Felix Salmon

Rortybomb’s run-your-own-stress-test spreadsheet

Felix Salmon
Jun 11, 2009 14:20 UTC

Mike at Rortybomb has the blog entry of the year I think; the background is here. Essentially he’s found a Rosetta-stone like table on page 6 of the stress test results, and has used it to create a fabulous spreadsheet which allows you to plug various different unemployment rates into a cell at the top and see what kind of capital needs result.

Of course there are lots of caveats — linear extrapolations are pretty down-and-dirty things. But the upshot is startling: if unemployment does rise more than Treasury feared it might, there are still quite a lot of banks which will be able to withstand the economic downturn and require no new capital. But let’s say that a realistic adverse scenario today has unemployment at 12.2% rather than 10.3%. What happens to banks’ capital requirements?

AmEx, BoNY, Goldman, and MetLife all remain at zero. A few banks require relatively modest cash infusions: FifthThird, for instance, sees its hole grow from $1.1 billion to $4.9 billion. JP Morgan requires $39 billion, which is probably doable; Morgan Stanley needs $15.6 billion, which might be a stretch. But look at Bank of America: rather than needing $33.9 billion, it suddenly needs to raise over $100 billion. In fact, BofA alone accounts for more than 25% of all the excess capital needs under this exercise.

Says Mike:

It really seems if you go out a bit all the losses are with a few specific banks, and maybe we should look into breaking them up before they become even more of a rotting albatross on our economy’s neck…

I was actually surprised – I assume turning up the numbers a bit would cause everyting to start leaking red ink. Instead it seems that if there is an additional slight downturn in the economy, we know the firms that will have all the problems. They are the ones that are too big to fail.

It seems that the result of the government’s ad hoc financial engineering over the past year or so has been to shove hundreds of billions of dollars of tail risk into a handful of enormous banking institutions. Which isn’t reassuring at all.


Results of calculations whose methodology is hidden must be rejected as nonsense. Hidden calculation methods ALWAYS hide an agenda. But have fun!

Posted by Jimster | Report as abusive

Revisiting the Merrill acquisition

Felix Salmon
Jun 11, 2009 13:57 UTC

All eyes are on Ken Lewis today: he’ll be testifying to Congress, and, according to the Reuters news planning email this morning, “Lewis is a fiery character and we will be looking for any departure from his script.”

Yet again we’ll be revisiting the history of the last four months of 2008, and specifically two decisions made by Lewis: the September decision to buy Merrill, and the December decision, in the face of pressure from regulators, not to pull out of the deal.

There’s no doubt that the September deal was done hastily. Matt Goldstein reckons that redounds badly on Lewis:

There’s still no evidence that anyone from the federal government was holding a gun to Lewis’ head when he and John Thain shook hands on the merger just as Lehman was spinning towards bankruptcy.

Lewis bears full responsibilty for that deal–along with his newly annointed chief risk officer Greg Curl. It didn’t take a rocket scientist or a mathematician to know that Lehman’s uncontrolled bankruptcy filing would have grave consequences for the financial system. Yet that didn’t stop Lewis and Curl from agreeing to buy Merrill. And at a price that was then a substantial premium to Merrill’s then share price.

If Congressional investigators want to do more than simple grandstanding they should begin by asking Lewis what kind of due diligence his team did in September when he inked the deal. They can start by asking whether he did any due diligence or was it just wishful thinking that everything would out.

But two facts are worth bearing in mind here. Firstly, the deal was of necessity rushed: Lewis and Curl simply didn’t have the time to do due diligence on a bank the size of Merrill over the course of one frantic weekend. But if the Merrill deal hadn’t been announced, there was an extremely high chance that Merrill would have collapsed in short order — and that at that point the shock waves from the Lehman-Merrill 1-2 punch would have been so systemically damaging that Bank of America itself would probably have gone under as well. Given that Lehman’s bankruptcy was obviously going to be harmful, it made some sense for Lewis to essentially draw a line under Lehman and show the market that at least Merrill was safe. If he didn’t, the entire financial system was in jeopardy.

Secondly, essentially all deals done during the financial crisis could reasonably be considered contingent until they actually closed. I noted when Lewis announced the purchase of Countrywide that it wasn’t an acquisition so much as a call option, and after that a whole spate of announced deals ended up being unwound, including Chris Flowers’s acquisition of Sallie Mae and Citigroup’s purchase of Wachovia. Given the rushed nature of the Merrill deal, it was probably reasonable for Lewis to think that if his due diligence turned up some particularly monster black hole in Merrill’s accounts (as it did), he would be able to find a way to wiggle out of the deal somehow.

