 the decline in rehypothecation (i.e., total collateral received that can be pledged) by the largest four broker-dealers was $1.774 trillion."

Reprinted from Portfolio.com

James Flanigan reports that "the number of ‘unbanked’ and ‘underbanked’ people is growing rapidly in the current economic crisis". (Don’t ask me why he felt the need for scare quotes.)

Is this really true? Flanigan adduces no evidence to back up his claim. And I always felt that the ranks of the unbanked and underbanked nearly always went down, absent low-income immigration: the unbanked can become banked, but it’s rare and uncommon for the banked to become unbanked. But of course many formerly rare and uncommon things are happening now; I’d just love to see some numbers on this.

(Related: My July 2007 blog entry on the Wal-Mart MoneyCard is still getting regular new comments. Feelings run high on this thing!)

Reprinted from Portfolio.com

From the reader mailbag:

So far, all of the commentary I’ve seen has focused on Bernanke trying to reflate the economy and lower long term interest rates. That’s obvious enough. But it seems like the real story here, or the backstory, is that China has essentially exercised a put option on its US Treasury bonds.
Bernanke made the move a week after China’s premier said he was "worried" about his US investments, and, as Brad Setser has graphed, the US was already having a harder time placing new debt issues. Besides, if China gets the money now it can fund its stimulus package more easily.

This is a good point, although I’m unclear on how exactly geopolitical considerations can make their way into FOMC meetings. I can’t recall seeing such things explicitly — and in fact when Argentina had its currency pegged to the dollar, the US would reiterate regularly that the Fed would not consider Argentine monetary considerations for one minute when setting monetary policy for what was effectively Argentina’s currency.

But obviously China is a lot more important than Argentina, and equally obviously Ben Bernanke spends a great deal of time talking to Tim Geithner — who was indeed himself a voting member of the FOMC until very recently.

My feeling is that these considerations made yesterday’s Fed move easier to take, but didn’t really drive it. Still, I’m sure the Chinese are smiling right now, and that has to be a good thing for Sino-American relations more generally.

Update: Brad Setser responds.

Reprinted from Portfolio.com

I’ve been rude about Gary Matsumoto’s conspiracy theories in the past, and now he has a doozy of a new one: the bankruptcy of Lehman Brothers had very little to do with its management or its insolvency, and everything to do with naked shorting. Gary Weiss is one journalist who’s convinced that naked shorting is not a problem: I had this IM interview with him this morning.

Felix Salmon: So Gary Matsumoto is out with 2,685 words of conspiracy-mongering on the subject of naked shorting and Lehman Brothers
Which I know is a subject dear to your heart

Gary Weiss: Yes, following stock market conspiracy theories is one of my favorite hobbies.

Felix Salmon: So, in a nutshell, what’s the problem with this one?

Gary Weiss: Well, let’s start with the lead paragraph. It says, "The biggest bankruptcy in history might have been avoided if Wall Street had been prevented from practicing one of its darkest arts."
My reaction was, "Is he serious?"

Felix Salmon: Well, is he?

Gary Weiss: Yes, that is what I find remarkable. He provides not a shred of evidence for his hypothesis, except for some warmed-over "fails" trade data that proves nothing, a quote from a former SEC chairman who has a vested interest in the subject, and he ignores little things like what Lehman Brothers didto cause its own demise.

Felix Salmon: Why does the failed-trade data prove nothing?

Gary Weiss: Fails to deliver can be caused by any number of factors, of which naked short selling is just one.

Felix Salmon: As for Lehman Brothers causing its own demise, well, yes, obvs. But if short-sellers hadn’t driven Lehman stock down to the level at which the bank had to declare bankruptcy over the course of a fraught weekend, might not the authorities in the US and UK have managed to cobble together some kind of rescue package allowing Lehman to be sold to Barclays or Nomura or both?

