Felix Salmon

Clinton’s apology

Felix Salmon
May 28, 2009 19:47 UTC

I’ve been searching for a while for a key policymaker of the bubble years to come out and apologize for his mistakes, and of all people it seems that Bill Clinton has managed to be first across that particular line. “I should have raised more hell about derivatives being unregulated,” he tells Peter Baker — and he’s absolutely right. Would that Alan Greenspan or Bob Rubin or Larry Summers could say the same thing — especially in the light of the revelations from Brooksley Born, the former head of the CFTC, about the way in which they actively agitated to keep derivatives unregulated.

Incidentally, for those of us who have sometimes suspected that Clinton has a brain the size of a planet and knows everything, this brings him back into the realm of the human:

Mr. CLINTON: You remember we had one institution failed that the New York Fed had to bail out. It had some derivative investments and it went down. Do you remember that?


Mr. CLINTON: What was the name of that? There was a bank that failed that the New York Fed bailed out an institution that had some derivative exposure? And so I talked with them.

NEW YORK TIMES: In ‘98-ish?

Mr. CLINTON: Yeah.

I’m almost positive he’s talking about LTCM here, which wasn’t a bank and which wasn’t really bailed out by the Fed — the Fed just knocked a bunch of bankers’ heads together until they agreed to bail it out themselves. But of course it wasn’t Clinton’s job to understand the ramifications of the LTCM crisis, it was his Treasury secretary’s job. And his Treasury secretaries signally failed to grok that, LTCM notwithstanding, there were massive and growing systemic risks in the financial sector generally and at highly-leveraged institutions in particular. When will they say sorry?


Hierarchical lender of last resort actions by the Fed are still bail outs. They’ve been doing them since at least the early seventies when the banks bailed out the REITS. I count it as a bailout since the banks ultimately are relying on the Fed as their backstop.
It’s pernicious because it’s a stealth(ish) bailout that pretends to validate market actions and encourages risk taking without a transparent debate about the building underlying risks.

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Circulation datapoint of the day

Felix Salmon
May 28, 2009 18:22 UTC

Total circulation of WWD: 46,728

Total unique visitors to WWD.com: 355,000

Total followers of WWD’s Twitter: 536,000


Thanks for pointing to this, Felix.

This is a great demonstration of

1) why otherwise good businesspeople buy moneylosing magazines
2) why I’ve watched product marketing people make entire careers of telling senior executives that they can curry favor with “key influencers.”

I’ve never been convinced of the validity of either strategy, but I’ve never seen a more concrete example of the concentric circles of “influence” from a subject matter expert. I wonder if you could repeat this pattern from, say, Wired.

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Credit card defaulters of the day, Dubai edition

Felix Salmon
May 28, 2009 16:09 UTC

The flipside of all those abandoned cars at Dubai airport — assets left behind by foreigners leaving the country for good — is the abandoned liabilities they’ve left behind on their credit cards:

Some UAE banks are seeing up to 2,500 customers leave the country every month without paying off their credit card bills, a number that could rise in June, a senior RAK Bank official said on Sunday…

RAK Bank recovers around a quarter of the debt that goes unpaid as a result of one of the customers leaving the country, Martin said.

I’m surprised the recovery rate in these cases is as high as 25%, frankly: chasing down debtors who live abroad is non-trivial and always expensive. But then again, I’m sure that many of the credit card balances in question are pretty enormous: as Julie Sherrier notes, Dubai is known as something of a shoppers’ paradise. If the credit card debt rises into six figures, which I’m sure it does on occasion, it’s be worth fighting for.


Credit card defaulting is not the wish of any bank customer who has spent the full limit on the card in UAE. New bank customers who cash the whole amount on their cards and leave the country immediately are the ones the bank should have tough measures on. In some cases, customers have left small amounts on their cards and due to job loss, expensive housing and life in general find they only have to leave the country as the little they are having at hand after a job loss cannot sustain them whatsoever. The reason as to why a bank can get working visas rejected for defaulting customers is never understood because how will they ever make it to repay their debts. Some one better get reality working to these kind of banks. Have a day free of debts!!

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What use economic history?

Felix Salmon
May 28, 2009 14:46 UTC

In the blogosphere, 2=trend, and recently two high-profile financial journalists — Alan Beattie of the FT and Justin Fox of Time — have come out with heavyweight new books of economic history. Beattie’s False Economy looks at global development, while Fox’s The Myth of the Rational Market looks at the history of the efficient markets hypothesis. What I didn’t know until today was that Beattie and Fox are both distant relatives of misguided liquidationists — something which came out when I asked them both about economic history.

How relevant is economic history at times like this, I asked. Can studying history prevent us from repeating past mistakes, or does it just end up forcing us into committing new ones? And how much of a good thing is it that an economic historian is chairman of the board of governors of the Federal Reserve?

