Fiji water’s invite-mockery marketing strategy: Justin Fox on the age-old question of how and why Fiji Water exists as a product. I have another question, though: why is domestic sparkling water so hard to find?
If you’re confused by the scandal surrounding the Ponta Negra hedge fund and its Biden landlords, don’t blame yourself: it’s really confusing stuff. If you have the patience for it, just read John Hempton’s archives: start here, and then run through this, this, this, this, and this. (Don’t worry, there’s more to come, but we’re up to something over 6,000 words already.) Alternatively, Alphaville is running its own series, of which the first two parts are now up: 1,700 words on 650 Fifth Avenue, and 1,250 words on the Biden connection. The Alphaville posts are quite hard to follow, partly because the FT lawyers have stripped them of links, and partly because this whole thing is just very opaque and complex.
The one thing which is abundantly clear is that Jeffry Schneider (always mistrust people who can’t spell their own name) is a very shady character indeed, who was fired from various financial-sector jobs before ending up selling fraudulent hedge funds and seemingly working out of the Bidens’ hedge-fund hotel. Schneider was a “marketer” for hedge funds, including Ponta Negra — which means he sold them to rich individuals, and took a commission for so doing. How did he find the rich individuals? Lots of ways, but one was that he paid upwards of $10,000 a month for access to lists of people who were rich enough to qualify as hedge-fund investors.
This is the bucket-shop end of the hedge-fund world: small and sleazy and shadowy. But here’s the thing: if you’re a rich individual who’s phoned up by Jeffry Schneider and told about some fabulous new hedge fund you should put lots of money into, he has a pretty good explanation for why it’s so difficult to get any information on him and his company: under the laws banning the advertising of hedge funds, he’s not allowed to give out much in the way of information.
As part of the forthcoming regulation of hedge funds I think there should be a lot of efforts to make them more transparent, rather than allowing them to use SEC regulations to justify their opacity. At the moment, simply giving out information about certain investments is considered to be advertising: I used to run into this problem the whole time when I was in New York, covering 144a bond issues which could only be sold to big institutional investors, and being told that therefore I couldn’t get any information on them. We need to move instead to a world where information is allowed to be free, even if the public at large still isn’t allowed to invest in the funds or securities in question.
Once we get there, it should become much easier for bloggers to uncover Ponzis — which is certainly a good thing. Hempton has a big advantage in that he’s part of that world himself, and has access to information which isn’t freely available online. Why can’t we all have that access?
The fact is that Citigroup is no longer in a position to pay hedge-fund-like bonuses for hedge-fund-like behavior. Here’s part of Barack Obama’s interview with David Leonhardt:
That doesn’t mean that, for example, an insurance company like A.I.G. grafting a hedge fund on top of it is something that is optimal. Even with the best regulators, if you start having so much differentiation of functions and products within a single company, a single institution, a conglomerate, essentially, things could potentially slip through the cracks… I think you can make an argument that there may be a breaking point in which functions are so different that you don’t want a single company doing everything.
What’s true of AIG is true of Citigroup: you don’t want to graft a hedge fund on top of it, even when the hedge fund is called Phibro and has been consistently profitable for 15 years.
A year ago, I said that Citi should just leave Phibro alone. But we’ve passed that point now, and Citi should let Andrew Hall and his extravagantly-remunerated energy traders do what they’ve been threatening to do, and just leave. All good things must come to an end, and Citi should just be happy that it’s managed to make so much money out of Phibro over the years without it blowing up.
Besides, Hall owns a castle, which means the optics are insurmountable. Jessica Pressler nails it:
Let him go. Spin off the unit, sell it to Japan, hire a monkey to trade oil futures at Citi. Anything to spare us from the histrionics that are sure to ensue once cable news finds out about the castle.
Citigroup should be trying very hard to become a very boring bank which can’t blow up. Phibro has no place in such an institution, and it’s undoubtedly a non-core asset. So I hope that Geithner tells Pandit that, no, he unambigously can’t continue to pay Hall his nine-figure bonuses. Those days are over.
