Felix Salmon

Catching up

Felix Salmon
May 18, 2009 13:46 UTC

So, what did I miss when I was off foraging for ramps (very successfully, I might add) in southern Vermont?

There was the big Geithner announcement about regulating OTC derivatives, of course, which is surely good news — much more constructive than simply trusting the market to get things right by setting up a central clearing house or three. The more information that regulators have about the size of net positions in the OTC market, the more alert to major systemic risks — like AIG — they will be.

David Reilly put out a column lazily conflating GM’s former employees with hedge-fund speculators, on the grounds that both of them can be considered to be “retirees”. Unhelpful.

Nicholas Carlson had some details of the proposed agreement between Google and the NYT, which looks very similar to the model of APIs and embeddable content that I’ve been quite enthusiastic about.

Vipal Monga has the details of the somewhat surprising bidding war which broke out between various financiers over whom would have the privilege of providing debtor-in-possession financing during the bankruptcy of General Growth Properties. When lenders are fighting with each other to provide credit to a shopping-mall operator, that’s surely good news.

More good news is coming from the bank funding market, where $24.6 billion of debt has been issued without government guarantees, compared to just $1.1 billion with guarantees.

And while I was walking in to the Reuters offices this morning, I passed an armed Wackenhut guard patrolling the street outside the new Bank of America tower. Which shocked me a little — I’m not used to seeing armed private security guards in New York, certainly not outside banks.

Anything else I should know?

How much is rebalancing worth?

Felix Salmon
May 18, 2009 00:41 UTC

A couple of weeks ago, Lance Knobel asked me what I thought of MarketRiders after reading Erick Schonfeld’s write-up. I kept on meaning to get around to it — you know how these things are — but before I could, Ron Lieber beat me to the punch. Ron says he likes the service, which basically keeps track of your ETF portfolio and tells you when it looks like it’s in need of a rebalancing.

I agree that it’s a useful service, but I’m not sure that it’s really worth $120 a year. For most of the people who will be using this service, the base-case scenario is that they simply buy up a bunch of index funds and then forget about them until the next point at which they have some money to invest, when they’ll probably throw that money into whatever pot looks most underweight at the time. Call it poor man’s rebalancing.

So the question is, how much value does active rebalancing add? I asked this a year ago, when three ETFs were launched which have a built-in rebalancing function, for which they charge 25bp per year. That seemed steep to me — but if you have less than $50,000 to invest, then you’d actually be better off paying 25bp a year than you would paying $9.99 a month.

I certainly don’t think that the rebalancing advice is worth more than 25bp a year, which means that I wouldn’t recommend MarketRiders to anybody with less than $50,000 in investable assets. But more generally I’d love to see some empirical data on the value of rebalancing, in basis points per year. Unless and until it becomes clear how much value it adds, I’d be hesitant to pay good money for the service.


Dear Felix,

You mention that an investor with less than $50K investable dollars should avoid the $100 annual MarketRiders’ fee (annual payment provides a discount on the $9.99 monthly subscription). This insight is spot on and is exactly what we state in our FAQs (http://www.marketriders.com/faq#10) under What Is The Minimum Size of a Portfolio. We provide a direct link to a target date fund which we believe is another good solution for such investors.


Stephen Beck

Hedge fund datapoint of the day

Felix Salmon
May 15, 2009 14:04 UTC

From Mark Gimein’s investigation of Paradigm:

An “Engagement Agreement” signed by Lotito, Jim Biden, and LBB Holdings, the partnership set up by the two Bidens and Lotito to buy Paradigm… promises James Biden and Lotito a “Placement Fee” of 10 percent of any money invested by clients they brought in.

Yes, you read that right. If James Biden were to bring in a $100 million pension-fund investment, a $10 million “placement fee” would be payable immediately.

In the end, no such fees were paid. But it gives you an idea of (a) how profitable hedge-fund investments are, for funds-of-funds; and (b) how big the incentives are for middlemen to go out and sell hedge funds to big investors.

A quick note on the yield curve for Alex Balk

Felix Salmon
May 13, 2009 04:08 UTC

Let’s say you have two apples. You’re scared of losing those apples, and you want to be sure that they’re absolutely safe. So you give them to the government, and in return the government promises to give you back two apples in a year’s time. You’re happy, and the government gets to eat your apples today, not worrying about paying you back until this time next year. So the government’s happy too. This is known as a “flat yield curve”, and it tends to happen when the economy is depressed and the general mood is rather grim.

Let’s say you have two apples. They’re delicious, and abundant, and you reckon that if you eat them now you’ll be full of vim and vigor and will have the wherewithal to find lots more apples if and when you need them in the future. So before you give the government your two apples today, the government needs to promise to give you back three apples in a year’s time. This is known as a “steep yield curve”, and it tends to happen when people are more optimistic about the future.

Caroline Baum says — rightly — that looking at the yield curve is a much better way of predicting the future than listening to economists. (Which isn’t saying much.) Right now, the yield curve is steepening quite dramatically, which Baum reckons constitutes a sign that “a proliferation of green shoots calmed investor fears of an endless dark winter”.

