Felix Salmon

How Ken Griffin would spend your money

Felix Salmon
Apr 27, 2009 17:22 UTC

Kelli K asks, in the comments, for a bit more detail on what exactly Ken Griffin was proposing this morning when he said that the government should socialize housing-market losses. He did use those words, but didn’t go into a lot of detail; later on in the panel, he talked about one idea which may or may not have been one of the proposals he had in mind.

Griffin said that the economy won’t recover until the financial system does, and that the financial system won’t recover until the housing mess is resolved, and that the housing mess won’t be resolved until the huge overhang of unsold real-estate is dealt with, and that the huge overhang of unsold real-estate won’t come off the market unless and until people start buying houses again, and that people won’t start buying houses again unless they can come up with downpayments, and that people clearly can’t come up with downpayments because the US savings rate has essentially been zero for most of the past decade. So Griffin’s proposed solution was for the government to provide low-cost, full-recourse 20% downpayment loans to anybody who wants to buy a house. Yes, he said, no-money-down house purchases were what got us into this mess to begin with, but we kinda need them in order to get out of the mess too.

I’m not sure this idea really works that well, because homeownership rates move slowly and aren’t going to rise overnight just because of a downpayment assistance program. But in any case, that’s (one of) Ken Griffin’s big idea(s). In general, of course, everybody has their own pet idea for how the government should spend a few hundred billion dollars in an attempt to shore up the economy. The trick is to find the ways of spending money which are (a) politically feasible; and (b) get the most bang per buck. And that’s almost impossible, given the anger in Congress these days.


For “permalink”, there are no hidden costs with home ownership. A specific house may have an undisclosed major problem (cracked foundation, mold starting in the basement, etc.); however, home ownership costs, such as utilities, maintenance, property taxes, insurance, etc., are what they are. Not everyone who initiates a home purchase actually endeavors to learn about what it takes to own a home.

Property taxes rise with over-heated housing markets; the tax appraiser uses actual sales prices to determine “tax assessed value”. If the sales prices are produced by laughably lax credit standards, the tax appraiser has no mechanism to say, “that’s not a REAL sales price”.

And for the general discussion, forget about “socializing the cost” of the housing debacle. The Government has NO MONEY, except what it collects in income taxes from the neighbors of the people who received loans that they could not possibly afford. Let the printing presses at the U.S. Mint run on overtime, and not have a commensurate rise in the marginal productivity of labor, and all the extra printed money simply devalues the currency in circulation (the alternative name for this action is price inflation).

To say that the Government is forgiving a mortgage loan, or otherwise modifying it in favor of the person who remains in the house that they could not possibly afford, is to say that the Savers in the United States are being forcibly compelled (the IRS tax evasion regulations are gruesome) to fund the profligate lifestyles of people who should not be home-owners. And after CNN finishes the story about the legitimate homeowner who was laid off (the one that makes the populace think, “gee, this whole thing could happen to anyone…”), they should play a thousand stories of people who obtained, through ignorance or deceit, mortgage loans that they could not possibly afford.

One way to approach the problem is to look at from a perspective of rewards. If you punish the savers, and reward the hyper-debt spenders (leave them in the house that they could not possibly afford and you have rewarded them) and you not only destroy the will to save, you destroy the seeds of capital that are necessary to pull the country out this mess. Savers are the ones who provide banks with money to loan. No savers, no capital for banks. And you don’t encourage saving by sticking a Government gun to the savers heads and demand that they bail-out the profligate among the population with either increased taxes, price inflation, or both.

What’s normal for the economy?

Felix Salmon
Apr 27, 2009 16:15 UTC

I’m at the Milken Global Conference for the next couple of days, where Pimco’s Mohamed El-Erian kicked off the first morning’s big breakfast session with the blunt statement that the assorted plutocrats have to stop hoping that things are going to get “back to normal” — ever.

The problem, he said, quite rightly, is that the crisis is “morphing” — a financial crisis became an economic crisis and is now becoming a socio-political crisis. It’s silly to hope that any government can get ahead of a morphing crisis, especially when government response is certain to be rife with unintended consequences — if you do what makes sense economically, you end up with a political backlash which creates a whole new set of possibly even more intractable issues.

As with all these panels, the panelists tended to talk their book: El-Erian was pushing the PPIP plan, Ken Griffin was asking the government to socialize housing-market losses, and John Micklethwait was literally talking about this week’s Economist covers.