There’s a great discussion going on in the comments of my financial literacy post about the question which 93% of Americans got “wrong”: what’s better, paying off a $1,000 appliance at $100 a month for 12 months, or waiting a year and then paying off a $1,200 lump sum?
The “right” answer is that the lump sum option is better, since it carries a much lower effective APR, but my point of view is that in the real world someone choosing the second option isn’t going to diligently put $100 a month into an interest-bearing savings account and thereby make a bit of extra money, and instead is just going to wind up owing $1,200 in a year’s time — basically just kicking the “how do I pay for this appliance” problem down the road, and making it $200 worse.
Dsquared asks if my view isn’t “just a leetle bit patronising” and accuses me of basically saying this:
I myself would of course choose option B, but as for the poor little feckless working class, they’re not really to be trusted with money, so they’d better go for option A.
But that’s not what I’m saying at all. The point is that there’s a hidden assumption here: that option C — which is simply writing a check for $1,000 — isn’t on the table, and that the purchaser doesn’t have $1,000 to pay for an appliance. So no, I myself would not choose option B, since I would choose option C and just pay for the thing.
On the other hand, Dsquared makes the very good point that a bit of empirical evidence would be very useful here, and that having this debate in the theoretical stratosphere really helps no one:
Is there actual evidence that people who own a load of stuff on installment credit have better financial outcomes than people who have a bunch of debt?
I don’t know whether there’s evidence to that effect, but I would love to see what the evidence is, and I have to say that my intuition is that, yes, people on installment credit do have better financial outcomes than people with a lot of undifferentiated lump-sum debt. But I might be wrong.
I also got a great email from Mike, of Rortybomb fame, who points out that this question is applicable not only to the poor but also to (a certain subset of) the rich:
Keeping the logic the other way: Let’s say instead of paying, you could get paid at your job $100 a month for 12 months, or get paid $1500 at the end of the year, and the interest rate is 1% a month. Option 1 is a net present value of ~$1125. Option 2, the one time payment, is a NPV of ~$1330. (ii) is the correct answer, it is worth more.
Unless your company goes bankrupt in month 11. (ii) is also the payment all the Wall Street kids took with their ‘no payments except for the yearly bonus’ option. And we wonder why they whine about not getting bonuses – time-value told them that was the smartest choice, way smarter than getting smaller payments throughout the year! How much better off would economics/finance be if they realized that people’s value of security and consistency wasn’t a defect of their puny minds not being able to handle utility theory?
More generally, the whole credit bubble was, in effect, what happened when the world started paying huge amounts of money today for jam tomorrow. Anybody choosing the $1,200 lump-sum repayment is basically making a bet that even though they can’t afford $1,000 today, they’ll be able to afford to pay $1,200 in a year’s time. But the fact is that people who can’t afford $1,000 today generally can’t afford $1,200 one year later, which means that most people taking that option are in a sense deluding themselves. Just as bankers deluded themselves that their year-end bonuses were money in the bank.
It’s surely a good thing that Chrysler is filing for bankruptcy: trying to get unanimous consent for a restructuring from dozens of stakeholders — especially small bondholders — was never going to happen on a foreshortened timetable, and it’s going to be much easier for Chrysler to get out of onerous obligations to dealers when a bankrupcy judge orders it. At the same time, the downside of bankruptcy — the fact that the public will be increasingly unsure about the company’s future — is here already; it’s unlikely to get worse, especially so long as Barack Obama makes it very clear that he’s committed to Chrysler’s continued existence as a going concern.
The broad outlines of a deal are already clear: Fiat will take a 35% stake in the company and manage it; the UAW will have a 55% stake; and all the government’s TARP funds will be converted into a 10% stake. Present-day creditors do not get equity but rather get cash; the sticking point is exactly how much cash they will get. And of course present-day shareholders — Cerberus and Daimler — are wiped out, and top management will be replaced.