And what is Baum talking about when she says that between 2006 and 2008 the yield curve was inverted? Well, in cases like that, the yield curve is like a bowl of fruit. It’s great right now, and it’s a lovely day outside, and you’re rather hungry, and you have a bottle of Champagne open, and so if the government wants to take your fruit off you now and give you back a fresh bowl in a week’s time, that fresh bowl is going to have to be substantially bigger than the one you’ve got today.

On the other hand, if the government wants to swap your bowl of fruit today for an identically-sized and just as tasty bowl of fruit all the way out on Christmas Day, then you’d be more interested. You know it’s going to be cold at Christmas, and you know that you’re really going to value that fruit a lot, because fruit won’t be as abundant then as it is now.

So while the yield curve is steep between now and one week, it’s flat between now and Christmas. That’s known as an “inverted yield curve”, and it’s often a sign that things are going to get worse.

On which note I’m going to sign off for the rest of the week. There might be the occasional posting, but nothing regular: I plan to be stomping around fields in Vermont and admiring lines on walls in North Adams. No major bank failures while I’m gone, you hear?


It’s one thing risking your own cash in the markets, but quite another risking other people’s money.

Most banks control funds that belong to the general public. They don’t have any business taking huge risks and Main Street has a right to their retirement which they earned.

Capitalism isn’t inherently evil, it is the greed that comes with it that needs to be regulated. If unchecked, stratification will become a giant problem. The ruling class cannot continue to step on the working class.

Tuesday links have second thoughts

Felix Salmon
May 12, 2009 19:58 UTC

Bank of America to take Merrill public? Buying it was a pretty bad idea, so maybe selling it will work better!

Dire data sparks anxiety over Lativa outlook: The economy shrank by 18% in Q1. Default looms.

Stanford Financial Group Chief Investment Officer Charged with Obstruction of Justice: It’s official, although really there’s nothing new here.


maybe in 5-7 years Merrill Lynch can be spun off. While BAC’s problems are well-known, it seems easily ignored they also own a nice %% of Blackrock (second to PIMCO in bond assets under management).

Posted by Griff | Report as abusive

Blaming CDS holders for a GM bankruptcy

Felix Salmon
May 12, 2009 19:50 UTC

The FT leads with a bold headline today: “Credit insurance hampers GM restructuring”. But the story itself is puzzling:

Analysts say the chances the proposal will be accepted have been diminished by the large number of credit default swap (CDS) contracts written on GM’s debt.

Holders of such swaps would be paid in the event of a default – but would lose money if they agreed to restructure GM’s debt. For investors who own bonds and CDS, this could create an incentive to favour a bankruptcy filing.

According to the Depository Trust & Clearing Corporation, investors hold $34bn in CDS on GM. Once off-setting positions are considered, the DTCC estimates CDS holders would make a net profit of $2.4bn if GM were to default.

The opposition of 10 per cent of bondholders is enough to derail the proposal, which has already triggered protests from investors who argue it unfairly rewards the UAW at the expense of bondholders.

“You have every incentive not to agree,” said one bondholder, a large credit hedge fund. “You would be locking in a loss if you did. It isn’t only the ‘shark’ capital; it will be the mom and pop mutual funds who will oppose this deal. ”

I’m not an expert on how GM CDSs have been written, but I’m dubious when it comes to the implication here that this restructuring will in general not count as a credit event for CDS purposes.

In general, my argument is that if bondholders have hedged their position with CDS, then they don’t particularly care whether or not a company goes into bankruptcy, and therefore are unlikely to expend much effort when it comes to avoiding bankruptcy. Since the costs of bankruptcy are generally high, this is at the margin a bad thing.

The FT story, however, goes much further, and says that holders of GM CDS have an outright incentive to prefer bankruptcy to a restructuring, and will “make a net profit” of billions of dollars if that happens.

It’s an interesting use of the word “net”, since it ignores the fact that net profit of a CDS transaction is always zero, with protection sellers losing exactly as much as protection buyers gain. If the protection buyers really have an incentive to see GM go into bankruptcy, then the protection sellers have an equal and opposite incentive to buy up their bonds and vote the other way.

Of course, it’s all pretty moot: GM is inevitably going into BK, CDS or no CDS. And it’s conceivable that a GM bankruptcy, like the Chrysler bankruptcy, might even be a good thing. But that assumes that a GM bankruptcy will cut like Alexander through the Gordian knot of contracts and competing claims in a swift and clean manner. And the probability of that happening is surely slim, the best efforts of Steve Rattner notwithstanding.

So while I’m sympathetic to the idea that credit default swaps make bankruptcies more likely, I don’t frankly think they’re going to make all that much of a difference one way or the other when it comes to GM, especially given that a bankruptcy is sure to happen in any event.