Gary Weiss: You’re talking about ordinary short selling driving down the price of Lehman stock. What he is talking about is fails to deliver, which is another issue entirely.
I agree that the unwise abolition of the uptick rule left open the possibility that shorting could drive down stocks.

Felix Salmon: Is there any real empirical data on what proportion of fails are due to naked shorting?

Gary Weiss: There is absolutely none. In fact, as the SEC enforcement division just pointed out, there are no studies indicating that naked shorting has any impact on the market whatsoever.

Felix Salmon: In that case, is there any evidence that the kind of things which cause fails (and aren’t naked shorting) spiked around the time of the Lehman bankruptcy?
Matsumoto has one theory on the spike in fails: that it’s due to naked shorting. Do you have an alternative explanation?

Gary Weiss: The problem with fails data is that you can’t comb out fails that are unrelated to naked shorting. Since most fails are caused by things that aren’t naked shorting, and since SEC Chairman Christopher Cox said that there was no significant naked shorting of bank stocks, including Lehman, I’d suggest that factors other than naked shorting were at work in causing the fails.
Actually Cox’s exact words were that there has been no "unbridled" naked shorting of financial issues.

Felix Salmon: Matsumoto nods to this:
"The Federal Reserve Bank of New York lists several reasons for fails-to-deliver in securities trading besides naked shorting. They include misunderstandings between traders over details of transactions; computer glitches; and chain reactions, in which one failure to settle prevents delivery in a second trade."
Still, it seems like it’s more than just coincidence that spikes in fails have coincided exactly with periods when the stock in question fell dramatically.

Gary Weiss: Then I guess Cox was lying. Seriously. I am no fan of the man, but if there was no "unbridled naked shorting" of financial issues, and if there actually was significant naked shorting of financial issues, than he should be strung up from the nearest lamp post.
I would suggest that he was not lying and that, as has been the pattern over the years when naked shorting is raised, it is a red herring.

Felix Salmon: But how would he know? And why can’t we see the same evidence that he’s seeing?

Gary Weiss: I would love to see the SEC release all the evidence that it has on naked shorting. As a matter of fact, I think they should drop everything else that they are doing, stop investing actual stock frauds and Ponzi schemes, and devote themselves entirely to disproving a conspiracy theory.
He would know, by the way, because all trades leave a paper trail, and if a fail to deliver is caused by naked shorting I would think it would be fairly easy to ascertain if that were happening.
And if it were happening, I am sure, given the pressure whipped up over this, that he would have been more than happy to say it was happening.

Felix Salmon: It is worth pointing out (a) that Cox’s statement about unbridled naked shorting came in July, before Lehman collapsed. But also (b) the SEC has given no indication that it thinks there was a problem with naked shorts in Lehman’s collapse.

Gary Weiss: Yeah, that too. Getting back to the Bloomberg story, that was omitted entirely from the article.
(Unless it was buried somewhere after the quote from the superb former SEC chairman Harvey Pitt.)

Felix Salmon: The article did quote Susanna Trimbath as saying this:
"Failed trades correlate with drops in share value — enough to account for 30 to 70 percent of the declines in Bear Stearns, Lehman and other stocks last year, Trimbath said."

Gary Weiss: It may also correlate with the tides and the phases of the moon. The question is, where is the evidence of naked shorting actually taking place? The conspiracists’ case depends entirely on statistical data related to a phenomenon ("failed" trades) that is almost always not naked shorting.
Where are the SEC enforcement actions?
Why did Cox say it wasn’t a factor?

Felix Salmon: So what would constitute evidence of naked shorting actually taking place? Are we wholly reliant on the SEC to be able to see it and prosecute it?

Gary Weiss: We know that statistical evidence of "fails" data is meaningless, so yes, we have to rely on actual enforcement actions by the SEC and SROs. Heaven knows, they are motivated to find such things happening.