Beattie replied first:

- yes, I think it definitely helps when looking at such once-in-a-century events to have a discipline which focuses on specific similar episodes in the past, not least because the sample size is so small. And that does seem to be having some effect on the policy response now. Despite the best efforts of some, I don’t think the Montagu Norman/Andrew Mellon liquidationist instinct or the 1930s “Treasury view” on deficit spending are getting much serious traction in the US or UK, for example. (Irrelevant trivia: I am very distantly related by marriage to Andrew Mellon – something like a third cousin three times removed. She divorced him in a spectacular case involving all sorts of legal shenanigans and managed to walk off with a sizeable chunk of the Mellon loot, though not a nickel has trickled down to me.)

- but of course you need to learn the *right* lessons and pick the right comparator. the current German reluctance to increase fiscal stimulus, for example, seems to be assuming that this is a 1920s/1970s inflationary situation, not a 1930s deflationary one.

- it is good that an economist *who is also an economic historian* is Fed chairman. Not sure you’d want someone who was reading entirely out of the previous playbooks without also being able to recognise that the monetary transmission mechanism has changed out of all recognition. The General Theory is a bit light on what to do about credit default swaps, for example.

Then Justin weighed in:

My book is basically the story of a bunch of guys who decided to ignore financial market history (the dodgy parts, at least) in order to create more elegant models of financial markets’ future. That didn’t work out so well, so yeah, knowing economic history would seem to be useful. But Alan’s right that there are lots of different lessons that can be drawn from the past, and sometimes people draw the wrong ones. I too am related to a liquidationist, by the way—George Washington Norris, the hard-line president of the Philly Fed in the early 1930s, was my great great uncle.

On Bernanke, I’d certainly rather have somebody with his background in that job than an ahistorical rational expectations type who believes bubbles and panics don’t happen. He’s not really a historian, though. He’s a macroeconomist who’s done some research on the financial system breakdown of the early 1930s. He’s worked really hard to avert such a breakdown over the past two years, and on balance that’s a good thing. But he hasn’t really been a student of what causes financial crises in the first place. Still, he’s an open-minded guy who reads a lot, so maybe he’ll figure it out.

I’d be interested in what Brad DeLong — one of the foremost economic historians of our own time — thinks about whether the “Treasury view” is getting much serious traction — I suspect he might have killed it before it had a chance to spread widely, and it certainly doesn’t seem to have been mentioned much since January 20. And in general I think that economic historians are having something of a day in the sun right now, with lots of people looking back to previous economic crises around the world, and fewer people finding modern theory-based economics particularly helpful from a policymaking perspective. Maybe economic history is a classic countercyclical asset.
Update: Brad DeLong comments:

The “Treasury View” that fiscal policy will be ineffective–well, in the past two months I have seen it advocated by Pete Klenow, Luigi Zingales, Michele Boldrin, Niall Ferguson, and Nobel Prize winners Gary Becker, Edward Prescott, and Robert Lucas. Of these, only Pete Klenow had even a half-coherent argument.


Dear Michael…………..

Some more thoughts on that book you mentioned “The Myth of the Rational Market’ by Justin Cox. I hope you were able to find his Blog site following the link I sent you. It’s a curious title he has given his book. He is obviously NOT a great believer in the market delivering quality outcomes, well not for ALL.

Where did this myth begin you may ask. I am proud to say a Scot wrote in 1776 (the same year as the American War of Independence) a famous book called the “Wealth of Nations” (short title!). Adam Smith wrote in his wonderful manuscript arguing passionately that the wealth of a nation is essentially driven by two most important ideas or concepts…..by the ‘invisible hand’ (his language for the market) and by self interest. He argued passionately that that economic growth and prosperity was assured if we built an economic society around these two things. The Market Economy was born and capitalism built around the relatively new factory system was set to flourish. We had reached utopia or paradise so we thought.

In that phrase ‘self interest’ is the root of rational behaviour. Of course Man will always operate by self interest rather than the common good or the greater good as the Jesuits would call it (the ‘Magis’). Economists always say ‘let us assume’ and all their assumptions are assuming (Ha) that Man is rational in his behaviour. For example with reference to the market, consumers will always demand less at high prices and sellers will always supply more at high prices (profit motive) thus creating an inherent conflict in the market. He believed the conflict best resolved by the freely operating market (the invisible hand) which would under a perfect market establish an equilibrium price and quantity (and so on).

