Felix Salmon

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?

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.

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.

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?

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.

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.

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!

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.

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.

Ford is issuing equity and will probably use some of the proceeds to buy back debt. At the same time, Microsoft is issuing debt and will probably use some of the proceeds to buy back equity. Which one makes more sense? The answer, quite clearly, is Ford.

There’s basically only one good reason why companies would want debt rather than equity, especially in these days of deleveraging, and that’s the tax advantages of debt — you pay income tax on corporate profits only after you’ve made your debt-service payments. Ford has lost so much money in recent years that it’s very unlikely to have to pay any tax at all for the foreseeable future — and as a result the less debt it has, the stronger it is.

The case of Microsoft is weirder, mainly because it’s sitting on $23 billion of cash already — why on earth would it need $3.75 billion more? Anything it can do with debt, like buying stock, it can do with cash. And although Microsoft’s debt is cheap — it’s paying only about 100bp over Treasuries, even as most triple-A corporates have a spread of more than twice that — it still is going to end up shelling out significantly more in debt service than it will receive in interest on the proceeds.

The main reason for the Microsoft bond issue, then, is signalling. It’s a way of Microsoft telling the market that it’s still ambitious, that it still wants to grow, that it has some doubts about whether its $23 billion will suffice to fund its plans, and that it wants to lock in low rates now to help finance all manner of wonderful growth over the coming decades.

The question is whether you believe it. My feeling is that Microsoft’s days of fast growth are long in the past, and that it’s increasingly becoming a utility. Not that there’s anything wrong with that. But it does mean that if it already has $23 billion of cash, there’s really no reason to go ahead and issue debt on top.

With the credit card bill finally coming in to focus, the banks’ complaints are ringing increasingly hollow:

“ABA is very concerned about the direction this legislation is headed and we are concerned over the impact it will have on the ability of consumers, students and small businesses to get credit cards,” said Ken Clayton, senior vice president of card policy at the American Bankers Association. “As we have said repeatedly, it is vitally important for policymakers to get the right balance of better consumer protection while not jeopardizing access to credit and the credit markets. We are very worried that the Senate bill fails to achieve this balance, to the detriment of American consumers.”

For one thing, the new bill isn’t all that different to new regulations imposed by the Federal Reserve which were due to take effect in July 2010; this just moves those regulations up a few months, probably to February. Other than that, the differences are minor: no one, at the margin, is going to fail to get a new credit card just because the terms and conditions have to be transparently posted online.

But in any event, “the ability of consumers, students and small businesses to get credit cards” simply isn’t a problem right now — and it’s very unlikely to be a problem at any time in the foreseeable future. If the average number of credit cards per American comes down, that’s no bad thing — and if, at the margin, a few people find themselves unable to get a credit card in future, that’s probably because they are so uncreditworthy that they really shouldn’t have one in the first place. Much better that they go to their local credit union and get a checking account with a debit card and an overdraft facility, or an outright personal loan.

I know that lobbying organizations have to do their very best to protect their members’ interests, but I do wish that sometimes the press wouldn’t simply parrot their statements with a straight face. At least in this case it’s obvious to the overwhelming majority of newspaper readers that the interests of the banks and their borrowers aren’t nearly as aligned as the ABA would have them believe: the more interest that banks charge, the more money they make, and the less money that consumers have left over.

But I think my favorite argument in favor of the banks comes not from the ABA but from Tom Brown, reliable shill for banking interests everywhere:

If you compare what the card industry looked like 20 years ago to how it looks today, you’ll be astonished at how much better a deal consumers are lately getting. And government regulation isn’t what drove the improvement; free-market innovation and competition, did. Twenty years ago, all consumers paid the same interest rate—and it wasn’t low (19.8%).

Um, Tom. For one thing, consumers ran much lower balances 20 years ago. And for another thing, interest rates generally were a good 10 percentage points higher, 20 years ago, than they are today. Comparing nominal rates, rather than spreads, is rather disingenuous.

The weird thing is that this credit card bill is mainly political theater anyway, thanks to those Fed regulations which are going to come into force anyway. It makes the president look good, but it’ll change very little in practice. So one really does wonder what all the fuss is about.

Update: Joe B emails:

Not only was the spread lower 20 years ago, as you so smartly point out, so were nominal rate. I have credit card bills from 20 years ago. The rate was about 12-15 percent on the cards I had. It was the scandalous cards at 19.8. Moreover, there was no such thing 20 years ago as a default rate or companies raising your rate based on your other relationships with the bank. The grace period was also 30 days, compared to 20 today. The junk fees (late, over-the-limit, forex) were lower. And consumers were NOT paying the same rate. There was a wonderful diversity of card issuers and rates (almost all fixed) available.

Paul Kedrosky points to this wonderful map of New York City with sparklines showing ridership over time at various subway stations. I can’t get the background map to show up, but the data is all still there, and here’s a bit of the Lower East Side:

It’s well known that the Lower East Side has been resurgent of late — and so the increased traffic at the 2nd Avenue F stop comes as little surprise. (To give you an example of the timescale here, the grey box covers the years from 1952 to 1977.)