Felix Salmon: But the only evidence we have that fails spikes are meaningless is that there’s no correlation between fails spikes and subsequent SEC actions
I mean, I’m sympathetic to what you’re saying, but it is 100% reliant on the SEC.

Gary Weiss: And the SROs. Here’s an analogous situation:
Occasionally there is statistical evidence of pre-announcement runups in volume and share prices before takeovers.
That is indicative of insider trading and, sure enough there are prosecutions and enforcement actions. It is something actually happening.
Here we have "spikes on charts" and consultants to parties engaged in litigation against alleged named shorters (Ms. Trimbath) finding "correlations" and we have absolutely no regulatory actions whatsoever.
Either the SEC and the SROs are corrupted, as the conspiracists suggest, or it ain’t happening.

Felix Salmon: Still, if your argument that naked shorting isn’t a problem is entirely reliant on (lack of) SEC activity on this front, then it seems hard for you to attack the SEC itself for releasing a report taking the issue seriously. Aren’t they, by your lights, the exact institution which has to take such allegations seriously?

Gary Weiss: Absolutely not. If organized pressure groups and astroturf organizations are demanding disproportionate, unnecessary deployment of scarce SEC resources, the SEC has an obligation to reject those demands, and not pander to them.

Felix Salmon: What’s more, we’re in a bear market, and it can at times be hard to find a borrow (see eg Citigroup right now) and the temptation to engage in naked shorting must be high. You’d think that at the very least the SEC would have found some small-scale idiots who gave it a try.

Gary Weiss: As happens in all bear markets, there is historically enormous public and political pressure to target people profiting from share price declines.
That happened during the Great Depression, and it is happening now. That results in some good regulatory initiatives, such as the uptick rule, and it results in wastes of time, such as pandering to the naked shorting conspiracy theorists.
Remember: the SEC is often incompetent. I wrote a book in which that was one of the main themes. However, when it is reacting to a public problem, the SEC has the capacity to actually find things happening.
Here we have a campaign that has gone on for some years, backed by "statistical data" to "prove" that a problem called "naked shorting" exists. And the result: zip. Nothing.
My question is: when is the SEC going to have the guts to say, "Enough. It is not happening. We are not going to waste any more time on this."

Felix Salmon: So maybe we can agree about this:
The best-case scenario here is that the SEC should come out and say definitively that in the Bear and Lehman cases, there was no naked shorting going on.
It should make the data public, and explain how it came to that conclusion.
And if that’s convincing, then I think allegations of naked shorting elsewhere will dry up.

Gary Weiss: Yes. In my last Portfolio piece on Madoff, I took the idea one step further and suggested that a 9/11 style commission should investigate the entire financial crisis. That should include naked shorting. The only way to combat conspiracy theories of any kind is with facts–not that it matters to the conspiracists, who will always be with us.

Felix Salmon: But maybe they won’t get the opportunity to write long articles for Bloomberg.

Gary Weiss: There will always be conspiracists and there will always be bad journalism.

Reprinted from Portfolio.com

There’s a lot of noise this morning on the Citi preferred/common arbitrage, with the WSJ giving an overview and Tyler Durden going into the gory details. And just in case you’re not completely confused yet, Citi has now announced a reverse stock split to go along with its preferred-common exchange.

Given the tendency of bank stocks to go towards zero on a nominal basis, I’m not sure this is a good idea, but at least it should get Citi out of the embarrassing situation of risking its stock trading at less than a buck a share. When stocks trade that low, weird things happen: Bill Ackman, for instance, is buying up large chunks of General Growth stock in the expectation that it will declare bankruptcy.

One of the weird things which happens when nominal stock prices are very low is that volatility goes through the roof, and percentage changes in the stock price can be enormous. Ultimately, that’s what’s happening at Citi, I think: it has been trading at zero for the past couple of months now, and it’s silly to (a) try to infer anything meaningful from stock fluctuations around zero; or (b) think that trading Citi common is anything other than a pure gamble. This is a penny stock now, let’s not obsess about its price too much.