I should say that I was introduced to a wonderful concept early in my study of economics, the famous ‘Fallacy of Composition”. This simply states that what is true for the individual will also be true for the whole!!! I always thought this to be a fallacy and was deeply suspicious of self interest as one of the driving forces of a market economy. How can everyone operating in their own interest be good for the nation as a whole? Every man for himself never works and generates chaos I have always thought. Smith said it would assure the ‘Wealth of A Nation’ but from my point of view only wealth for some! It did not take long for critics to emerge and the ultimate critic was obviously Karl Marx (much under appreciated I feel) who clearly thought that the market would only deliver wealth for some and poverty for the many. His solution of socialism was bold but too extreme perhaps and failed as we know in the 20th century probably because it was introduced in a Communist political State. To this day “Das Kapital” remains a mystery to many but Marx clearly had the right idea about market capitalism but maybe the wrong solution.

Adam Smith of course wrote in his book many things about the “Wealth of A Nation (the concept of specialisation for example being pivotal for productivity and growth). To be fair to Smith he wrote in the late 18th century when markets were small and competition fierce. In those days he could not for see the growth of the New Industrial State and the post market economy of John Kenneth Galbraith who clearly had it right in realising that in reality eventually market power would determine outcomes and wealth (for a few)! There is no such thing as a perfect market (a magical invisible hand) and mans behaviour is often far from rational. Look at the superficial frenzy in ‘bear and bull’ financial markets for example.

On a greater scale the power eventually shifted to big firms first domestically and now globally. Consumer power and labour market power have been swamped by the power of large firms who manipulate the market to suit there ends. This has led to post market ideas and to a realisation that there are great social and economic costs associated with market liberalism. Are not greenhouse gas emissions and climate change one such example? The social cost is great. Man simply must be more vigilant and markets which are set free to operate like an invisible hand are a recipe for potential disaster such as the GFC now filtering down to reach the real economy, economic growth and the loss of jobs. We must learn from this that in modern times the world of Smith and Co cannot simply operate the way Smith so eloquently explained.

It will be interesting to see what a brave new world might look like. Have we learnt from these mistakes? I doubt it but we must be vigilant with markets or we risk prosperity in a brave new world

In all this you may discern the economic philosophy of an old mate who has proud Scottish roots. I love Adam Smith (ha) and still despite my comments regard him as the founding father of modern economics.

cya Steve

We must learn from history.

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When bankruptcy is good for bondholders

Felix Salmon
May 28, 2009 14:05 UTC

I’m fascinated that after roundly rejecting GM’s offer to swap their bonds for equity in the existing company, GM’s bondholders seem to have embraced with alacrity GM’s new offer to swap their bonds for equity in a new, post-bankruptcy company. It’s increasingly obvious, it if wasn’t clear all along, that the old exchange offer was in neither GM’s interest nor in that of the bondholders, and that bankruptcy is necessary to allow GM to shed certain obligations — especially obligations to its dealerships — which would otherwise hobble it for the foreseeable future.

The new plan essentially constitutes the nationalization of GM: the US government will own 72.5% of the common equity, plus another $2.5 billion in preferred stock. I can see why bondholders like it: the US will be extremely hesitant to let any state-owned company default, and it won’t sell off its stake until GM’s future viability is assured.

Everybody was worried that a GM bankruptcy would be vastly more complicated and fraught than the Chrysler bankruptcy, given that it has orders of magnitude as many creditors as the private Chrysler. But today’s news gives me some hope that both bankruptcies might go relatively smoothly, as planned and hoped. Although I still have no idea why GM’s shares are trading at over a buck apiece, valuing the existing common equity — which will be wiped out — at more than half a billion dollars.


I’m curious about the dealership position. The dealers publicized in the press seem to indicate that they cost the auto manufacturer nothing (not sure about that) yet are profitable (I’m getting ready to buy a car from a soon-to-be shuttered Chrysler dealer with that story). I suspect that too many dealerships in the era of the Internet cost them margin on vehicles as customers better comparison shop. But there has to be more to that story. Does anyone care to enlighten?

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T-bond one-liner of the day

Felix Salmon
May 28, 2009 13:46 UTC

The rise in US long-dated Treasury yields summed up in a nutshell, from Fitch’s David Riley: Treasuries were “moving from a risk-free asset to a return-free risk asset”.


I’m glad that James Grant was brought up:

http://www.greenlightadvisor.com/documen ts/Grant120408FTcom.pdf

“In their magnum opus Security Analysis Benjamin Graham and David L. Dodd advise that “bonds
should be bought on their ability to withstand depression”. They wrote that in 1934. So far is that
rule from being honoured by today’s financiers that not a few bonds—and boxcars full of
mortgages – could hardly withstand prosperity. Two urgent questions present themselves. One: does
something far worse than recession loom? Two: does that certain something definitely spell much
lower interest rates?
We can’t know, but we can at least observe. What I observe is a monumental push to reflate. The
Federal Reserve is creating more credit in less time than it has ever done before – in the past three
months the sum of its earning assets, known in the trade as Reserve Bank credit, has grown at the
astounding annual rate of 2,922 per cent. Are the bond bulls quite sure that these exertions will raise
no inflationary sweat?
Evidently, they are—at least, forward swap rates betray no such concern. The market’s best guess as
to what the 10‐year Treasury will yield in 10 years’ time is 2.78 per cent, never mind the famous (and
now, as it seems, prophetic) remark of Fed Chairman Ben Bernanke that the Fed could drop dollars
out of a helicopter in a deflationary pinch.
The non‐Treasury departments of the credit markets have crashed. No surprise then that prices and
values are deranged. Market makers have closed up shop for the year, while hedge funds cower in
fear of redemptions. You’d suppose that professional investors – doughty seekers of value – would
be combing through the debris for bargains. Alas, no. Most seem content to lend money to Henry
Paulson (subsequently to Timothy Geithner) at 2 per cent or 3 per cent.”


