Felix Salmon

Wednesday links lose their meaning

Felix Salmon
Apr 22, 2009 22:44 UTC

Infrastructure Madness: Jack Shafer on the meaninglessness of crumbling-infrastructure statistics.

Rich People Things: A great rant from Chris Lehmann.

The German econblogger space is just fine: Edward Harrison responds to me with some good points.

Portals and Rails: The Federal Reserve Bank of Atlanta has an entire blog devoted to risks in the retail-payments system. I love this medium.

Geithner fails to impress: In front of Congress, and Elizabeth Warren.

The Infinite Loan Machine. An examination of the effect of loan securitization on the fractional reserve banking system: Is fractional reserve banking incompatible with securitization? Maybe.

Forging Ahead: How the rise of eBay means more fake antiques, but less looting.

A flawed first draft of history: The editor of the FT in self-criticism mode.

Hedge fund datapoint of the day

Felix Salmon
Apr 22, 2009 22:38 UTC

From Jesse Eisinger’s profile of Bill Ackman:

In 2007, he set up a special fund to invest in a single stock in a highly leveraged way. In a sign of how frothy the markets were, he raised $2 billion from start to finish in a week, about two-thirds of which came from other hedge funds. Investors knew the outlines of the investment but not that it would be in Target.

I can understand investors buying into a single-stock fund because they’re convinced about the thesis behind it. But raising $2 billion for a single-stock fund in one week, without revealing what the stock in question actually is? Yikes. Whatever sympathy I had for Ackman’s investors in PSIV has now completely disappeared.


Ha. I post my comment, and then I follow EDM’s link, only to discover that he had _precisely_ the same thought.

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CDS and valuing control rights

Felix Salmon
Apr 22, 2009 22:20 UTC

Craig Pirrong weighs in with a very long post on the question of whether credit default swaps make bankruptcies tougher. He has a perfectly good way of looking at the problem, but comes to the wrong conclusion, I think because he has a very skewed idea of the costs and benefits involved in the transactions:

A completely hedged debtholder (i.e., a party that has purchased protection in an amount equal to his holdings) would appear to have no incentive to behave constructively during the reorganization. But this means that a potential source of value—the control and legal rights attached to the ownership of the debt security—is not being maximized. There is therefore a set of mutually beneficial transactions that would leave the insured debtholder no worse off than if he acts in the passive manner that the critics of CDS hedgers suggest, but would result in the efficient exercise of the control and legal rights. Specifically, another party could purchase the debt from the insured current holder at a price that is satisfactory to the latter, but which allows the purchaser to capture some of value associated with the control rights. That is, there is a set of transactions that would allow the hedged debtholder to capture some of the benefits of the control rights.

The problem with this way of looking at things is that it essentially ignores the whole reason why the bondholder hedged with CDS rather than simply selling his bonds in the first place. Pirrong claims to be conducting what he calls a Coasian analysis, but he never attempts to explain, in terms of that analysis, how we got to the state of affairs which allowed this problem to crop up.

There’s a big reason why the CDS market exploded as it did: especially when it comes to small and/or distressed credits, it’s vastly more liquid than the cash-bond market. And it’s worth noting that Pirrong’s proposed solutions generally involve trading the cash bonds rather than credit derivatives.

Note that Pirrong is perfectly happy, in his ivory-tower way, to posit trades which capture what he calls the “value associated with the control rights” of a cash bond. But very few people trade in such value: basically, it’s the province of a small number of distressed-debt funds who like to buy debt cheap and then wade into invariably-arduous litigation. Those funds tend to have extremely high target IRRs, which makes Coasian arbitrage of the sort outlined by Pirrong very difficult.

Writes Pirrong:

The anti-CDS argument holds only if transactions costs materially impede the consummation of value enhancing bargains, but those advancing this argument undertake no analysis of transactions costs.

The first bit is right, but the second bit is wrong: I concluded my first blog entry on the subject by saying that the answer to the problem was to “minimize the economic costs of bankruptcy”, and devoted substantially all of my follow-up blog entry to explaining how arduous debt renegotiations are, and how therefore it’s not at all easy to extract value from them.