As far as policymakers are concerned, the important price is not that of the common stock, but rather that of the senior and junior debt. Yields on senior debt, remember, are the rate at which banks fund themselves wholesale — at least in normal times. If healthy banks are in the national interest — and they are — then it’s in the national interest for the yields on that debt to come down substantially.

But then you get into the senior/junior arb. There’s an obstacle to senior bank debt yields coming down, and that’s the fact that junior bank debt yields — the yields on preferred stock — are stratospheric:

A Merrill Lynch & Co. index of European banks’ lowest-rated debt has collapsed this year, with its market value sliding 50 percent to 19.7 billion euros, on concern lenders may be nationalized and junior bondholders wiped out. In the U.S., a similar index has declined 42 percent by value in the period.

Deutsche Bank’s Jim Reid thinks that the way of solving this problem is for governments to wade in to the market and start buying up preferred stock (junior debt). The idea has something to be said for it: Treasury, for one, is sitting on hundreds of billions of dollars of freshly-issued preferred stock already, so it’s clearly comfortable taking that kind of risk.

Buying up preferred stock would be a clear indication from any government that nationalization is not an option, or at least that it’s willing to lose quite a lot of money up front if it does end up deciding to nationalize. (Any sensible nationalization plan involves recapitalizing the banks, which in turn involves wiping out the common equity holders and most of the preferred stockholders as well.)

But there might be other ways of making investors more comfortable with senior bank debt. I got an email this morning from a reader saying that "the existence of governments liable to nationalize banks for systemic reasons has itself created a major hazard for investors"; I’m not sure that’s true. It might be a hazard for investors in common equity, but there’s no way that banks are going to be able to raise new equity in this market anyway. And it might be a hazard for investors in junior debt, but investors in junior debt have historically been a very small and select group. As far as investors in senior debt is concerned, the possibility of nationalization, at the margin, makes the debt safer, not riskier: the government is essentially the last resort now, as opposed to liquidation — which would hit senior debt hard.

So maybe the government might start making public the nationalization schemes which we know they’re thinking about in private. Naming no names, it could make it clear that none of the schemes involve imposing a haircut on senior debt holders. And it could also make it clear that it will always nationalize a big bank rather than allow it to fail. Maybe that alone could help support the very important wholesale funding cost for banks.

Reprinted from Portfolio.com

Buffett Is Unusually Silent on Rating Agencies: Why the Sage of Omaha should tackle ratings-agency reform.

Free Money? Another arbitrage, if only you can find the borrow.

Correction: Chinese coal mine deaths: James Fallows on the murk that is Chinese statistics. "The government has committed itself to a growth rate of at least 8 per cent this year. Whatever else happens, it is safe to assume that at year’s end the reported growth rate will be about 8 per cent."

And finally, Sesame Street explains the Bernie Madoff scandal:

Reprinted from Portfolio.com

Dan Golden profiles David Swensen for Portfolio magazine:

On the other hand, Swensen points out, he’s still beating the stock market, which has slid by an even greater amount. When critics deride the performance of alternative investments, “they aren’t asking, ‘Relative to what?’ Hedge fund returns are negative. That’s very disappointing, but they’re still far superior to equity returns,” he insists, spinning the numbers like a campaign manager.

Is this just spin, or is there something to it? The fact is, as Dan told me, that it really doesn’t make sense to compare Swensen’s returns to a hypothetical endowment invested wholly in the stock market — because his big idea of picking up illiquidity premiums by investing permanent capital in highly-illiquid investments has been pretty much universally adopted by endowments at this point.

And besides, endowments were never invested 100% in equities, even long before Swensen arrived on the scene.