But the point which resonated more than any other was El-Erian’s home truth: there’s going to be “a new normal, not an old normal” if and when we finally emerge from the current recession. Ken Griffin might hate the stealth nationalization going on at places like AIG, GM, and Citigroup, but we simply are entering what El-Erian calls “a period of deglobalization”, which is going to affect different sectors of the economy in very different ways.

To that point, there probably won’t be such a thing as “the recovery” — certain parts of the old economy simply might not recover at all. Any financial and economic crisis of this magnitude will have permanent victims. In sunny California, it’s easy to forget that things really can go to zero, especially when you are personally highly invested in them. John Micklethwait talked darkly about how a political hurricane ripped through Europe, in the form of World War I, just when many people in 1913 thought that things would only ever get steadily better. Or, to put it another way, if we are reverting to mean, which mean are we reverting to?


Stealth internationalization seems more like it – much of it not all that difficult to see.

Haven’t all notions of past Recoveries been somewhat of a statistical and political mirage, just looking at the ongoing spread in the rich poor gap throughout the ‘good’ years to start. On the other hand, aren’t El-Erian and friends still enjoying an extended boom? How’s attendance at the Milken conference this year?

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Conde Nast Portfolio closes

Felix Salmon
Apr 27, 2009 15:08 UTC

Very sad news this morning that Conde Nast Portfolio is closing. They were a wonderful home to me for two years, and I feel particularly bad for the amazing Ryan Avent, who’s got off to a truly smashing start at Market Movers and who looks to have jumped ship from the Economist at exactly the wrong time. But he’s chock-full of talent, and I’m sure will find an even more fabulous job soon.


I subscribed to portfolio one month before it folded. Now I cannot seem to get thru to Conde Nast re a refund. Any suggestions ????????????????

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How the Gaussian copula got adopted

Felix Salmon
Apr 27, 2009 08:05 UTC

In December 2008, Sam Jones of the FT was kind enough to mention the Gaussian copula function to me. That mention eventually became my Wired magazine cover story, and I always felt a little bit guilty about my story coming out first, since I knew that Sam was working on one too.

Well, Sam’s feature on the copula has now appeared, and it takes a rather different tack than mine; in any case, it’s a great read, so do check it out. Here’s one thing I learned from reading it:

On August 10 2004, the rating agency Moody’s incorporated Li’s Gaussian copula default function formula into its rating methodology for collateralised debt obligations, the structured finance instruments that subsequently proved the nemesis of so many banks. Previously, Moody’s had insisted that CDOs meet a diversity score – that is, that each should contain different types of assets, such as commercial mortgages, student loans and credit card debts, as well as the popular subprime debt. This was standard investing good practice, where the best way to guard against risk is to avoid putting all your eggs in one basket. But Li’s formula meant Moody’s now had a model that enabled it to gauge the interrelatedness of risks – and that traditional good practice could be thrown out of the window, since risk could be measured with mathematical certainty. No need to spread your eggs across baskets if you knew the exact odds of your one basket being dropped. A week after Moody’s, the world’s other large rating agency, Standard & Poor’s, changed its methodology, too.

They’re like Sotheby’s and Christie’s, those two. I’m not sure that “criminal” isn’t too strong a word for the way in which they offer no real alternative to each other, instead chosing to ape whatever the other one does.

Brand licensing and counterfeiting

Felix Salmon
Apr 26, 2009 22:58 UTC

Ryan wades into one of my favorite subject areas today: counterfeiting.

Ryan is absolutely right that counterfeit goods are, in many cases, more likely to help than harm the business being knocked off. Dolce & Gabbana, as I’ve mentioned in the past, passively encourages the counterfeiting of its brand by refusing to lift a finger to help prosecute counterfeiters. But Ryan goes one further:

Why don’t designers sell their own knock offs? Even if they couldn’t put other counterfeiters out of business, they’d at least capture some share of the revenue. And while perhaps the designers aren’t all that interested in investing in such a low margin business, one would think they’d at least consider licensing someone to legally produce knock offs. That looks to me like big bills left on the sidewalk.

This one, I’m afraid, doesn’t quite fly. There’s always pressure on luxury goods manufacturers to produce “diffusion” lines and the like at ever-lower price points — but go too far in that direction and you end up with what happened to Gucci in the mid-80s: so much brand dilution that you cease to be luxury at all.