All of this is necessary but not sufficient for Chrysler to have any hope of a long-term future. One of the more interesting things going forward will be how Chrysler manages to turn itself into a smaller, nimbler, change-oriented company while being majority owned by the UAW — which is nobody’s idea of a change agent. In general, if you need a dose of creative destruction, big unions are not the place to look.
On the other hand, it’s not as though anybody else has been able to manage Chrysler any better, and now, by definition, workers’ interests are aligned with the owners’ interests, just because the workers are the owners. Given how everything up to now has failed, this structure is at the very least worth a try.
As for the smaller creditors who stood in the way of a deal which would have avoided bankruptcy, I have very little time for their plaints. They’re offering nothing which will help Chrysler in the future: they just want to get the maximum return on selling the bonds they picked up for pennies on the dollar. I hope and trust that the bankruptcy judge will give them short shrift.
According to Francesco Guerrera, Citi is pushing back against the idea that rising unemployment is going to mean large credit losses on its credit cards:
People close to the situation said both Citi and BofA were contesting some of the conclusions made in the stress tests. Citi executives, led by finance chief Ned Kelly, are believed to have told regulators the estimates for losses on credit cards – based on rising unemployment – are too high.
Which is not the impression you get from listening to David Simon of Citigroup’s credit card unit, who popped up at the Milken Global Conference on Wednesday to say this:
As people have read in the newspapers, credit losses are at somewhat of an all-time high, and they go tracking directly with unemployment. So as unemployment goes, so go credit card payments. And since this is all based on statistical models, you don’t have the opportunity to look a person in the eye and say “let me help you”.
(Video here, it’s at about the 35-minute mark.)
I think this might count as a “gaffe”, under Mike Kinsley’s famous definition of a gaffe being when someone accidentally tells the truth. Or maybe Simon hasn’t been talking to his brand-new CFO recently. Or maybe Citigroup really thinks it can persuade Treasury that its statistical models are particularly reliable. Which is an argument I’d love to be a fly on the wall to see.
Banks Juice Profits, Fantasize About Loan Quality: By lowballing loan-loss reserves, banks can squeeze out substantial profits ahead of a stress test.
Quote of the Day: The amount of information needed to understand fully a CDO-squared. But actually that’s kinda the point, people were counting on the law of large numbers to help them out. Unfortunately, this particular large number was an exception to the rule.
Simon Johnson has a close reading of Larry Summers’s speech on the crisis, and notes what is conspicuous by its absence:
There was not even an indirect mention of political economy. Summers’ public narrative for the crisis is essentially that there was an accident: stuff happens. This narrative matters.
Johnson puts this in a context of asking Summers for a mechanism to avoid regulatory capture in the future — which is certainly important. But there’s another reason why it’s important for Summers to admit that government policies were part of the cause of the crisis: we’ve had virtually nothing in the way of apologies for screwing up the global economy, and it would do us all a lot of good if people who both caused and benefitted from the financial-services boom would man up and admit to their mistakes.
Top of the list, just by dint of his present importance in the government, is Larry Summers. In his tenure as a senior Treasury official during the Clinton years, Summers was intimately involved in laying the regulatory and philosophical foundations for the bubble. Johnson, who’s been following Summers’s thinking for some time, says that it has evolved in interesting ways, especially as regards the over-reliance on the financial sector for economic growth in the 1990s. It’s not a giant leap from that evolution to a simple admission from Summers that he made mistakes at the time. Except there’s the whole problem of Larry’s massive ego, which makes it hard for him to ever admit being wrong.
Of course, Summers isn’t the only person who should be apologizing: I very much look forward to reading or watching something similar from Bob Rubin, who managed to compound his errors at Treasury with further massive blunders at Citigroup. And the list goes on. Greenspan would be nice, but he’s already admitted being wrong on some fronts, and has at least engaged substantively with his critics on most others. Ken Lewis and Stan O’Neal and Sandy Weill and Dick Fuld, of course. Phil Gramm, absolutely. But let’s start with Summers, since he’s the one name on the list who’s still actively involved in making incredibly important decisions which affect the future of the country. And if he can’t admit to making mistakes, how can he learn from them?
