Felix Salmon

The New York Lottery Turns Evil

Reuters Staff
Mar 21, 2009 00:59 UTC

I’ve been contrarian about lottery tickets in the past: I’ve said that buying them can be rational, and they can even be a sensible investment. So I’m not sure why this ad I saw today made me so very angry:


Of course if anything can unstimulate the economy, it’s lotteries. In times of financial and economic crisis, the state should be doing good things on the financial empowerment front, not spending taxpayers’ dollars on ad campaigns pushing a highly regressive tax on poverty. And if you are going to pay for an ad campaign, then at the very least don’t try to dress lottery tickets up as some kind of economic stimulus. It’s disingenuous in the most harmful way I can imagine.

Reprinted from Portfolio.com

Save the Credit Unions!

Reuters Staff
Mar 20, 2009 19:41 UTC

The good news is that the two largest corporate credit unions — cesspits of toxic waste which loaded up on mortgage-backed securities for no good reason and in violation of their raison d’etre — have been "conserved" (taken over) by the NCUA, the credit-union equivalent of the FDIC, which has finally woken up to the fact that the current management at these shops is utterly incompetent and can’t be trusted.

The bad news is that the NCUA is still committed to the disastrous decision it made back in January, to whack 56 basis points off the net worth of every federal credit union in the country, as well as reducing those credit unions’ return on assets by 62 basis points, in an attempt to bail out these selfsame untrustworthy corporates.

NCUA believes that the actions to conserve the two corporates, in tandem with established plans to enhance liquidity and generally stabilize the corporate network, represent the most cost effective and prudent alternative available to the credit union industry.

Today’s decision is proof, if proof were needed (and frankly it wasn’t) that the old plans — which essentially involve member-owned and well-run retail credit unions being forced to bail out a bunch of sharks and gamblers — were not only misguided but also woefully insufficient. I’m particularly mindful here of the small community development credit unions like the one I live next door to and sit on the board of, LES People’s.

We were always extremely assiduous in our loan underwriting, our asset quality is very high despite the fact that our membership has very low credit ratings, and our operating income has never been higher. Yet this proposal from the NCUA would force us to expend extremely precious and hard-fought-for capital in order to bail out the wastrels at the likes of WesCorp. At a stroke, it manages to redistribute capital from the people who really need it — the poor members of local-community credit unions — to faceless financial institutions which were lying to their regulator about their solvency all along.

Here are the facts about community development credit unions (CDCUs), and how they’ll be affected by the proposed bailout:

Last year, CDCUs nationally posted approximately $12.75 million in net income. Assuming all factors remain equal, a mandatory investment of 62 basis points translates into $28 million and would represent a net loss for CDCUs of $15.3 million in 2009, wiping out the modest gains made this year. The fallout from the economic downturn, coupled with the lack of capital, will result in a rapid reduction in community wealth, and for CDCUs, a crippling loss in earnings. We fear these challenges could permanently shutter dozens of CDCUs nationally.

Remember that all things are not going to remain equal: banks in general are suffering from rising delinquencies, and credit unions are no different. But after they’ve carefully built up capital cushions to protect themselves from exactly such an eventuality, it’s unconscionable for their regulator to then turn around and remove that capital cushion just when they need it, saying that a bunch of speculators with more money than sense managed to gamble it away in the RMBS markets.

The big question in Washington these days is simple: "How can we get banks lending again?". Any sensible answer to that question must involve credit unions, which have proved themselves to be extremely responsible lenders. We should be bolstering their capital right now, rather than confiscating it.

Now that the NCUA has woken up and realized that the corporate credit unions are beyond redemption, its board must rescind its extremely harmful decision to ask the real, consumer-facing credit unions to bail them out. At the very least, come up with some way of recapitalizing the small but vital credit unions which will be worst hit by this misguided policy. It’s a nasty world out there, but they can be a hugely important force for good. If only you’ll let them.

Reprinted from Portfolio.com

Replacing Geithner

Reuters Staff
Mar 20, 2009 08:15 UTC

David Reilly is the latest columnist to weigh in with Geithner-resignation speculation; he alights on Jamie Dimon as the next Treasury secretary. And he’s right when it comes to both Dimon’s biggest strength and his biggest weakness:

On a personal level, Dimon has a sense of self-assurance that Geithner lacks…
Whereas Geithner often looks uncomfortable in the spotlight, Dimon basks in it…
Dimon is also a banker and may not have the stomach to force upon his former industry some of the tougher medicine that may still prove necessary. Given the populist mood in Washington, a Wall Street banker, no matter how respected, may not be the ideal candidate.

Yes, it would be great if Geithner had more self-assurance — both Rubin’s aura of quiet mastery and Paulson’s authoritarian decisiveness work better in a key political leader than Geithner’s slightly dweeby earnestness. But then again, both Rubin and Paulson learned their leadership skills from being in charge of the most insightful and ambitious group of professionals on the planet. That might have served them well in terms of projecting competence and charisma, but at this point "I used to run a major bank" is a disqualification for the job of Treasury secretary, not a prerequisite.

I don’t think that Reilly — or most people connected to Wall Street, for that matter — really understand the national depth of anger at the financial system — the driver of the current spat over AIG bonuses. With unemployment at 8.1%, underemployment (U6) at 14.8%, and a similar number of Americans underwater on their mortgages, no one is any longer buying the idea that only the people who were paid hundreds of millions of dollars getting us into this mess are qualified to get us out of it.

Americans may or may not be right on this front. But if you played a key role in screwing up the economy, your reward should not be to run it. Dimon was by no means the worst offender on that front, but he certainly never complained about the paychecks which flowed into his pocket from the greatest financial boom of all time.

Let’s keep Dimon where he is, at JP Morgan: he seems to run the place well. And for that matter, let’s keep Geithner where he is, too: we need fewer jobs needing filling at Treasury, not more. But do keep a close eye on the eventual nominee for deputy Treasury secretary. My guess is that person — whoever it ends up being — has a very good chance indeed of taking over before Obama’s first term is up.

Reprinted from Portfolio.com

Extra Credit, Thursday Edition

Reuters Staff
Mar 19, 2009 22:56 UTC

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

Are the Ranks of the Underbanked Swelling?

Reuters Staff
Mar 19, 2009 22:56 UTC

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

The Fed Bails Out China

Reuters Staff
Mar 19, 2009 15:25 UTC

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

Naked Shorting: An IM Exchange

Reuters Staff
Mar 19, 2009 11:11 UTC

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

Further Adventures in the Citi Capital Structure

Reuters Staff
Mar 19, 2009 08:46 UTC

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

Extra Credit, Wednesday Edition

Reuters Staff
Mar 18, 2009 22:48 UTC

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