Felix Salmon

Whither new car sales?

Felix Salmon
May 31, 2009 16:53 UTC

The NYT has an interesting chart showing light-vehicle sales, on a seasonally-adjusted annual basis, every month since 1976. The chart would seem to imply that a large uptick in vehicle sales is in the offing. But there’s one other chart I would like to see total cars per household (or per person) in the US. Was there a significant increase in cars per household as America suburbanized and moved into bigger homes with bigger garages? And if we’ve reached a far-too-high number of cars per household, how long will new-car sales have to remain near current levels before we get back down to a “new normal”?

I think that when auto financing becomes broadly available once again, the number of new-car sales is bound to rise. But those new cars might well be smaller and less profitable than the SUVs of the past decade. I suspect that much of the boom in SUV sales was a function of everybody else buying SUVs: it’s much more pleasant to drive a small car in Europe, surrounded by other small cars, than it is to drive a small car in the US, surrounded by SUVs which you can’t see around and which tower menacingly over you.

What happens to car sales when the getting-bigger trend comes to an end — as it must — and starts to reverse course? For one thing, the desire to upgrade to a bigger car starts to dissipate. And if you’re not going to upgrade to a bigger car, why buy a new car at all?


Automobiles today come in enough sizes and shapes to meet just about any consumer’s demand. This may be a luxury, but it can also make choosing the right vehicle a tough decision. This choice often boils down to the size of the vehicle, and this is completely up to any owner’s preference. When purchasing car, you can refer to class-leading dealer websites for information; some of these websites provide good information for your needs. As e-commerce systems continue to develop, they progress at an accelerated pace to meet our expectations and increase efficiency.


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Where should mutual funds invest their repo collateral?

Felix Salmon
May 31, 2009 15:53 UTC

Jason Zweig is the lastest person to decide that the financial sector should take less risk. After looking at mutual fund practices when it comes to securities lending, he concludes:

Your fund should lend out your securities, but the proceeds should go to you. And fund managers should reinvest the collateral only in absolutely safe securities. The current system, where they keep half the gains and stick you with all the risks, has got to go.

He’s right that funds should lend out securities, he’s right that the proceeds should go to investors, and he’s right that the current system is broken. He’s absolutely wrong, however, about the “absolutely safe securities”.

Investing in absolutely safe securities is something of an oxymoron: if they’re absolutely safe, it’s not really investing. Investing is meant to be the means by which capital gets allocated to where it can be most used efficiently. Securities lending is an important part of that process, since without it shorting stocks would be almost impossible, and as a result there would be less liquidity and the price discovery process would be damaged.

Mutual funds are also an important part of the capital-allocation process, since they’re actually paid to assess and take risks with investable capital. Consequently, it’s ridiculous that a mutual fund — pretty much the definition of an active risk-taker — should be shunning all conceivable risk when it comes to investing repo collateral.

The only “absolutely safe securities” are short-dated Treasury bills, and the last thing we need is an institutionalized flight to quality whereby every repo transaction involves an uptick in demand for short-term government debt. After all, we’re meant to be getting credit flowing again — and short-dated credit securities are far less risky than the equities in which most mutual funds are paid to invest. So let’s have mutual fund companies taking small and sensible risks with their repo collateral: it’ll be much better for all of us.


Felix, it’s a question of getting the risks that you want to take. Why should I find out that I lost money on subprime ABS, when I thought I was buying a stock fund? Unless it is prominently disclosed that they are taking abnormal fixed income risks — warning kids, don’t try this at home — they should stick with safe, vanilla collateral.

Harvard datapoint of the day

Felix Salmon
May 31, 2009 01:45 UTC

Richard Bradley reports:

Harvard has already halted the hiring of junior faculty and announced an early retirement program for tenured professors, and for the first time ever is considering laying off tenured professors.

And why might Harvard be laying off tenured professors? Because it’s down to its last $25 billion, of course.

Bradley adds a bit to what we know about Harvard’s financial mismanagement:

According to the university’s 2008 financial report, in the next 10 years it must pay various private investors some $11 billion in capital commitments. Where will that money come from if, as seems likely, endowment growth over those years is minimal or nonexistent, and alumni’s own strained budgets limit their generosity?