As for Pirrong’s proposed solutions, insofar as they destroy the anonymity of the markets, I think they’re highly impractical and will never be implemented. As for speeding up the CDS auction after a credit event, that does nothing to solve the problem at hand, which is how to avoid credit events in the first place by encouraging the full participation of bondholders in restructuring negotiations. Bondholders have discovered that if they hedge themselves in the CDS market, they can be lazy about such matters. And there aren’t any easy ways to get a lazy bondholder to do hard negotiating work.



Thanks for taking the time and thought to respond to my post. Re long–well, that’s nothing for me;-) I like to be thorough.

I am not at all persuaded by your response. Rather than responding in turn with a comment, I’ve done so on Streetwise Professor.

In a nutshell, I don’t think that your arguments address the crucial issue, which is what is the incremental contribution of CDS hedging to the lazy bondholder problem (to use your analogy). Many of your arguments are true of all distressed debtor situations, even when CDS are absent.

Anyways, thanks again, and perhaps this debate will continue.

Ecuador’s chutzpah-filled exchange offer

Felix Salmon
Apr 22, 2009 20:49 UTC

Here are the official details of Ecuador’s exchange offer — the one where it’s attempting to buy back its own debt at 30 cents on the dollar.

The 108-page document kicks off with a letter from the finance minister, Maria Elsa Viteri Acaiturri, where she talks about “alarming… indications of illegality and illegitimacy” in the process which led to the issuance of the 2012 and 2030 bonds which Ecuador has defaulted on. She then however continues:

The Invitation is designed to assist in allowing both the 2012 and 2030 Bondholders and the Republic to close, on an acceptable basis, a very challenging period in Ecuador’s external debt history.

We appreciate your understanding and consideration and we look forward to restoring normal relations with the national and international investor community.

I think she’s serious, and honestly believes that buy unilaterally and unnecessarily defaulting on some (but not all) of its bonds, then buying those bonds back at about 30 cents on the dollar, Ecuador might be able to achieve “normal relations with the national and international investor community”.

Viteri doesn’t make threats in her letter — those come later in the document, on page 13 of the document (page 19 of the PDF):

Bonds acquired by the Republic (or a person nominated by the Republic) pursuant to the Invitation may be held by the Republic or the nominee. If a nomination is made, it is the Republic’s intention that the nominee will acquire all rights, including, if the Republic does not control the nominee, rights in respect of voting currently exercisable by Holders or beneficial owners of the Bonds that are accepted pursuant to the Invitation. The Republic will then consider a range of amendments to the Bonds, which it will propose to Holders after the Settlement Date. Certain amendments to the Bonds may be made by the Republic and Holders of a simple majority by value of the Bonds.

In English, Ecuador is saying that after this tender offer is over, it’s going to control a majority of the bonds — and that it will happily strip away from the bonds a large swathe bondholder protections embedded in the bonds at that point in time.

I’m not sure how much of a threat this really is: Ecuador tried a very similar tactic in 2000, with its notorious “exit consents”, and when it issued the new 2012 and 2030 bonds as part of that transaction, it limited itself as to the protections which could be stripped in such a manner. But still, I’m sure that Ecuador could cause no little mischief this way — especially considering that it has almost certainly bought up a large number of the bonds already.

My favorite bit of the document comes later, however:

The Constitution defines its goals in terms of multiculturalism, pacifism and relations with our neighbours, including… achieving Sumak Kawsay, a life in harmony with nature.

Is this the first time that principles of harmony with nature have been literally embedded in a sovereign debt exchange offer? And what do such principles mean for bond valuations? Perhaps we’re about to find out.

Eventually, the document gets around to explaining why Ecuador’s debt load is so burdensome that it’s being forced into this offer:

The Republic’s economy is estimated to have grown at a rate of 5.3%, in real terms, in 2008. The balance of the foreign debt was U.S.$10.0 billion, which was approximately 19.2% of GDP. As of December 31, 2008, the freely disposable reserves amounted to U.S.$4.4 billion.