As Aaron Pressman points out, Swensen’s investment advice when it comes to retail investing hasn’t done so well of late:

If you take a simple mix of exchange-traded funds, allocate per Swensen’s book and look at the results over the past year, the bottom line is pretty ugly: -32%. That beats the S&P 500, but it’s much worse than a simple mix of say 70% U.S. stocks and 30% bonds, which lost only 25%. A 60/40 mix dropped 19%.
And a year-end rebalancing wouldn’t have helped — at least not yet. If you set Swensen’s allocations up at the beginning of 2008 (and lost 23%) and then rebalanced at the beginning of 2009, you’d be down 17% so far this year. But if you let your winners ride, so to speak, and went with the portfolio as it stood, you’d only be down 12%.

Swensen does seem to be a very good portfolio manager when it comes to managing his own billions. Whether or not he’s a good person to listen to when it comes to investment advice, however, is another matter entirely. If your name isn’t David Swensen, there’s very little chance that the Swensen technique will do as well for you as it does for him.

Reprinted from Portfolio.com

David Leonhardt wants to hike taxes on the very highest earners:

Today’s tax code makes no distinction between income above $373,000 and income above, say, $5 million. Both are taxed at 35 percent.
That is a legacy of the tax changes of the early 1990s, when far less of the nation’s income went to millionaires. Today, you can make a good argument for a new, higher tax bracket on the very largest incomes. In the past, the economist Thomas Piketty says, higher marginal tax rates tended to hold down salaries and bonuses, because executives had less incentive to angle for multimillion-dollar pay.
Do these ideas stem in part from anger and bitterness? Of course they do. How can you not be a little angry and bitter about the role that huge, unjustified pay played in causing the worst recession in a generation?
In fact, that’s sort of the point. Given the damage that’s been caused by our decidedly unmeritocratic system of paying executives, the most irrational course of all would be the status quo.

Creating a new tax bracket for people making more than $5 million a year wouldn’t raise a huge amount of money for the government, but that’s not the point — just as the reason that people like me want to claw back bonuses from AIG has nothing to do with recouping any significant portion of the money that the government has poured into the insurer.

The point is that incentives matter, and that if you skew people’s incentives with horribly-designed winner-takes-all pay structures, you’re liable to get extremely nasty consequences.

I’m reminded of Dan Ariely’s TED talk on cheating: if you create an atmosphere where large sums of money start to lose all meaning, people are going to cheat more. And when pay soars past the $5 million-a-year mark, it no longer has any connection to expenditures: it’s just a race, really, to see who can make the most money.

One person infected by such a mindset is Evan Newmark, who’s nicely stilettoed by Ryan Chittum:

Think about your own behavior in the giddy pre-Crash years. Did you bully a raise from your boss when one of your colleagues left? Did you buy a little condo in Miami to cash in on the boom? Did you throw more money into brokerage stocks as they rose higher and higher?

Well, outside the bubble the answers for 99 percent of us are : No, no, and no.

Is it the job of fiscal policy to create a tax regime which mitigates against the formation of devastating bubbles? I don’t see why not; it might even fit in with the behavioral-economics bent of the Obama team. But still, I doubt this is going to happen: it’s quite un-American. Many people work very hard, in this country, because they dream of one day pulling down a spectacular seven-or eight-figure income. Does Obama really want to kill that highly-motivating dream?

Reprinted from Portfolio.com

The Investment Company Institute, the mutual-fund industry group, today released a massive 228-page report on what has happened to the money markets over the course of this crisis and how they should change in future. There are lots of recommendations, most of which make perfect sense to me. But I’m particularly interested in Section 6 of the report, which gives a very detailed 22-page history of what exactly happened to the money-market industry in September 2008.

If you recall, according to the Kanjorski meme (both Mark 1 and Mark 2), there was significant direct intervention by Hank Paulson in the week of September 15 to prevent hundreds of billions of dollars of redemptions from money-market funds. But there’s no hint of any such intervention in the ICI report.