These are the famous capital calls from Harvard’s private-equity investments, which previous HMC managers assumed could be met out of earlier private-equity payouts. Or something. But now — and for the foreseeable future — Harvard is facing a massive liquidity crunch:

HMC “took the university right to the edge of the abyss,” one alumnus, a financier who is privy to details of the university’s balance sheet, told me. I asked what he meant. “Meaning, you’re out of cash.

“That,” he added, “is the definition of insolvency.”

Er no, actually it’s the definition of illiquidity, but never mind. The point is that Harvard has run out of liquid assets, and that’s going to have huge effects on its institutional psyche — and possibly even on the job security of tenured professors. My guess is though that no one with tenure will be laid off involuntarily.

And maybe Harvard’s alumni might start giving a lot more now than they have in the past. After all, until recently, any giving from alumni was dwarfed by the investment gains of the endowment, and so the incentive to add another drop to the bucket was greatly reduced. Now, by contrast, cash from alumni is desperately needed to meet the university’s annual liquidity requirements. It might even feel better, giving money when you know it’s going to actually be spent, rather than giving money simply to augment some gargantuan endowment.



First to conflate Yale and Harvard is not thinking properly– different situations since Harvard had a huge change in managers that affected their situation. Second, if Swensen were an awful, greedy s.o.b. like you suggest he would have bailed on Yale along time ago and made a lot more than his current salary. Is his compensation a lot? Yes, and he acknowledges it, but if he were as you suggested (just in it for a buck) he would have left Yale to go into Private Money Management and made a hell of a lot more. Additionally, his pay was significantly less than the pay of his Harvard peers…

Lessons from Ecuador’s bond default

Felix Salmon
May 29, 2009 21:05 UTC

EMTA, formerly the Emerging Markets Traders Association, had an interesting panel on the Ecuador default today. It was a bit lopsided: no one on the debtor side — and EMTA invited the country’s own representatives, as well as its lawyers and bankers, and even the US Treasury — would agree to attend. As such, it was really a panel of private-sector participants, and felt much like a wake: it was clear that with the success of Ecuador’s exchange offer, the country has won and the private sector has lost.

In the long term, of course, Ecuador might not have benefitted all that much from its antics: Erich Arispe, of Fitch Ratings, pointed out that the country is paying out much more in cash payments for its bonds than it would have had to pay over the next couple of years in coupon payments. On top of that, Ecuador is racking up lots of new debt to multilateral institutions like the Andean Development Fund and the Inter-American Development Bank, so even its fiscal position isn’t really improving.

But in the short term, Ecuador has elegantly managed to buy back a very large chunk of its debt at just 35 cents on the dollar. Old Ecuador hand Hans Humes, of Greylock Capital, summed up how spectacularly successful the Ecuador strategy was, calling it “one of the most elegant restructurings that I’ve seen”.

In hindsight, the deal could hardly have been done any better. First and most important was the matter of timing: as all the panelists agreed, there’s no way that Ecuador could have pulled this stunt in 2006 or even the first half of 2007. But the country was playing the long game: president Rafael Correa was elected president, on a platform which included debt repudiation, in January 2007; Ecuador’s clear intention to default on its debt earned it a pretty much immediate CCC rating from Fitch. Yet the default didn’t happen until December 2008, almost two full years after Correa’s election.

The wait turned out to be the best thing that Ecuador could have done, because in the interim the global debt markets were plunged into turmoil. And Correa didn’t pull the trigger until he could see the whites of his opponents eyes: he announced that he was defaulting on the 2012 global bonds at exactly the time that three huge hedge funds, which held Ecuador’s debt, were being forced by their prime brokers to liquidate their holdings. As a result, the selling pressure on Ecuadorean bonds sent them tumbling from the 70s to the 20s almost overnight.

They would have fallen further, into the waiting arms of a small army of hungry vulture funds eager to get back into the distressed-debt game after many years essentially being priced out of it. But then Ecuador pulled its next smart stunt: it used Banco del Pacifico, a large Ecuadorean bank, to start buying bonds at levels above 20 cents on the dollar. That was just high enough that the vultures didn’t want to amass a large position, and ensured that any future restructuring would face little organized opposition just because Ecuador’s bondholders were so fragmented.