Remember here that the total amount of the bonds in question is no more than $4 billion; Ecuador is current on all of the rest of its debt, and claims to have no intention of restructuring any of it. Meanwhile, Ecuador grew by 5.3% last year — one of the best economic performances in the world; its total debt load has actually been shrinking of late; and its debt-to-GDP ratio is so low that it could easily be mistaken for a budget deficit in more profligate countries.

In other words, Ecuador has no economic rationale whatsoever for defaulting on this debt: it’s doing so because it can, basically. I suspect that bondholders will prove unimpressed, and will tender very few bonds into this exchange. If you’re still holding Ecuador bonds right now, you’re doing so because you don’t need the coupon income. Eventually (although not in this election) the current administration will be replaced with one which is friendlier to the market. Most of Ecuador’s bondholders can wait until then, or else try their luck in the Southern District of New York in the meantime.



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When banknotes expire

Felix Salmon
Apr 22, 2009 19:54 UTC

Greg Mankiw had an unorthodox idea on Sunday:

Imagine that the Fed were to announce that, a year from today, it would pick a digit from zero to 9 out of a hat. All currency with a serial number ending in that digit would no longer be legal tender. Suddenly, the expected return to holding currency would become negative 10 percent.

That move would free the Fed to cut interest rates below zero. People would be delighted to lend money at negative 3 percent, since losing 3 percent is better than losing 10.

Of course, some people might decide that at those rates, they would rather spend the money — for example, by buying a new car. But because expanding aggregate demand is precisely the goal of the interest rate cut, such an incentive isn’t a flaw — it’s a benefit.

The problem with this scheme is that it leaves too much to chance: on the day before the Fed’s announcement, you don’t know whether your $100 bill will be worth $100 or $0 the following day. So there will be a mass exodus out of $100 bills, to no good purpose.
Instead, the US should go the way of Zimbabwe, which has its own solution to this problem, as evidenced on a $500,000,000 note I just received in the mail:

This note has an issue date (May 2) and an expiry date (December 31). If Tim Geithner started putting expiry dates on the bills he signed, that would do wonders for the velocity of cash in the economy, I’m sure. And it would help reduce Treasury liabilities, too. What’s not to love?


Might i suggest we use snakes instead of either? Since they need to be fed, they have the same benefit of increasing aggregate demand as both solutions, but they need to be fed always as opposed to simply on one expiration date.

So rather than a boom in aggregate demand or a rush from large denomination bills at a fixed date we just get all of the benefits.

except your money might kill you.

TARP repayment: An IM exchange

Felix Salmon
Apr 22, 2009 15:18 UTC

John Carney: this issue of TARP repayment conditionality is fascinating

Felix Salmon: It’s a bit like the rules-based vs principles-based debate

John Carney: I’m convinced that Geithner is violating the law by imposing conditions.

Felix Salmon: Should TARP repayment conditionality be written down in legislation, or should it basically be left up to Treasury on an ad hoc basis?
I think the law is largely irrelevant

John Carney: Which is kind of troubling. I mean, if Congress specifically includes a provision, can the Treasury just ignore it? Has the democracy bubble popped?

Felix Salmon: The law gets written in a hurried way by people who don’t really know what they’re doing, and then the facts on the ground change
I know you can say that about most laws of course
But in this case things are just moving too fast, and it’s the job of the Treasury secretary to stay on top of them

John Carney: Yeah. I think a truly interesting question is how this wound up in the stimulus bill.

Felix Salmon: It is a bit weird that a pro-bank clause ended up in the bill when Congress was mainly trying to punish Wall Street as much as possible

John Carney: especially since it specifically nullifies a clause in the original TARP agreements

Felix Salmon: My guess is that rather than pick a fight with Congress, Treasury let it slide, safe in the knowledge that no bank would try to repay TARP funds in the face of Treasury opposition, no matter what the law says

John Carney: Possibly. Or they just didn’t see it.

Felix Salmon: Lord knows Treasury was (and is) woefully understaffed back then

John Carney: yeah. and it was a huge bill.