What fascinates me about this map is how four stations all of which are quite close to each other can have such very different ridership experiences — a true demonstration of how New York really is made up of very small microneighborhoods.

The Bowery J/M/Z stop has seen less ridership than any other subway station in Manhattan for years, and there are always rumors floating around that it might just be closed. Meanwhile, the Grand Street station just a few blocks away has loads of traffic. Partly that’s a function of the lines they’re on — the B/D lines are useful, while the J/M/Z lines are notoriously unlikely to go anywhere you might ever want to go. But it’s also a function of the fact that the Bowery stop is in a weird not-quite-anything neighborhood, while the Grand Street stop is increasingly finding itself in the heart of a very vibrant Chinatown.

Meanwhile, the Essex and Delancey stop is only very slowly beginning to pick up a little steam — it’s well behind the East Village on that front.

But this chart, of course, is just the beginning. Next up, someone should overlay local property prices, rebased to the NYC average. That could be very interesting indeed.

Back in January, Google’s Eric Schmidt was dismissive when asked about whether he had any interest in buying the New York Times, although he did say he was interested in doing a peculiar thing where he would “merge without merging”, whatever that meant.

In any event, it seems to have meant that when a real opportunity arose, he spent a good deal of time looking at it:

Scott Galloway, a Web entrepreneur and New York University Business School professor who is one of two Harbinger appointees on the Times board, made an overture to Google co-founder Larry Page about Google buying the Times Co. Even though Google CEO Eric Schmidt has publicly lamented the state of the newspaper industry and dismissed the notion of Google investing in it, people involved said the company looked seriously at the opportunity before deciding to pass.

My feeling is that there’s no point in Google talking to Harbinger: unless and until the Sulzberger family has serious interest in talking, it makes essentially no difference who owns the B shares. But at that point, there are all manner of interesting structures which might be created, some of which might well involve Google’s charitable arm, Google.org. Schmidt’s claim that he didn’t want to mix philanthropy with business was always the least convincing part of his claim not to be interested in the NYT.

Ryan Chittum makes a good point about the hedge funds kvetching about the Obama administration on page C1 of the WSJ: their “pique” (to use the word in the WSJ headline) might well be a function of the fact that their income taxes are about to rise dramatically:

Obama’s plan would force hedge funds and private equity and the like to pay income tax like the rest of us instead of much-lower capital-gains rates they pay now on their earnings. Sure, some hedge funds have honorably acknowledged they ought to pay the same rates as everyone else, but nobody likes to effectively have their tax rate doubled overnight—especially when their earnings are already down.

It’s also worth noting that the piece says that 70% of hedge-fund campaign donations went to Democrats in the last election cycle — and then goes on to quote at length Paul Singer, of Elliott Associates. What it doesn’t mention is that Singer was the single biggest supporter and fundraiser that George W Bush had in New York; that he gave even more money to Rudy Giuliani, partly by lending him his private jet; and that in general he is about as loyal and committed a Republican as they come.

Personally, I think it’s a positively good thing that hedge funds are feeling piqued by the White House. Maybe they were hoping that Larry Summers’s presence (not to mention that of Rahm Emanuel) would make the White House a bit more hedge-fund friendly. On the other hand, maybe this is being a bit more hedge-fund friendly. After all, if the worst that the White House does is make good on its promise to keep the Detroit car industry from imploding completely, you can make a pretty good case that hedge funds have gotten off pretty lightly.

There’s another of Bill Ackman’s song-and-dance shows today: he’s waging what the FT calls “one of the largest and most expensive proxy battles in US corporate history” against Target, and eliciting some pretty compelling pushback from Bill George in the process. George is no lightweight: he’s the former CEO of Medtronic, is a professor at Harvard Business School, and is a board member of both Exxon Mobil and Goldman Sachs.

The Ackman fight is confusing, especially given the very peculiar quote he gave to the FT:

“This is not a poorly managed company,” he told the Financial Times in an interview. “This is really just about improving the board.”

I really have no idea what this is supposed to mean. No one spends $15 million on a monster proxy battle just because he thinks that one set of independent directors will be marginally better at giving direction to existing management than the current set of independent directors. But Ackman has backed himself into a corner.

When he started his fund, Ackman had all manner of bright ideas about how Target could achieve better results through financial engineering. But the world was different then, and much more amenable, in principle, to such suggestions. Today, talk of spin-offs and lease-backs is extremely unfashionable: we’re living in a back-to-basics business culture, and that’s no bad thing.

The problem for Target is that Ackman still has a fund to run, and pushing financial engineering is the only way that he knows to try to justify that fund’s existence. The fund might have been a bright idea when it was set up in 2007, but not all bright ideas turn out well, and this is one which turned out badly. So we get mission creep: Ackman is now targeting the board, rather than management, for reasons which are increasingly vague.

Most investors, if their investment in a company doesn’t work out, sell it and move on. But Ackman can’t do that, because he’s running a single-stock fund. So he’s liable to be an expensive annoyance to Target for the foreseeable future. He has very little choice.