The problem was that Lewis didn’t wiggle hard enough. Faced with stern disapproval from Ben Bernanke, Lewis quietly stopped wiggling and went ahead with the acquisition, even though he knew it would be extremely bad for his own shareholders. What he should have done is simply told Bernanke in no uncertain terms that his fiduciary duty to his shareholders forced him to back out of the Merrill deal, even if doing so was going to cost him his job. It was when he buckled in December that Lewis made his biggest mistake — not when he agreed to buy Merrill in September.


if you read the MAC he really didnt have much room to get out of the deal, so really you are overstating his strategic intelligence. The fed really were only telling him what was obvious. Furthermore if you believe that Lewis paid that price initially to prevent the failure of the banking system then surely he would have felt the same before pulling out of the deal. as its happens the guy is just an idiot.

Posted by dazedandconfused | Report as abusive

Preservation and zoning

Felix Salmon
Jun 11, 2009 04:26 UTC


These houses are going to be demolished to make room for a parking lot. Says Ryan:

In my view, it takes a particularly unimaginative, short-sighted, and careless sort of person to see a piece of property in this location and determine that the best and most profitable use for it is a surface parking lot (particularly since street parking near H Street isn’t exactly difficult to find).

Not at all. A parking lot is pure optionality. It generates income, it lowers your property taxes, and it makes it really easy to build something highly commercial if and when developers can actually borrow money again. Old houses like these are never going to be particularly lucrative. Best to take any opportunity to demolish them, so that down the road they can be easily replaced with something shiny and new.

As Ryan’s commenters point out, the problem here isn’t that the owners of the houses want to demolish them, or even that the Historic Preservation Review Board neglected to save them. Rather, it’s that the zoning laws allow parking lots (and the associated curb cuts etc) at all. The problem with the parking lot isn’t that old housing will be demolished, the problem with the parking lot is that it’s a parking lot. Historic preservation boards shouldn’t be used as stealth zoning authorities. There are real zoning authorities for that kind of thing.


Built environment may not be Felix’ beat but he nails this one perfectly: “Historic preservation boards shouldn’t be used as stealth zoning authorities.”

Wednesday links are largely mistaken

Felix Salmon
Jun 11, 2009 04:03 UTC

The first Stanford book arrives. But only in Spanish, so far.

Kai Ryssdal interviews Anna Schwartz

How Holman Jenkins joined the “How wrong can you get it?” tour:

The Wall Street Journal’s strange, and somewhat terrible, case against health care reform.

Robin Hanson on why life’s so much easier for white doctors

A visit to Art Capital Group

Felix Salmon
Jun 10, 2009 22:28 UTC

I had a very interesting chat with Ian Peck, the CEO of Art Capital Group, this afternoon, trying to learn a bit more about his business and how it works. Art Capital is a business which specializes in lending money to liquidity-constrained art owners; business, says Peck, is booming these days, since most other lenders in the market (private banks, the auction houses) have pretty much closed up shop.

The main thing I was interested in was the underwriting process. The average Art Capital Group loan is $5 million and has a duration of just two years: if someone doesn’t have $5 million now, what are the chances that they’re going to be able to repay that kind of money in two years’ time?

Certainly Art Capital does quite well, a lot of the time, if its borrowers do end up defaulting on their loans. They take the painting, sell it, and then pay themselves a 20% commission for selling the painting before paying themselves back everything they’re owed in terms of principal, interest, penalties and the like. “The commissions and fees are designed to be prohibitive,” says Peck.

Still, if you can’t repay the money, that doesn’t mean Art Capital won’t lend to you: “we are an asset-based lender,” says Peck. If Art Capital doesn’t think you’ll be able to repay the money easily, it’ll try to structure something else: a bridge loan, perhaps, against its own future sale of the painting. “We’re not in the business of providing ninja loans,” he says, “but we will do a pre-planned sale where you get 50% of the value now, and we’ll consign it to Christie’s or Sotheby’s for sale.” Peck says that one third of his deals are designed from the get-go to end with a sale, rather than just the repayment of a loan.