What’s more, we live in a world where “expensive” is largely synonymous with “quality” or “luxury” — price is the main criterion that people use to determine how good something is. If you can get a real Prada bag for $20, your inclination to buy one for $2,000 or $20,000 naturally evaporates somewhat.

Looking at it another way, the luxury brands are already licensing their own knock-offs, but to avoid cannibalizing their own high-end sales, they make sure that the licenses are always for a category outside the headline-grabbing formalwear sector: things like perfumes or eyeglasses or jeans. You didn’t think those Prada shades were handmade by Milanese artisans, did you?


If your brand is good enough to be counterfeited, then you know you have a strong product.

Friday links find new websites

Felix Salmon
Apr 24, 2009 23:29 UTC

TARP Tales: Your one-stop TARP shop. See also ProPublica’s Eye on the Bailout.

The Hearing: Simon Johnson and James Kwak add a second blog to their quiver, this one at WaPo.

Oh No You Di’int: TED on warrant valuation.


The article re: BAC is terrible. Takeover of Ken Lewis is the result of union pressure. It is wrong for the bank and wrong for investors, of which I am one. The media print are mere tools for the left wing, led by Obama and the unions. CUT IT OUT!!!!!!!!! Stop these one-sided anti-Ken Lewis articles. You can sway the unintelligent, but not those who realize what is really going on. To hell with Cuomo and the others who put their nickel in without a thought to how it will affect the market; they will destroy market sentiment to gain political clout!

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Are CDS a good thing?

Felix Salmon
Apr 24, 2009 23:25 UTC

Kevin Drum asks whether I’m “still as bullish about credit default swaps as I have been in the past”. It’s a good question: after all, a large part of my speech to the regional bond dealers (more of the actual speech than of the notes) comprised me explaining that I was very wrong about a lot of this stuff.

On the subject of CDS specifically, yes I think I was entranced by the shiny-new-toy aspect of them. They were so elegant, they were such efficient ways of moving risk around the markets, that they had to be a good thing, right?

I’m still no fan of the CDS demonizers, who generally have no idea what they’re talking about: if they are remotely right, they’re right for entirely the wrong reasons. But I will admit that I did rather jump in an unwarranted manner to the conclusion that because the CDS critics were so very wrong, then the CDS market must have been largely benign.

The fact is that AIG could never have blown up if it wasn’t for CDS. UBS and Citigroup could never have suffered their billions of dollars in super-senior losses if it wasn’t for CDS. And therefore the CDS market was intimately involved in some of the most systemically-devastating events of the crisis.

That said, CDS had nothing whatsoever to do with the failure of Bear Stearns. The fact that CDS allowed you to effectively short a credit you didn’t own was not particularly harmful. The the CDS market was incredibly useful in terms of price discovery, and it remained impressively liquid even as virtually all other credit markets froze up altogether. Etc etc.

So right now I’m vacillating on this one. I’ve recently finished reading Gillian Tett’s new book, and although she tells a good story, I don’t think she really succeeds in making her case that the creation of the CDS market was the proximate cause which “unleashed a catastrophe” on the world.

On the other hand, I don’t think I can really add credit default swaps to the list of undeniably positive financial innovations, like ATM cards. CDS are powerful instruments, which can be — and were — misused, most egregiously by AIG. I’m not happy about that. But I’m not remotely ready to start banning them, or to start trying to require that any buyer of protection have an “insurable interest” before being allowed to do the deal.

Update: The comments, in general, are well worth reading. It’s true that in an enormous zero-sum market, you’re going to find situations where both buyers and sellers are booking profits, and that can’t be good. I’m also still pondering the excellent question asking why price discovery is a good thing. And less specifically but just as importantly, CDS encourage a certain kind of laziness on the part of the buy side — not just in bankruptcy situations, but more generally too. The easier it is to hedge your position dynamically, the less homework you’re likely to do before entering into that position. Which is a recipe for trades getting very crowded very quickly.


“Soros Says Default Swaps Should Be Outlawed”

http://dealbook.blogs.nytimes.com/2009/0 6/12/soros-says-default-swaps-should-be- outlawed/?ref=business

“The more I’ve heard about them, the more I’ve realized they’re truly toxic,” Mr. Soros said Friday, according to Reuters. Later, he added: “It’s like buying life insurance on someone else’s life, and owning a license to kill.”

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The attraction of Lending Club

Felix Salmon
Apr 24, 2009 22:09 UTC

I just had a very interesting meeting with Renaud Laplanche, the CEO of Lending Club, the peer-to-peer lender, and I’ve come out very enthusiastic about what he’s doing there.