Justin Fox has a great post up on models of regulation, linking a comment from Gary Becker (“When you give a lot of discretion to regulators, they don’t use the tools that are given to them”) to a theory from Matt Yglesias that when it comes to regulation, it’s important not to try to be particularly clever or sophisticated. Where there’s a serious systemic risk, says Yglesias, we should “lean in with a heavy hand”: a satisficing solution which makes no bones about the fact that it’s suboptimal, but which is based on the insight that when you’re pushing the envelope of optimality, a regulatory oversight or mistake can be vastly more damaging than when you have crude and simple rules in place.
In the perennial debate between rules-based and principles-based regulation, this is an argument in favor of the former, while I’m generally in favor of the latter. But Becker’s right: principles means discretion, and discretion means danger.
What I would do, then, is implement a largely discretionary principles-based approach to bank regulation, but pair it with one or two heavy-handed rules: a cap of $300 billion on total assets, say, along with increasingly stringent tier-1 capital requirements the larger a bank gets, based very simply on total assets rather than on clever Basel II risk weightings. The weight of avoiding huge systemic risks would then be borne largely by the big, dumb rules, leaving the rest of the regulatory function to deal with smaller-scale issues on a more flexible, case-by-case, and intelligent basis. Sure, there would still be the risk of regulators getting things wrong or being blinded by science, but the downside would be much smaller.
David Leonhardt seems to be on roughly the same page as me when it comes to debt-for-equity swaps at America’s banks:
In February, the Treasury began twisting the arms of some holders of Citigroup preferred stock to get them to convert it into common stock. (Preferred stock, despite its name, is something between a loan and stock.) The credit markets hiccupped, but quickly returned to their previous state. In the wake of the stress tests, the Fed and the administration may well push for more conversions along these lines.
The trickier issue is what to do with holders of so-called subordinate debt. In the spectrum of investments, subordinate debt is considered safer than preferred stock and tends to be subject to haircuts only when a company slides toward bankruptcy. Pushing a bank to the brink of bankruptcy would raise the specter of Lehman Brothers.
What Leonhardt doesn’t say, but leaves implicit, is that if you’re this nervous about touching the sub debt, then that means there’s no question of touching the senior unsecured debt — let alone depositors. This could be the beginning of a consensus: when a bank needs more recapitalization than the government has money to provide, then it’s certainly OK to convert preferred stock to equity (we’ve already seen that, at Citigroup), and in extremis one can convert sub debt to equity as well. But we’d be getting far ahead of ourselves if we started talking about tapping senior unsecured debt — which is banks’ chief wholesale funding mechanism.
After all, there’s no point in solving the solvency problem in the banking sector if you don’t solve the liquidity problem as well — which means that banks need to continue to have the ability to fund themselves in the private markets. If you start touching the senior debt too often — as we did in the cases of Lehman Brothers and WaMu — then even healthy banks’ ability to fund themselves rapidly disappears.
I’m very glad that after the literally ridiculous performance he put on today, BofA’s Ken Lewis has been stripped of his job as chairman. Annual meetings are largely theatre, of course: the important votes have all been cast long before the meeting takes place. But with Lewis still saying with a straight face that the acquisitions of both Countrywide and Merrill Lynch were a really good idea, I can’t see how the principle of shareholders (as opposed to the CEO) electing the chairman could really survive Lewis’s re-election.
For the time being, Lewis remains as CEO, but that’s up to the board, which presumably now will take succession planning much more seriously than it has done hereunto. If and when a viable candidate for CEO emerges, I doubt Lewis will stay in charge for long.
I had a brief conversation with Eli Broad at the Milken Global Conference, and asked him about my idea that his foundation is well placed to be a home to many different art collections, not just his own.