Felix Salmon: Do you see any bankers taking the letter-of-the-law argument?
My guess is they’ll think about it for a few minutes, and then decide that it’s far too dangerous to go there

John Carney: I dunno.
Paycaps are a mighty incentive to defy Timmy

Felix Salmon: true dat
and Timmy isn’t looking particularly fearsome these days

John Carney: I’d piss tim off if it meant the difference between making $30 million and $500K

Felix Salmon: And certainly Jamie Dimon’s ego is well-developed enough to take on anybody

John Carney: He’s far more popular than Geithner anyway


Actually, it makes a lot of sense to me that this was in that bill. The same bill that rewrote the terms of the TARP money by attaching far more onerous strings to it than the banks agreed to also allowed them an out. The populist outrage against the bank bailout that was channeled through Congress wants the banks to repay the money now or, better yet, sooner. As you note, this very much makes life harder for an administration that feels differently.

When receivers bicker

Felix Salmon
Apr 22, 2009 15:05 UTC

This is unhelpful in the extreme. As you probably know, Stanford International Bank, an Antigua-based financial institution, turns out to have been an $8 billion Ponzi scheme, and now the receivers in both Antigua and the US are trying to pick up the pieces and return whatever money they might be able to find to Stanford’s depositors. Except instead of cooperating, they’re bickering, nastily:

In court documents filed late on Monday, Nigel Hamilton Smith, the receiver appointed by the Antiguan government, asked a Texas judge to rescind some of the authority initially bestowed on the US-appointed receiver, Ralph Janvey…

In the filing on Monday, Mr Hamilton-Smith described Mr Janvey as “initially giving lip service to the concept of co-operation”, and said the US receiver had “by and large refused to co-operate”…

Subsequent to the court ruling, Mr Janvey said he intended to contest any efforts by his Antigua-based counterpart “to seek to recover assets that would be distributed only through the Antiguan proceedings”.

There is no reason whatsoever why assets properly belonging to Venezuelan depositors, who put their money in an Antiguan bank, should travel through the USA before being returned to their rightful owner — especially when there’s an enormous tax lien against Stanford in the US, which is senior to any depositors’ claims.
It’s unclear to me why Janvey is taking such an aggressive approach, but he should tone it down: he’s sounding borderline imperialist right now, with his implications that because he represents the USA, he should automatically be in charge of the entire operation.



Before writing an article informing the public on any subject, you should first get your facts straight.

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Geithner anecdote of the day

Felix Salmon
Apr 22, 2009 14:35 UTC

Gary Weiss thinks this story, from Bill Seidman, says a lot about Tim Geithner, and I do too:

It was the late 1990s, Lawrence Summers was Treasury secretary, and Geithner, as the undersecretary for international affairs, was his loyal deputy. Summers gave a speech on Japan’s troubled banking system, a subject that Seidman, who then worked for Morgan Stanley, knew intimately from his frequent visits to the country. “It was essentially not relevant,” Seidman says of Summers’ speech. It showed “a lack of familiarity with what’s going on there.” Seidman, never a shrinking violet, said as much at the time when a reporter asked him in Japan for a comment—at which point he ran afoul of Geithner. According to Seidman, Geithner called him and said, “You’re a disloyal American. You can’t make statements like that on foreign soil about a secretary of the Treasury.”

Seidman, who was awarded the Bronze Star for his service in the U.S. Navy during World War II, wasn’t accustomed to having his loyalty questioned, certainly not by someone approximately 40 years his junior. “I said, ‘Where does it say that in the Constitution?’ ” Seidman tells me…

Seidman says he bears Geithner no ill will, but he has no illusions about what he witnessed. Geithner, he says, “was doing what his boss wanted, I assume. Everybody is a product of what they’ve done. I have high respect for bureaucrats, but that doesn’t mean they’re going to have the leadership quality needed when they get to be something like secretary of the Treasury—particularly now.”

Viewed through the lens of his bureaucratic background, Geithner’s behavior since coming to the Treasury—tentative, sometimes hesitant, always hedging with his comments, lacking in boldness and imagination—seems not only logical but inevitable.