The report gives great credit to the government actions which did take place that month: bailing out AIG, implementing the Asset-Backed Commercial Paper Money Market Mutual Fund Liquidity Facility and the Commercial Paper Funding Facility, and announcing the Temporary Guarantee Program for money market funds. Concludes the report:

The U.S. government’s programs were highly successful in shoring up confidence in the money market and money market funds. Immediately following the difficulties of Primary Fund, assets in institutional share classes of prime money market funds dropped sharply as institutional investors, seeking the safest, most liquid investments, moved into institutional share classes of Treasury and government-only money market funds and bank deposits. Within a few days of the announcements on September 19 of the Treasury Guarantee Program and the Federal Reserve’s AMLF program, however, outflows from institutional share classes of prime money market funds slowed dramatically. Indeed, by mid-October, the assets of prime money market funds began to grow and continued to do so into 2009, indicating a return of confidence by institutional investors in these funds.

There’s nothing here about personal intervention by Paulson — and indeed everybody I’ve spoken to who knows about the workings of the money-market fund industry says that it’s basically impossible that Paulson could have even gotten the information about the redemptions before they occurred, let alone phoned anybody up and persuaded them to change their mind.

The ICI report is at this point the definitive history of what happened to money-market funds in September 2008; if it says nothing about phone calls from Treasury to prevent a meltdown, I’m inclined to conclude that such phone calls never happened. It’s pretty much impossible to prove a negative, and I’m still interested in learning where Robert O’Quinn, the author of the House Economic Committee report making the assertion, got his information. But for the time being I think we can lay the Kanjorski Meme to rest.

Reprinted from Portfolio.com

Andrew Ross Sorkin used his column yesterday to push "the sanctity of contracts" in general — and of AIG guaranteed-bonus contracts in particular. Lawyers, in general, were not impressed. John Carney responded quickly:

I don’t see anything about voiding the contracts on the grounds of public policy as violating the sanctity of contracts.

And now Anna Gelpern gives chapter and verse:

Enforcing contracts where private parties have no money means either suffering default and firm failure, or using public funds to pay up on the parties’ behalf. The alternative is using government power to rewrite the contracts.
There is no doubt that the U.S. Congress has such power aplenty. In an article coming out in the Southern California Law Review, Adam Levitin and I examine Supreme Court jurisprudence assessing the veritable extravaganza of contract rewriting in the New Deal. In opinions spanning over two decades, the Court was unequivocal: the government’s power to regulate the economy, not just to manage economic emergency, trumps private contracts.

It’s pretty obvious that in the midst of a financial crisis, there are lots of things more important than the sanctity of contracts entered into by a company which, were it not for hundreds of billions of dollars of government cash, would by now not only be in liquidation, but which might well have dragged a large part of the global financial system down with it. To put it bluntly, those contracts ain’t worth shit.

But even then l like the idea of simply applying a surtax to the bonus payments rather than abrogating the contracts. If there’s a way of clawing back the bonuses which doesn’t involve abrogating contracts, then why not use it?

Reprinted from Portfolio.com

Should Yuppies Take Food Stamps?

Andrew Ross Sorkin: We Have To Pay The AIG Bonuses: Carney disagrees.

Betting your views, follow-up: The main reason not to bet your views, I think, is that in doing so you artificially exaggerate the overconfidence bias that all of us are already prone to.

Reprinted from Portfolio.com

Serena Ng has the non-story of the day, but given the general brouhaha surrounding AIG, you can be sure that all manner of noise will surround it. AIG was a net seller of credit protection on mortgages; it lost a lot of money. Credit default swaps are a zero-sum game, so that means the net buyers of credit protection on mortgages made a lot of money. Among those buyers of credit protection were hedge fund mangers like Steve Eisman, who was famously profiled by Michael Lewis.

Follow the string far enough, then, and you can quite easily manage to justify a headline like "Hedge Funds May Get AIG Cash". But the crazy thing is that the hedge funds didn’t even buy their protection off AIG. They bought it from a special-purpose vehicle as part of a deal to create synthetic CDOs; AIG was then brought in to insure the most senior parts of the structure. The connections here are tenuous, and boring. But of course that won’t stop the pro-forma expressions of outrage.