Ecuador’s next clever step was to pay cash for its defaulted bonds, rather than trying to do a bond exchange. That meant that it didn’t need to go through a laborious SEC registration process, during which the legality of the Banco Pacifico stunt would surely have been questioned. And its final clever step was not to put forward a take-it-or-leave-it offer, as Argentina did, which would allow bondholders to agitate for a mass “no” vote. Instead, they just asked bondholders to name their price.

Of course that’s what the bondholders did. None of them wanted to be left as holdouts, given the ease with which Ecuador could change the covenants on the bonds, and also the fact that they hadn’t even managed to accelerate the 2030 global bonds by the time the default happened.

Joe Kogan of Barclays Capital said that bondholders’ inability to accelerate the 30s doesn’t just show a collective action problem. “It demonstrates that people weren’t really willing to hold on to the bonds, and that the original investors who had these bonds were trying to get rid of them,” he said: no one, in the present environment, had any appetite at all for litigation which could drag out for years.

No one expected Ecuador to pull this particular rabbit out of the hat. The country has a reputation for utter incompetence when it comes to fiscal matters, and a few months ago it fired its highly-respected and long-standing legal counsel, Cleary Gottlieb. Somehow, however, this exchange offer was probably the most successful and least fraught debt restructuring in the history of Latin American sovereign defaults.

The multilaterals played their part, by condoning Ecuador’s actions and basically taking its side, despite the fact that the country had no fiscal need to default. And Argentina, weirdly, helped too: holdouts there have got very little to show for their litigation to date, and indeed Argentina was found in contempt of court in New York this week for basically ignoring a judge’s orders to keep certain funds in the US. It was a legal victory for bondholders, but won’t help them get any richer.

And of course it also helped that Ecuador was so small. Even with the bonds at par, they accounted for only about 0.5% of the emerging-market index, which means that at this year’s prices Ecuador constituted about one quarter of one percent of a diversified EM portfolio. You could fight them, but when your portfolio is down 20% for other reasons, what’s the point.

Kogan was sanguine on the question of whether Ecuador’s default would spill over into other emerging-market sovereigns. Most countries with bonds outstanding have some kind of access to the bond market, he pointed out; Ecuador hasn’t been able to issue debt in years, so losing access was no big deal for Ecuador, as it would be for most other countries. Ecuador also isn’t going to suffer as much in terms of economic costs as other countries might — its corporations aren’t going to lose bond-market access either (because they never had access) and it’s not going to suffer a bout of hyperinflation, because it’s dollarized. And although the last Ecuadorean president to default did immediately get kicked out of office, this one was re-elected comfortably, so there aren’t the kind of political costs that you’d expect in other countries. The only real new costs to Ecuador might come in a few years, if holdouts manage to attach Ecuador’s oil exports in one way or another — but given the success of the exchange offer, there probably won’t be any holdouts, or Ecuador could continue to pay them their coupons, just as it’s continuing to pay the coupons on its old Brady bonds which weren’t tendered into the 2000 exchange.

Hans Humes, however, was more worried about Ecuador setting a precedent. “As much as we can say this is an outlier, any country which runs into trouble has a great blueprint now of how to do it,” he said. The last time Ecuador defaulted, it was reasonably constructive, at least in hindsight: it hired Cleary Gottlieb, a big financial-markets law firm, it entered into dialogue with creditors including the Dart family, and it was criticized in some quarters for paying too much to bondholders rather than too little. No one can accuse it of that this time around.