It’s true that Geithner is a bureaucrat to his toenails — Weiss’s phrase is that he “was born with a briefcase tucked under his arm”. He’s excellent at navigating labyrinthine institutions, be they Treasury or the IMF, and at mastering a brief given to him by a superior. Would Geithner have upbraided Seidner had a less thin-skinned Treasury secretary been in place? I doubt it. And I’m sure that Geithner felt free to disagree with Summers privately — Summers loves participating in internal debate. It wasn’t the substance of Seidman’s dissent that Geithner had a problem with, just the fact that Summers was undoubtedly upset about it.

I remember Geithner when he was at the IMF, selling the sovereign-bankruptcy policies of his then-superior Anne Krueger, and not giving the slightest hint that he might disagree with them (despite the fact that I’m pretty sure he personally thought they were nonsense). In other words, Geithner is a good and loyal deputy — in ways which might leave him a bit lost for direction when he himself is the man in charge.

I part ways with Weiss’s profile here, however:

No matter how well rehearsed, Geithner strains to exude the confidence that comes with knowledge and experience. It’s old news to people familiar with ­Geithner that he is not an economist and has no private-sector experience in finance, in contrast to pretty much every other Treasury secretary in recent years. For his critics, that says it all. “He may not be that comfortable with the subject matter,” Change author Cohan says. “I think that, in general, people who are good at math are more comfortable with talking about finance and thinking about financial policy and strategies. I think that if you’re going to come up with better strategies and better ideas, you need to have someone who’s a strategist, who understands how to come up with better policies.” Cohan says he’ll be “very surprised if Geithner comes up with any really new, insightful ideas on how to solve the financial problems.”

I think that Geithner is comfortable with the subject matter: he’s always been excellent when it comes to being on top of his brief. He just doesn’t know what to do with the subject matter once he masters it, since there’s no one giving him clear direction. So he hedges, in that way he has, instilling zero confidence in the market.
It’s not Geithner’s job to “come up with really new, insightful ideas on how to solve financial problems”. But it is Geithner’s job to source those ideas elsewhere, to pick the best ones, and to implement them. Does he have the self-confidence to be able to determine which ideas are the best, and then to stick to them through lots of criticism? He hasn’t shown it yet, but he must.


If the idea of Free Markets can mean that they sort themselves out eventually, then don’t we want someone in place who reacts to markets, rather than trying to anticipate (guess) at them?

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Tuesday links fail to reduce risk

Felix Salmon
Apr 21, 2009 22:48 UTC

A Central Clearing House Doesn’t Reduce CDS Risk: It’s talking about this paper. I think the key point here is that most non-CDS derivatives are traded over the counter, rather than through clearing houses. And as a result, a CDS clearing house might not result in as much of a reduction in counterparty risk as you might think.

The Close: I appear on Canada’s BNN to talk about where TARP money is going, and whether it should be paid back.

The US Singles Map: A very nice piece of information design.

America’s Newest Profession: Bloggers for Hire: A pretty awful column from Mark Penn, with lots of statistics, substantially all of which ultimately come from one Technorati survey which made no real attempts at statistical significance. I’d expect more from a pollster.

File No. S7-08-09: A fabulous letter to the SEC.


Re: Duffie and Zhu on CDS clearinghouse

Duffie and Zhu argue that a CDS clearinghouse, by removing (quite a bit of) CDS from current bilateral clearing agreements, may actually increase the net risks a bank faces if a counterparty defaults. Essentially their focus rests heavily on the dangers of a clearinghouse failure.

This is really a silly argument. The whole point of having a clearinghouse or exchange is that dealers are coming together to tax themselves to ensure that the market functions well. If the dealers are unwilling to put up the funds necessary to bailout the clearinghouse, then that is proof positive that the market is a negative sum game and does not deserve to exist in a market economy.

Yes, the government might have to bail out the clearinghouse temporarily — but there will also be no rational objection to the complete dissolution of the market after the government does so.

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