Broad first explained his art-lending policy: if a museum wants any work of art in his collection, they can have it for as long as they like, so long as they have it on show. But if they take it down for any reason other than on-lending or restoration — if they feel like just putting it in storage for an indefinite amount of time — then Broad will ask for it back.
Would Broad accept a bequest of art from another collector? Yes: “If it’s worked that fit,” he said, “we’d love to have it, lend it, pay for the insurance” and generally add it to the collection. He has a staff doing all that already, and if collectors didn’t feel like reinventing the model themselves, they could outsource it to the Broad Foundation, just like Warren Buffett outsourced his philanthropy to the Gates Foundation.
As for the art market, Broad said that “a big bubble was created, and we’re in the midst of a major correction. It was up 500%, it’s now up 250%, it could fall further.” He seemed to think that the Old Master arbitrage made sense: “Why should Richard Prince sell for more than a great Old Master? Because people don’t want to have on Old Master on their walls.”
I’m sympathetic. But at the same time, Prince is an interesting example to use, since he’s so clearly bubblicious. Broad told me that a Nurse painting which sold for $8 million a year or so ago would be worth $2.5 million now, and I suspect that you can extrapolate that decline pretty much all the way to zero. People might not particularly want to have an Old Master on their walls, but there could easily come a time, in the none too distant future, when absolutely no one has any desire to have a massive joke painting on their walls, either: it would just look dated and embarrassing. Now’s a bad time to sell a Richard Prince, to be sure. But it might well be better, financially speaking, to sell the painting now, when it’s “merely” at parity with an Old Master, rather than to have any hope that it will soar to multiples of Old Master prices ever again. Because that, frankly, seems improbable.
I was keen to go to the panel on financial literacy, which was moderated by John Bryant, the founder of Operation HOPE and a member of the U.S. President’s Advisory Council on Financial Literacy. He’s clearly committed to this cause, and is doing a very good job of picking the low-hanging fruit: in some areas, for instance, only 25% of people eligible for the Earned Income Tax Credit actually claim it. Since it can be claimed going back three years, and since it can amount to $4,000 per year, families earning less than $40,000 a year can end up with a $12,000 windfall just as a result of some simple outreach and basic education. In many cases that’s “more money in many cases than they’ll ever see in their life,” said Bryant; “it’s transformational”.
I was disappointed, however, in the way that Bryant kowtowed to the credit-card representatives on the panel: I think they’re clearly a big part of the problem, but Bryant said that he loves credit cards, on the grounds that they represent the only credit line that most poor families have.
My feeling, by contrast, is that credit cards are a really bad way of structuring an unsecured personal loan from a bank to an individual. Banks have made a concerted effort to make personal loans very difficult and expensive to obtain, complete with prepayment penalties and the like, precisely because they’d much rather their borrowers run a balance on their credit cards. And so I had no sympathy at all for David Simon, of Citicards, when he started moaning about how banks were taking enormous credit losses and how “credit card companies are the people that we love to hate”. Well, yes: because they’re basically evil, with what Elizabeth Warren calls their “tricks and traps”. But no one pushed them on this panel.
While the Obama administration continues to push on credit card regulations, and that’s a very good thing, I’d be much more interested in a parallel push to bring back the old-fashioned personal loan: something which is designed to be paid down over time, and which carries a transparent interest rate. Disappointingly, no one on the panel even mentioned the phrase “credit unions”, despite the fact that credit unions in general, and community development credit unions in particular, are a great way to educate the public on financial matters and to extend good loans rather than bad ones.
Instead, the conversation remained firmly at about 40,000 feet most of the time, with lots of talk about things like the parallels between physical and financial health: in both cases Americans have consistently failed to take responsibility for their own well-being, with disastrous consequences.
The most sanity was injected by Sean Cleary, who did push back a bit against the card issuers, saying that an economy with 8.5 credit cards per person is “a completely dysfunctional institutional context”. He also noted a powerful truism:
If you do not have the quantum of life skills needed to succeed in today’s market-based economy, then you will fail.