Lending Club is the most advanced of the US peer-to-peer lenders, in that it has gone through all the legal pain needed to get full SEC registration and therefore has less in the way of legal question marks hanging over it. It also seems in some way the most professional: rather than scrolling through sob stories looking for someone sympathetic to lend to, lenders never even know the identifying details of the individuals they’re lending to, and generally just invest a lump sum over a couple of hundred different people.

The returns so far have been good: according to a report from Javelin Research,

At the close of November, the overall investment return averaged 9.05%, with a median return of 10.48%, based on a Weighted Average Return on Invested Capital (WAROIC). That calculation accounts for Lending Club’s 1% service charge, as well as for loans paid off early, hobbled by late payments or defaulted.   

That’s a healthy return, for a fixed-income investment, without being usurous as far as the borrowers are concerned. Indeed, that’s one of the reasons I like this model so much: it allows people to pay off their credit-card debts, which might be well over 20% or even 30% per annum, at a much cheaper rate, over a reasonable three-year time period. You can even prepay your loan at any time without penalty.

Lending Club isn’t trying to lend to people who can’t borrow money elsewhere: indeed, it has pretty stringent underwriting standards, and turns down 90% of the would-be borrowers at its site. The ones who do qualify end up paying somewhere between 8% and 19% interest, depending on their creditworthiness; the interest rate is set by Lending Club, rather than bilaterally between borrowers and lenders.

The company’s default rate is more or less where you’d expect, in the 3% to 4% range; once a loan has defaulted, the recovery is very low. But recoveries on loans which are 60 days delinquent are actually very high, in the 75% range: borrowers really want to repay these loans, and don’t hate Lending Club in the way they hate their bank or credit-card company. What’s more, because the loans amortize over three years, a substantial chunk of the principal amount has generally already been paid back even by those borrowers who do end up going into default.

Another thing I like about Lending Club is that it isn’t only stringent about its borrowers; it’s stringent about its lenders, too, requiring an income of at least $70,000 a year and liquid assets of at least $70,000. In California, where right now most of the lenders are based, those numbers actually rise, to $100,000. For the time being, substantially all of the company’s lenders are individuals — there are a lot of angel-investor Silicon Valley types who consider this kind of investing to be extremely low-risk and a way of making the world a better place. But moving forwards, there’s no reason why Lending Club shouldn’t get substantial institutional investments as well, especially once it’s been going for three to five years.

That said, this kind of investment is particularly well suited to retail investors, because of its three-year time horizon. (It recently launched an IRA product, too, with income reinvested.) There is a secondary marketplace for loans, but it’s not a major feature of the site, and most investors are very much buy-and-hold.

Lending Club is not the best way of looking for particularly sympathetic borrowers, or for lending in an arm’s-length and legally-binding way to a friend. (Virgin Money is the place to go for that.) Instead, it’s just a way of disintermediating a banking system with which many Americans have become increasingly disgusted, with both sides happy with the deal.

How safe an investment is Lending Club? This is the bit I like the most: it’s safe, but not too safe. The desire for safety was one of the main drivers of the financial crisis, and I believe that people with thousands of dollars to invest over a three-year time horizon should be comfortable taking a certain amount of risk. Going forwards, it’s possible that Lending Club will find an insurer willing to offer a principal guarantee in return for a certain insurance premium of say 300 basis points, but in a weird way I like it more this way: it forces investors to worry just a tiny bit about the prospect of losing some of their money, and that worry is ultimately healthy.

No investment yielding 9% a year can ever be risk-free, but I don’t think the amount of risk embedded in a diversified portfolio of Lending Club loans is at all excessive, given the yield. It’s certainly much lower than the risk of investing in a diversified portfolio of stocks, which is something that hundreds of millions of Americans do as a matter of course. Plus, you get to help out people who are really grateful for your money. So if you want to diversify out of the markets and make more money than on a bank CD, it’s definitely something to consider.

Should you borrow from Lending Club? Well, you can try — but most people who do try, fail. For the time being the demand for loans greatly exceeds the amount of money available, so there’s not a great chance you’ll get what you want. But if and when Lending Club takes off, it could become a great place to borrow money easily and at much lower rates than your credit-card company is charging. Banks have been making it increasingly difficult to get a personal loan in recent years, because they make so much more money from credit cards. Lending Club is now offering a product which really the banks should have been offering all along, but weren’t. I wish it very well.