Art Capital will also finance the purchase of art: if you need a bit of time to pay for a painting, whether it’s bought from a dealer or at auction, Art Capital will help pay for it. The downside, of course, is that you probably won’t be able to put that painting on your wall: Art Capital likes to have possession of the art that it’s lending against, since art is highly mobile and a lien won’t do you much good if you can’t locate the art in question. Besides, in jurisdictions like Switzerland, France, and Italy, the courts won’t recognize a security interest unless you have physical possession of the art in question. Sometimes, however, Art Capital can arrange for art to be loaned to — and displayed at — a museum, instead of languishing in its own warehouses.

Art Capital rarely if ever buys art outright, which is one reason it doesn’t have a big business providing guarantees to auction houses. The paintings always belong to the collector, until they’re sold — Art Capital just has a lien on the paintings, and takes what it’s owed out of the proceeds before passing the rest on to the borrower.

The business sounds like it’s very profitable: Art Capital’s clients often need cash in a hurry, and have few other places to turn. At the same time, the company is building up a set of strong relationships with its own lenders — banks and hedge funds, mainly — as a way of minimizing its own cost of capital. Some of the structures it’s put in place are pretty sophisticated: at one point Art Capital sold a portfolio of loans to a hedge fund, which then repackaged them into a collateralized loan obligation. Unsurprisingly that business seems to have shut down for the time being.

In general, Art Capital is happy to be inventive when it comes to relationships with its own lenders, who might well end up sharing in some of the fee and commission income when its art is sold. “Historically, art funds were equity funds,” says Peck — investors would put up money and the fund would use it to buy art. But that doesn’t work well, because exits are so hard. Peck is taking the next step and essentially setting up debt financing for art funds, where lenders share in some of the upside of the art market but don’t rely on perfectly-timed entrances and exits.

Peck is pretty puritanical about bankruptcy — he won’t lend to people who have declared bankruptcy in the past, and he’s afraid of what might happen to his liens in bankruptcy court, so he wants to avoid that if at all possible. But at the same time he recognizes that people who have fallen hard do have a tendency to get back up on their feet and do quite well again: the likes of Alan Schwartz and Dick Fuld, for instance, still have highly-paid jobs.

Is there art that Art Capital would be hesitant to lend against? Damien Hirst, probably — or, at least, they’ll only lend at a fraction of the valuations that they would have used last year. The dot paintings, in particular, have come down in value a lot, says Peck’s colleague Baird Ryan. It seems they were bought up in bulk by Wall Street types, who liked the fact that there were so many sales of similar works, with values going up and to the right. These days, rarity is becoming sought-after again, and overswamped markets like the dot paintings could take a very long time to recover — if they ever recover at all. My guess is that they probably won’t.

Update: Art Capital’s flack wants me to clarify that the “prohibitive” commissions and fees exist “to encourage borrowers not to default”. And Abnormal Returns notes that at least one old-fashioned art fund seems to be alive and well — even if its grasp of the English language is a little on the weak side.



Natty bikewear

Felix Salmon
Jun 10, 2009 21:48 UTC

Last week, I had a rather miserable bike ride home in the rain, and tweeted as much when I’d managed to dry off a little. A few hours later, I got an email from Abe Burmeister, the CEO of Outlier, telling me about his office-friendly and water-resistant bike trousers. Would I like to try a pair? I would — and in fact I’m wearing them today. I rode them in to work in the drizzle this morning and my legs stayed nice and dry; I then rode up to a meeting with Art Capital Group on the Upper East Side and back through Central Park. They’re certainly comfortable — and they’re more presentable than the jeans I usually wear. If you didn’t know they were bike trousers, you probably wouldn’t guess.

But after reading Alex’s blog entry about the Rapha bespoke cycling suit today, a pair of off-the-peg cycling trousers clearly isn’t going to cut it. The only problem is that I very much doubt Timothy Everest is going to offer to make me one of these things to try out — and weirdly I don’t have £3,500 to spend on looking particularly natty while riding my $300 bicycle. I might have to make do with the Outlier trousers after all.


I just pull a pair of wind pants on over my regular pants. Lets me go down to about 15 degrees Fahrenheit too.

Posted by Noumenon | Report as abusive

What is Thomas Lauria playing at?