Update: Stephen Lubben rides to my rescue to explain the nitty-gritty of why a restructuring would probably not be a credit event for these CDS.


I think bankruptcy is the right way to go, but not the way the Administration wants it to go. It should be a disconcerting fact that in both the Chrysler and GM bankruptcies, the Administration is pushing senior bondholders to take well less than they are legally entitled. Secured creditors should be paid the full amount, according to the rule of absolute priority. Additionally, the UAW and government are getting the lion’s share.

I read a very good article with a humorous title, “Goodbye GM, Hello People’s Car” at http://economicefficiency.blogspot.com/2 009/05/good-bye-gm-hello-peoples-car.htm l

My other great concern is that GM is going to be used as a policy tool and not as a private business. There have already been claims from the Administration that the focus is going to be on small, hybrid cars, while trucks and SUVs have the highest profit margins. Is Obama the new Clement Attlee?

How to cure a municipal bond default with terrorists

Felix Salmon
May 12, 2009 19:16 UTC

Becky Shay reports on an empty prison in Montana:

The $27 million facility, which was built with revenue bonds, went into default last year. Bond payments are being made out of a reserve fund, which will have to be replenished and payments made, once revenue starts.

Smith said the bond holders are sticking with the project because the long-term risk outweighs selling the facility for cents-on-the-dollar in foreclosure.

Smith and others continue to look for out-of-state contracts, including a multiyear deal with Alaska, which is looking for space as its contract to house prisoners in Arizona comes to an end.

As part of the search for contracts, TRA’s board and the Hardin City Council decided – both unanimously – to seek the Guantanamo detainees.

Clearly the US government shouldn’t even be thinking about sending the Gitmo prisoners back to Yemen. After all, there are foreclosures to avoid right here in Montana!


montana? isn’t that cruel and unusual? i doubt the red cross will even be willing to send inspectors there.

Posted by master yada | Report as abusive

How much cap-and-trade is politically feasible?

Felix Salmon
May 12, 2009 16:17 UTC

John Kemp has a great column today on the politics of cap-and-trade in America. This is particularly interesting:

The White House included revenues from permit sales in its budget plan for symbolic reasons — to show it was committed to implementing cap-and-trade; it would spend the political capital needed to get legislation through Congress; to showcase the benefits auctions could bring; and to show how low-income groups could be protected against the impact of rising permit and energy prices by redistributing the proceeds.

But officials have been careful not to rely on the anticipated revenues too heavily. The president’s plan allocates the money to discrete tax breaks and research spending rather than general government revenues. If the permit revenues do not materialize, the tax breaks and research funding will be cancelled, and there will be no implications for the deficit.

The big picture here, in other words, is unchanged: you do what’s possible. A cap-and-trade bill is possible while a carbon-tax bill is not possible, so you do a cap-and-trade bill. A 100% auction cap-and-trade bill, as promised by Obama during the election campaign, is not possible, so you give away emissions permits at the beginning and then dial them back over as long as 10-15 years.

All of this is fine, as Kemp says, just so long as it’s automatic — ie, that Congress won’t have to vote again in order for the move to a 100% auction system to be completed. And just so long as the caps are inviolable, regardless of how many of the emissions permits are given away and how many are auctioned.

I’m cautiously optimistic that something can be cobbled together, and that it will create an infrastructure which can be fine-tuned in the future. But of course I’d be much happier if we could start with a 100% auction system on day one, as happened with RGGI. Obama has a strong mandate, it seems, but unfortunately it’s not that strong.


Democrats are beginning to sour on the idea of Cap and Trade. Like I, Britt Borden stated above, having killed of nuclear energy many moderate democrats are now afraid to embrace cap and trade.

Posted by Dr Britt Borden MD | Report as abusive

How we super-seniored the entire financial system

Felix Salmon
May 12, 2009 15:27 UTC

Gillian Tett was just in the office to talk about her new book; I interviewed her for Reuters TV, and the results should be up soon. But we got to chatting afterwards, and she made a great point which we didn’t cover in the more formal interview and which she says she would have liked to have put in her book. But since it’s not there, I can at least put it on YouTube. She talks about the Bistro deal (see Jesse for background on that), and how it can be seen as a metaphor for the financial system more generally:

The point is similar to the one I made in my speech to the regional bond dealers: we were far too worried about risk, and not nearly worried enough about safety. And really it was the insatiable demand for safety in general, and triple-A risk in particular, which caused this financial crisis.


In the typical usage, which I can’t guarantee Tett is using as I haven’t watched the video yet, it doesn’t matter what size the first loss piece is specifically. What matters is that the super senior tranche is senior to another tranche that is rated AAA. Basically You need enough subordination or other credit enhancement for AAA, and then some more. So you could have a tiny first loss piece, then a second loss, third loss and so on, provided that below the super senior piece, there’s a AAA one. Obviously, the “thicker” the AAA tranche, the sounder your super seniority – although as we all discovered, if correlations are high, it doesn’t make much difference.

Posted by Ginger Yellow | Report as abusive