“Risk‐free return” is the standard tag attached to the government’s solemn obligations. An investor I
know, repulsed by prevailing government yields, has a timelier description – “return‐free risk”.

I think that it’s these investors that we’re trying to tempt.

When US deficits support its triple-A

Felix Salmon
May 28, 2009 13:36 UTC

From a narrow sovereign credit and ratings perspective, said Fitch’s David Riley, the huge spike in the US government deficit “is the right policy response”. His point was that we’re in a historically very rare period when both companies and households are deleveraging — they’re not borrowing, they’re not spending, and the government has to step in and make up the difference, lest we suffer an even worse recession and the destruction of massive amounts of value and potential economic growth.

If you’re worried about the ratings agencies’ view of the US government, then, (which you shouldn’t be), don’t worry about Fitch. Or at the very least, to the degree that Fitch does get worried about US creditworthiness, it would be even more worried were it not for the fact that the government is going to run a $2 trillion deficit this year.


What rating did Fitch give MBS?

Excuse me, if I don’t take his imprimatur too seriously.

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The fine line between too much inflation and a W-shaped recession

Felix Salmon
May 28, 2009 13:31 UTC

David Riley, the head of sovereign ratings at Fitch, gave the first big presentation at the Fitch banking conference today — and quite rightly, too. The future of banking is inextricable from public finance and macroeconomics: looking at things on a bank-by-bank level ensures that you’ll miss the big picture. His presentation was a good one, and definitely worth blogging.

Riley’s message was simple, after a recap of what happened in the Great Depression and in Japan and in Sweden: the faster that governments move the better, and the stronger their initial response the better. Don’t worry, at least in the short term, about inflation, in an environment such as this one which is fundamentally disinflationary: instead, worry about a multi-year decline in the total quantity of bank credit, which will continue even after the recession has ended, and which will put a medium-term cap on future growth.

Riley was not impressed, in hindsight, with the ad hoc way in which policymakers first addressed the crisis, before Lehman’s collapse: the way they tried to put out fires at places like the monolines or Northern Rock or Bear Stearns, without really tackling the problems of the financial sector more generally.

After Lehman, however, there was much more system-wide intervention, with deposit guarantees being raised, the Fed injecting huge amounts of liquidity into the banking system and the economy as a whole, and the Treasury playing along too with TARP and all the rest. Post-Lehman, said Riley, the international policy response “has been pretty impressive, and well coordinated across countries”.

Interestingly, Riley noted that European households are much more reliant on bank financing than US households are: historically about 80% of their financing comes from the banking sector, compared to about 30% in the US. That probably explains why the Fed has been doing so much in the capital markets (and why the government needed to nationalize Fannie and Freddie), while the ECB hasn’t bothered. But Riley’s charts also showed that Europe is continuing to borrow — at lower rates than in the past, to be sure, but still significant sums — while the US household sector is actually paying down its debts these days, for the first time in living memory.

Riley said he’s not worried about inflation just yet, but that he will be worried about inflation if the government waits too long before unwinding its current fiscal stimulus efforts. On the other hand, it can’t do that too soon, either.

“I think that there is a serious risk that we get a W-shaped recession”, he said, with the current fiscal stimulus running its course over the next year and the economy falling back into recession. “As we saw in Japan,” he said, “if you tighten policy too soon, if you leave it too late, then you start getting concerns about solvency and inflation risk.” Guess he’s happy he’s not a central banker these days.

Defining alpha

Felix Salmon
May 28, 2009 11:50 UTC

One of the more challenging and interesting aspects of being a financial journalist is trying to define terms like convexity and covariance for a lay audience — it’s not easy. So I was particularly taken with Justin Fox’s one-sentence definition of alpha in his new book on the efficient markets hypothesis:

Alpha is a portfolio’s performance minus the performance of a hypothetical benchmark portfolio of equivalent risk.

Elegant, eh? It’s a shame, in a way, that it arrived just as the reputation of CAPM is hitting new lows and the race for alpha is looking increasingly laughable.


@dsquared: agreed alpha doesn’t include “active benchmark timing” but skill still get’s credit for it.