“The world has changed,” said Humes — we’re now living in a world where not only Ecuador can default, but Iceland can default as well. And that’s a world where defaults by small emerging-market countries simply don’t have the systemic consequences that everybody thought they might have. I even heard Humes say something I never thought I’d hear a died-in-the-wool buy-sider like him say: “Maybe,” he said, the solution to “go back to Anne Krueger’s model”

He was referring to SDRM, the attempt by then IMF first deputy managing director Anne Krueger to create a sovereign bankruptcy court. Not a single private-sector player thought this was a good idea, as far as I could tell, and certainly no one on the buy side had any time for the idea. But now, it’s clearly better than nothing — and nothing is what bondholders are ending up with these days. “The official sector’s already beaten us,” said Humes. If you’re going to capitulate to Ecuador, then capitulating to the IMF is easy in comparison.


we are going to litigate
please contact danielfranciscomontero@hotmail.com

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When sovereigns selectively default

Felix Salmon
May 29, 2009 15:01 UTC

I’ve lost count of how many times I’ve recommended James Macdonald’s excellent book A Free Nation Deep in Debt: The Financial Roots of Democracy to people interested in the connections between democracy, development, and debt capital markets. So I’m very chuffed that Macdonald has popped up in the comments on this blog to talk about the historical precedents behind Ecuador’s decision to repudiate some of its old debts, while staying current on certain of its newer debts.

His comment is, naturally, worth quoting in full:

One of the interesting features of this default is the revival of the idea of different treatments accorded to different types of debt. There is a long history of such practice. The main purpose has always been to gain the short-term cost benefits of default without incurring the lont-term penalty of reduced access to the credit markets.

In this case, the regime treats its own debts as legitimate while treating those of its predecessors as illegitimate (or at least less legitimate). Eighteenth- century France used a different technique: treating previously defaulted debts as immune to further write-downs, while more recent debts were viewed as fair targets for default because their interest rates were, not surprisingly, considerably higher and could therefore be deemed usurious.

After the Napoleonic War, France finally became a reliable borrower, and one of the main demonstrations of this was honoring the Napoleonic debts in spite of the temptation to repudiate them. It was argued at the time that this was not merely a matter of good faith, but rather an unavoidable price for access to the credit markets on favorable terms as enjoyed by Great Britain.

To my mind, this remains a valid argument. Historically, default almost always had a negative short-term cost – it certainly did so on for France before 1815. The regime always had access to new loans after each bankruptcy; but its access to credit was limited by its previous track record. Attempting to justify its actions by differentiating between types of debt did not fool creditors. They may have continued to lend, but always at rates that factored in the risk of default, and in amounts considerably lower than they were willing to lend to Great Britain.

Just because Ecuador currently experiences a short-term gain will not turn it into a good credit risk. Only paying debts regardless of short-term incentives to default will remove it from the vicious cycle of borrowing and default which has mired Ecuadorean (and Latin American) history since liberation from Spain.

Madonald is right, of course, but it’s also worth noting that “the idea of different treatments accorded to different types of debt” is not something old which is being rediscovered — in many ways it never went away. The international community, including established debtor nations like France and the UK, even enshrined it in the concept of “preferred creditor status” — the idea that the IMF and the World Bank should always be senior to bondholders. And the Brady plan was basically a plan to turn sovereign loans into sovereign bonds on the grounds that while lots of countries had defaulted on their bank loans, none had defaulted on their global bonds, and as a result global bonds were considered safer or more senior than bank loans.

Anna Gelpern has written extensively about this issue: the big difference between sovereigns and corporates is basically that sovereigns are constructively ambiguous about which debts they consider senior to which other debts. “Sovereign immunity,” she writes, “empowers a government to choose the order of repayment among its creditors based on political imperatives, financing needs, reputational concerns or any other considerations”. The answer to this problem is not the idea that all governments should always pay all their debts in full — after all, sovereign credit risk has always existed and will always exist. Instead, a more formal system of transparent and enforceable seniority could make debt markets more efficient and debt restructurings less ugly.

For the time being, however, if and when there’s another wave of sovereign defaults, it’ll be largely up to each individual country which debts they choose to default on. Will it be foreign-currency debts, like Argentina, or domestic-currency debts, like Russia? Will it be bonds, or loans, or both? What will they do with trade finance and other vital short-term credit lines? And where will the multilaterals stand? No one ever knows, until the default actually happens.

Update: Yet more from Macdonald in the comments.


Two typos here, lont and “did so on for France”. Please quote the man correctly, or use an editor.


lont-term penalty of reduced access to the credit markets.

In this case, the regime treats its own debts as legitimate while treating those of its predecessors as illegitimate (or at least less legitimate). Eighteenth- century France used a different technique: treating previously defaulted debts as immune to further write-downs, while more recent debts were viewed as fair targets for default because their interest rates were, not surprisingly, considerably higher and could therefore be deemed usurious.