Felix Salmon
Jun 10, 2009 21:11 UTC

The Detroit News today bellyaches about how the Chrysler bankruptcy deal “may make raising cash more difficult for companies”. I have no idea where they got this idea, but it’s ludicrous. As the WSJ story on gadfly lawyer Thomas Lauria notes, Chrysler’s secured creditors are getting significantly more out of the existing bankruptcy deal than they would without the government throwing in its billions.

The fact that unsecured creditors (the UAW) are getting some recovery from the Chrysler bankruptcy even though secured creditors are taking a haircut is actually good for the secured creditors: it means they’re getting more than they otherwise would be able to salvage out of a liquidation. And when recoveries go up, raising cash becomes easier, not more difficult.

The Indiana pension funds who hired Lauria and brought the complaint are making very little sense:

“As I’ve said countless times, it wasn’t the investment that was made by our Hoosier pension funds that put Chrysler in bankruptcy,” says Indiana State Treasurer Richard Mourdock. “It’s been the egregious actions of the U.S. government.”

Actually, Chrysler went into bankruptcy because it ran out of money. The overwhelming majority of Chrysler’s secured creditors, knowing a good thing when they saw one, signed on to a plan which allowed Chrysler to come out of bankruptcy. The alternative would be to try to sell off Chrysler’s plants and other infrastructure — assets for which there’s not exactly a lot of bids out there.

Now, depressingly, Lauria has his eyes set on the GM bankruptcy — even though there are no issues surrounding senior creditors at all in that case: GM’s secured creditors are getting paid out in full. The fact is that the government has spent tens of billions of dollars bailing out both Chrysler and GM; bondholders of both companies are much better off as a result. They have nothing to complain about, and it’s ridiculous that anybody is willing to pay Lauria $900 an hour to try to throw a spanner in the bankruptcy works.


Felix, I love your blog and it’s part of my daily reading but this particular post is, to borrow the words of Wells Fargo’s Chairman, asinine.

Posted by Skip | Report as abusive

Powerful software

Felix Salmon
Jun 10, 2009 16:37 UTC

I’m quite excited about getting access to Datastream, Thomson Reuters’s flagship data product, which should allow me to go swimming in all manner of information. Just how powerful is this software? Well, for one thing, before I’m allowed to download it I need to confirm that I’m not going to use it for proliferation activities. I promise!



Reminds me of the US entry forms that require you to declare whether or not you have committed genocide.

Posted by Ginger Yellow | Report as abusive

The fight between the buy side and the sell side

Felix Salmon
Jun 10, 2009 15:19 UTC

The age-old fight between the buy side and the sell side is flaring up again:

In the US, William Dudley, president of the New York Federal Reserve, is trying to give investors a louder voice. The Fed used to garner almost all of its market feedback from the sell side – groups such as JPMorgan Chase, Citigroup, Goldman Sachs or Merrill Lynch. But in recent months the New York Fed has started including asset managers in advisory committees and created an informal advisory group of hedge fund, private equity and asset managers. “Our aim in this is not to disenfranchise the dealers but to enfranchise the buy side. We want the whole market to be part of the decision-making process,” says Mr Dudley.

Whether the “whole market” can be corralled into making collective decisions remains unclear: though groups such as Sifma and the Fed itself stress that it is in everyone’s interest to co-operate, the turf wars are likely to grow more rather than less intense. “All over the place, there are fights going on about who will control the system. It’s ugly,” observes one Wall Street financier.

What’s happening here is that the sell side has been weakened by the financial crisis, and the buy side sees no reason why the big banks should continue to dominate both the markets and industry groups, to the detriment of the people who are actually investing money over the long term. If the banks won’t provide investors with the kind of leverage and liquidity that they could offer at the height of the boom, then investors, quite reasonably, want more say in how the markets operate.

The banks are likely to win this game, though, if only by being obstructionist for the time being. There have been numerous efforts over the years to organize the buy side, but they’re generally doomed to failure just because hedge funds and other investors generally view each other as competitors rather than natural allies, and they’re never good team players at the best of times. Indeed, a large part of the history of the success of the sell side over the years is a function of the fact that the sell side seems to have more ability to organize the buy side into things like dark pools than the buy side has to organize itself. Plus, of course, most of the largest buy-side institutions are owned by banks, so there’s a limit to how bolshy they’re ever going to be allowed to be.

Still, it’s good to see the buy side getting a voice in these matters, even if it only lasts a year or so. After all, decisions made in the coming year about the fate of capital markets going forwards are going to have very long-lasting implications.