Reprinted from Portfolio.com

From an IM conversation between me and Jesse Eisinger, in the wake of my post earlier today:

Jesse Eisinger: Of course a cause of the financial meltdown is the CDS market. Just because it didn’t START there and that there are OTHER causes doesn’t mean the CDS market functioned fine and didn’t fail. Of course it failed. Miserably. And if the government didn’t have its head up its ass, it would have given all those wildly irresponsible AIG counterparties a massive haircut.

Felix Salmon: The CDS market failed (only) insofar as triple-A monolines wrote more protection than they were able to cover — AIG being by far the most egregious offender in this respect. The US government stepped in to backstop the insurance that AIG wrote, and as a result there were no further systemic consequences of AIG’s irresponsibility.
What’s more, AIG’s CDS contracts were generally large bespoke deals with commercial banks; they didn’t conform to ISDA documentation and were pretty much outside what most of us considered to be the two-way CDS "market". That market didn’t fail at all. In any case, I fail to see how the CDS market — even broadly understood to include AIG — was in any way responsible for the financial meltdown. Maybe it would have been, had AIG not been bailed out. But AIG was bailed out, so it wasn’t.

I have a copy of Gillian Tett’s new book in galleys; I’m reading it right now, and I’ll have more on this subject when I’m done. Tett and Eisinger are both smart and astute journalists who are convinced that the CDS market really did cause a large part of the financial and economic crisis that we find ourselves in today. I can half see it: is it that the existence of the CDS market gave banks false confidence that they could lay off credit risk in huge quantities, even while nominally keeping hundreds of billions of dollars worth of assets on their books? But I’m not fully convinced. More anon.

Reprinted from Portfolio.com

Alea finds a speech from the governor of the Trinidadian central bank, which reveals that the country’s largest financial-services company, Clico, had assets of $24 billion but that local regulators required it hold just $3 million in capital. "This is what I call real leverage," notes Alea, drily: "8000/1".

Shortly after the Stanford scandal broke, I had brunch with a Trinidadian friend who was worried that just about all of Trinidad’s banks were offering CDs paying suspiciously high rates of interest — not just in local currency, but in pounds and US dollars too.

After taking a quick look at what was going on, I reckoned that Trinidad’s financial institutions, while they might have been unwise, were not criminal Ponzi schemes: the rates of interest they were paying, while high, weren’t substantially higher than the Trinidadian government’s own cost of funds. A Trinidadian depositor is naturally taking sovereign risk, and is being compensated for the fact that risk is high.

In general, it has never been riskier to have your deposits in a small country with its own currency — just look what happened to Iceland. When the currency is pegged to the dollar or the euro (eg Trinidad or Latvia) you’re not much safer: as we saw during the Asian crisis and in Argentina, currency pegs tend to disappear overnight in times of crisis.

It’s also worth noting that most of Citibank’s deposits are held in its foreign branches, are not insured by the FDIC, and are subject to the sovereign risk of the country where they’re deposited. Those depositors aren’t just taking Citibank risk: they’re taking increasingly-perilous country risk on top. If they decide to move their money somewhere safer, that could be a serious liquidity problem for Citi. It has built up a global franchise by being seen as something of a safe haven in small countries. As that reputation wanes, the value of its franchise likely wanes with it.

Reprinted from Portfolio.com

Chuck Schumer wants to tax "virtually all" of the bonuses being paid to AIG employees. The surtax being proposed by Gary Peters is 60%; presumably that comes on top of the regular federal income tax. But why stop there? If you set the surtax at, say, 150% of all bonus payments, then that would pretty much guarantee that the recipients would decline to receive them. Seems like an elegant solution to me.

Reprinted from Portfolio.com