After the Napoleonic War, France finally became a reliable borrower, and one of the main demonstrations of this was honoring the Napoleonic debts in spite of the temptation to repudiate them. It was argued at the time that this was not merely a matter of good faith, but rather an unavoidable price for access to the credit markets on favorable terms as enjoyed by Great Britain.

To my mind, this remains a valid argument. Historically, default almost always had a negative short-term cost – it certainly lont-term penalty of reduced access to the credit markets.

In this case, the regime treats its own debts as legitimate while treating those of its predecessors as illegitimate (or at least less legitimate). Eighteenth- century France used a different technique: treating previously defaulted debts as immune to further write-downs, while more recent debts were viewed as fair targets for default because their interest rates were, not surprisingly, considerably higher and could therefore be deemed usurious.

After the Napoleonic War, France finally became a reliable borrower, and one of the main demonstrations of this was honoring the Napoleonic debts in spite of the temptation to repudiate them. It was argued at the time that this was not merely a matter of good faith, but rather an unavoidable price for access to the credit markets on favorable terms as enjoyed by Great Britain.

To my mind, this remains a valid argument. Historically, default almost always had a negative short-term cost – it certainly did so on for France before 1815. before 1815.

Why the government shouldn’t insure securitized assets

Felix Salmon
May 29, 2009 14:14 UTC

Ezra Klein does us all a favor this morning by spending 1,000 words or so summarizing a 20,000-word, 53-page paper by Yale’s Gary Gorton. Now to make it even shorter!

The key concept is the distinction between informationally-sensitive financial assets — assets which change in price when new information emerges — and informationally-insensitive financial assets — assets which don’t change in price when new information emerges. In the latter bucket we can include insured bank deposits, but bank deposits are insured only up to $250,000, and there are a lot of companies and other institutional investors who just want a safe place to park their cash and are also on the hunt for informationally-insensitive assets.

They found them — or thought they found them — in things like asset-backed commercial paper: they would hand over cash, and receive the senior tranches of securitized loans as collateral. When that happens, writes Gorton,

A ‘banking panic’ occurs when ‘informationally-insensitive’ debt becomes ‘informationally-sensitive’ due to a shock, in this case the shock to subprime mortgage values due to house prices falling.

Gorton’s solution to this problem is to involve the government in all manner of regulation — and insurance — of the securitization market, thereby making ABCP behave much like federally-insured bank deposits. I don’t like this solution at all, since it would send the contingent liabilities of the government into the stratosphere, and more importantly would ratify the demand for informationally-insensitive assets by creating trillions of dollars of new ones.

In my view of the crisis, it’s precisely the demand for informationally-insensitive assets which is the problem. And we need to get individuals, companies, and institutional investors out of the mindset that they can do an elegant little two-step around the inescapable fact that anybody with money to invest perforce must take a certain amount of risk. If you have a world where people are all looking for risk-free assets, you end up shunting all that risk into the tails. And the way to reduce tail risk is to get everybody to accept a small amount of risk on an everyday basis. We don’t need more informationally-insensitive assets, we need less of them.


Well we’ve been here before in near the start of the last century. Admittedly there are more extravagant financial instruments that control our economy now, but the underlying cause is the same – risk assessment. The government should insure securetised assets. Moreover their risk assessment will surely result in a fee which is beneficial to the tax payer while also essential to reinstill confidence in the market. The market is now forced to review their attitude to risk whether it’s through legislation or their own board. In fact further legislation at this time is just going to cause more problems at the consumer end of the market, through increased costs of the institutions. It’s times like this the short term of goverment is a real problem with inaction being seen as an election loser.

Dinallo hands an opportunity to Geithner

Felix Salmon
May 29, 2009 12:31 UTC

If Andrew Cuomo tries to become the next governor of New York State — which he almost certainly will — then his current job, attorney general, will open up. And Eric Dinallo almost certainly wants it.