Update: Renaud, Steve Waldman, and I spent much of the weekend emailing back and forth about weaknesses in the Lending Club business model, most of which I won’t get into but which Steve might, if he’s so inclined. The upshot is that there is a weakness there: lenders get unsecured obligations of Lending Club, rather than a direct security interest in the loans themselves. Just how much of a weakness this is is open to debate: Renaud told us by email a bunch of things which are not easily findable in the prospectus, if they’re in the prospectus at all, and which are pretty reassuring. But if you’re thinking of Lending Club as a place to invest a serious amount of money, they might be worth looking into.


Why is everyone ragging on Jon and avoiding his point? Nowhere in his post did he say his $25 loan defaulted, so why the immaterial advice for him to diversify? It seems their might be a discrepancy with the rates being published on a per annum basis.

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Can the stress tests breathe new life into PPIP?

Felix Salmon
Apr 24, 2009 17:58 UTC

According to the FT today, there are increasing signs that the PPIP is going to go the way of the MLEC — which is to say, nowhere. Potential buyers are worried about regulatory uncertainty, while potential buyers have very little interest in selling at fire-sale levels.

Meanwhile, Ryan Avent reckons that the government is going to have to come up with hundreds of billions of dollars, somewhere, to recapitalize banks in the wake of its stress tests — even as it doesn’t have hundreds of billions of dollars, and there’s no chance that it will be able to get hundreds of billions of dollars from Congress.

Are you thinking what I’m thinking? Just as the original TARP was designed to buy up toxic assets and then got repurposed to inject capital directly into the banks, might the same thing happen with the PPIP? Might it be the case that investors who are wary of buying up hard-to-value toxic assets might be more keen on leveraging FDIC guarantees to buy common stock in public banks? And if Timmy asks her nicely, is there any way that Sheila Bair could say no to such a plan?

I’m not clever enough to come up with a structure which would make such a plan workable — it’s hard to see what kind of event would trigger the FDIC guarantee. Still, I’m sure there’s an options whiz out there who could construct something. The market could then be asked to value those equity-like securities, and any private investor — even you or me — would have the ability to buy them at the market price, thereby helping to recapitalize the banks concerned.

Neither the stress tests nor the PPIP has really gone according to plan since they were announced: maybe some kind of marriage of the two is the only way of saving them.



As you may remember, I have complained that nobody really understands the Geithner Plan and that hence it is just increasing uncertainty, instead of turning some of it into calculable risk of some sorts. Which means that the most recent non-developments are not exactly surprising from my perspective. But there is another reason why we should not be surprised by these non-developments.

I have argued that the Bernanke-Geithner-Summers policy has, in fact, committed itself to a very special sort of “triage”. Of course, not in the sense Nouriel Roubini has advocated, namely, to take over the banks temporarily and then recapitalise those that are still basically solvent and eliminate the zombies. That would be tantamount to challenging the financial oligarchy, which is something Bernanke, Geithner and Summers are loath even to contemplate.

Rather, BGS are deliberately trying to avoid tackling head-on the seemingly insuperable problems of toxic assets and the plight of people whose mortgages are already under water. Instead, their policy can be seen as “subsidizing the solvent.” So, the idea is to bolster the creditworthiness of the “creditworthy” customers and the solvency of “solvent” banks. If a relatively stable policy plateau can be reached and some sort of “return to normalcy” can be achieved, it is hoped that the rising tide will make the now insuperable problems easier to tackle.

There is no doubt in my mind that this B-G-S policy has been a major factor that explains the (undoubtedly partially correct) impression of greater stability, both in the financial markets and in the wider economy. But this policy has not been meant as a way to solve the problems of “legacy assets and loans” now; neither has it been the intention of B-G-S to do now anything substantial to help the plight of those persons who cannot refinance their loans.

Which means that if and when the nonoperative nature of the Geithner Plan becomes all-too-evident, it will be replaced by some other smoke-and-mirrors delaying tactics.

If some sort of economic recovery begins in the latter part of 2009 and it continues next year, B-G-S will stick to their policy, in the hope that they can address the truly difficult questions piecemeal and with the help of revived animal spirits.

Of course, the Four Trillion Question is whether the global developments permit such a scenario. If they do, Bernanke, Geithner and Summers will become the saviors and heroes of the establishment. If not, they will become political zombies and eventually be sacked from their duties.

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