There was, unfortunately, very little discussion of how exactly to give Americans those skills. There was a reference to a recent paper by Annamaria Lusardi and Peter Tufano, which sought to measure financial literacy, and found that only 7% of people could answer this question correctly:
You purchase an appliance which costs $1,000. To pay for this appliance, you are given the following two options: a) Pay 12 monthly installments of $100 each; b) Borrow at a 20% annual interest rate and pay back $1,200 a year from now. Which is the more advantageous offer?
(i) Option (a);
(ii) Option (b);
(iii) They are the same;
(iv) Do not know;
(v) Prefer not to answer.
Lusardi and Tufano are clear that (ii) is the right answer: a 20% interest rate is much better than the 35% APR on the installment plan, and people who don’t answer (ii) are ignorant, they say, of the time value of money.
But of course there are good reasons to want to pay an affordable repayment every month rather than simply putting off for a year — and exacerbating by $200 — the question of how on earth you’re going to pay for this appliance. If we want financial-literacy classes to be really helpful, I think they should concentrate not on teaching people the “right” answer to a time-value-of-money question, but rather just make people understand that there are fundamental sustainability problems whenever you’re spending more than you’re earning.
Banks are really bad at communicating to their customers that personal loans, including credit cards, should only be used when you are pretty sure that you have a way of paying that loan back in the future. That is real, useful financial literacy, and it requires very little in the way of boring mathematical concepts.
I’m happy however that no one said anything about financial-literacy education involving learning about investments. That’s a fraught area indeed, and it’s far from clear that teaching people about the stock market is ever a good idea. If you want to get rich, there’s really only one way to do it: spend less than you earn. Borrowing money, for most people, is a very bad way of getting wealthier, and investing money, for most people, doesn’t work particularly well either. Don’t count primarily on investment returns: instead, just try to put money away, steadily, month in and month out, until you retire with a decent nest egg.
But pay off those credit cards first.
Update: I’d like to respond to James Shearer, in the comments, who writes this:
Either way you pay $1200. So the second option is clearly better as long as interest rates are greater than 0.
Which is the “right” answer, assuming that a rational person would simply take the $100 a month they’d otherwise spend on the installment plan, and put it in an interest-bearing account: at the end of the year, they can repay the full $1200 in a lump sum, and keep the interest.
But in the real world, people don’t do that. An installment plan is a commitment device, much like a mortgage, and there’s serious value to such a device. Under option (a) you end the year owing nothing; under option (b) you end the year owing $1,200 — and there’s a very good chance that you’ll have no more money then than you do now.
From this morning’s atrociously bad GDP report:
Exports collapsed 30 percent, the biggest decline since 1969, after dropping 23.6 percent in the fourth quarter. The decline in exports knocked off a record 4.06 percentage points from GDP.
By my reckoning, that means exports are now running at half the level they were at six months ago, more or less. (These are absolute drops, right, not annualized rates?) That’s a pretty startling sign of how global this recession is, and how hard it’s going to be to turn things around. Yes, the massive decline in inventories is probably good news. But it’s really hard to see a -6.1% headline figure as anything but a brutal sign that things are continuing to get much worse than almost any mainstream economist (or government stress-tester, for that matter) dared fear.
Update: Turns out that the export declines are annualized: they’re off 11% or so in absolute terms. Which is still bad, but at least it’s not at Japanese levels.
From Mimi Swartz’s 9,700-word monster article on Sir Allen Stanford:
Stanford’s now demoralized compliance department—responsible for making sure the company followed the rules—coined a new term: FUMU, for “fuck up and move up.”
I think this happens at many banks, if not quite as egregiously as it happened at Stanford. It’s the Peter Principle taken one step further: if the people in charge of promotions are themselves utterly incompetent and/or malign, they might well end up promoting fellow-incompetents rather than anybody honest or good at what they do. And it only takes one look at Stanford’s now-arrested chief investment officer to see the natural conclusion of that process.