I like two aspects of Dinallo’s decision to step down from his post as New York’s insurance superintendent. The first is the fact that he’s doing it at all: there’s technically no need for him to resign first before running for AG. But clearly a big political campaign would detract from the amount of time and attention he could devote to the insurance industry, and it’s the responsible thing to do.

More interestingly, Dinallo’s resignation temporarily leaves the country without a strong insurance regulator — and that, in turn, should make it much easier for Tim Geithner to push through plans to rationalize the nightmare that is insurance regulation, and bring America’s insurers under one federal regulatory umbrella.

A lot of the consumer-facing aspects of the insurance industry properly should be regulated by a new financial products safety commission: things like variable annuities, in particular, can come close to being predatory, and it’s high time that a regulator with teeth put an end to the sale of the most egregious products. Now would be a great time to introduce legislation creating such a body, and slashing the number of regulators in Washington. If Geithner waits much longer, he’ll only give the entities to be abolished more time to put together a strategy for defeating his bill.


While I don’t disagree that consumer regulation of variable annuities should be enhanced, I worry that the one entity which has solid risk management–insurance–may be under a Federal umbrella.

Only a third of the actuarial exams are dedicated to the math–the rest are public policy, history and law. When an actuary becomes a fellow, he knows that the only difference between a Ponzi scheme and an insurance reserve is the actuary. Further, the threat of 50 insurance commissioners–not all of them powerful, I grant you, and generally there is a standard form which most follow, as well as one or two trend-setting states like California and Texas and New York. Still, the threat of actuarial review for each product from multiple states sets a discipline in the insurance risk management world that has no equivalent in the financial engineering world. And until those standards become realized, we should maintain an example of good risk management somewhere in the financial services world. After all, aside from AIG, the insurance industry has been a pretty good example of risk management.

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Thursday links get their full URLs back

Felix Salmon
May 28, 2009 21:26 UTC

How government is helping drive entrepeneurship — not. Then again, what do you expect from NY State.

Is the Dow up 8, or is it down 43? Who cares? Not CNBC.

U.S. mortgage mess worsens

The difficulty of preserving private capital

Felix Salmon
May 28, 2009 21:12 UTC

Most of the attention being paid to yesterday’s Ira Sohn conference seems to concentrate on David Einhorn, with his quite compelling idea that a triple-A rating is a curse, and that therefore Moody’s, whose highest praise is to bestow a triple-A rating on a company, is in for a world of pain.

But looking at Mike O’Rourke’s summary of the conference (embedded below), I was struck by comments from Paul Singer, of Elliott Associates:

Singer discussed the rule of law. He noted it is devilishly hard to preserve private capital for a long time. Rule of law is a necessary but not sufficient condition. The color of money can change over time.

This is very true. An enormous number of families have become dynastically wealthy over the centuries; precious few have managed to remain so over many generations, even if they implement harsh and unfair rules like giving substantially everything to the first-born son.

The families which have done very well over the course of centuries — the Hapsburgs, perhaps, or the Rothschilds — carry more than a whiff of helping to write the rules of the game themselves, as opposed to leaving themselves open to the caprice of others. And for all the thought experiments saying “if you put $1 in a bank account paying 1% interest in the year X, it would be worth $Y today”, the fact is that in most cases Y is zero — your money would have been taken from you, in one way or another, by now.

That probably helps explain, at least in part, why Paul Singer and his ilk spend extremely large amounts of money on political lobbying. But it should also be sobering to anybody who thinks that a passive buy-and-hold investment strategy will work over the really long term — not only into your own retirement, but even unto your children’s and grandchildren’s retirement. If you have that kind of time horizon, a whole new set of geopolitical risks starts coming into play — all empires fall, after all, and being in one of those empires when it’s falling can be extremely hazardous to your wealth. Which is maybe why family offices can spend two years searching for exactly the right person to hire.


The Grosvenor family is descended from Raoul Le Veneur who shot the arrow that pierced King Harold’s eye during the Battle of Hastings and saved William the Conqueror’s life. There are many names including: Fenner, Venner, Vennor, Le Venables, Le Gros Veneur that are derivatives of the name. The name, Le Gros Veneur, meant the great hunter and not fat hunter because of the skill involved with the longbow. I am an ancestor of this family.
Susan Fenner Latshaw

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