Felix Salmon

Hummer: Too dirty even for the Chinese

Felix Salmon
Jun 26, 2009 13:54 UTC

China is likely to block the acquisition of Hummer by Sichuan Tengzhong:

Hummer, as an expensive, gas-guzzling sports utility vehicle, would not fit in with the government’s policy of encouraging energy-efficient vehicles, the radio said.

Could this be the beginning of the end of China importing carbon emissions from the US?


I find it fairly implausible that a sound Chinese government would give up this sort of opportunity. This would be the very FIRST live, non-dead auto company that would have acquired overseas.

Reading the article, the concern rather seems to be that the buyer does not have the requisite management experience. That can be amended by forcing it to merge with a bigger auto company.

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Thursday links state the obvious

Felix Salmon
Jun 26, 2009 04:02 UTC

A very sophisticated debate between Nick and csissoko in my comments section

Ah, Citi. “Until Tuesday, mortgages were still being processed without appraisal and income verification docs”

Thank you, Alan Greenspan, for telling us that US GDP growth is tied to house prices. What would we do without you?

How Goldman hides risks from investors

Why newspapers matter: here and here are important domestic stories which need to be fearlessly reported.

Cyclist gets dragged under car running red light. Police tell him to go home or get a ticket.


Note about Scientology – one of the links – an absolute must read is Bare-Faced Messiah, the (very unauthorized) bio of L. Ron Hubbard. Used to be the library copies would go (suspiciously) missing but now it’s posted on the net. Utterly amazing read about a truly fraudulent person, from his war fakery on up.

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Measuring fun

Felix Salmon
Jun 25, 2009 21:30 UTC

Tyler Cowen raises more questions than he answers in Fast Company:

The traditional gauge of economic success is profit, but over time we’ll find that such statistics as measures of GDP tell us less and less about broader efforts to improve human well-being. Much of the Web’s value is experienced at the personal level and does not show up in productivity numbers. Buying $2 worth of bananas boosts GDP; having $20 worth of fun on the Web does not. And this effect is a big one. Each day more enjoyment, more social connection, and, indeed, more contemplation are produced on the Web than had been imagined even 10 years ago. But how do we measure those things?

This is not necessarily new. Having $20 worth of fun by reading a library book, or running down a hill, or visiting the Tate Gallery, doesn’t boost GDP much either. So I guess my question for Tyler is this: are you saying that the web has increased the amount of fun that people can have without spending money, or at least has increased the nation’s aggregate fun-to-spending ratio? Are you saying that the correlation between aggregate fun and GDP used to be stronger than it is now, thanks to the advent of the web? And if so, are you implying that policymakers should be concentrating on new aggregates, such as some kind of Gross National Happiness measure, since GDP is proving an increasingly bad proxy for such things?

Of course, determining whether the fun-to-GDP ratio is improving requires coming up with some independently quantifiable measure of aggregate fun, which seems pretty hard. Maybe as an interim measure, before we get there, we should start thinking about Joe Stiglitz’s concept of green net national product. Maybe that would be more correlated to fun than GDP.


How perceptive of you. Your commentary is always sharp and on target. You are a real gift to the internet (seriously).

Why LTV ratios aren’t always a good default predictor

Felix Salmon
Jun 25, 2009 20:21 UTC

John Carney responds to my post about his anti-CRA crusade this morning:

That deal has a ridiculous LTV. You go wrong by calculating only the bank loan, and not the total financing. A slight drop in home values puts this buyer underwater, which hugely increases odds of default. LTV is meaningless for predicting defaults unless you are considering all the debt that goes into the financing.

This is simply not true. LTV is useful for predicting defaults because it gives an indication of how much home prices need to fall before the homeowner is underwater. But LTV is not a default predictor on its own — it can only be useful when combined with a second key variable, which is the ratio of mortgage payments to prevailing rents.

During the housing boom, nearly all houses were more expensive to buy than to rent: your mortgage payments would be higher than it would cost to rent the same place. (Or, to put it another way, if you immediately rented the place out, you’d be losing money every month, although you might be making money on a mark-to-market basis if the value of the home was rising quickly.)

When it’s cheaper to rent than to buy, a huge amount of work is done by the homeowner’s equity: it’s the main economic incentive to keep current on a non-recourse mortgage. On the other hand, if it’s cheaper to buy than to rent, the amount of equity that a homeowner has is pretty much irrelevant. If the borrower defaults and loses his home, his monthly costs go up rather than down — in Carney’s example, from $550 a month to $750 a month.

Paying $550 a month and owning your own home is clearly superior in every way to defaulting on your mortgage, ruining your credit, and renting for $750 a month instead. As a result, when a homebuyer is saving money every month a result of buying his home, LTV is pretty much useless as a default predictor.

I’m on the board of a financial institution which helps underserved poor New Yorkers buy homes — in our case, normally apartments in HDFC (Housing Development Fund Corporation) buildings which have severe restrictions on resale and which often cost about $20,000. It’s hardly surprising that our default rate on those loans is basically zero: our borrowers might have high LTVs, but they’re managing to live in Manhattan for a few hundred dollars a month, and you can’t beat that deal.

Carney’s example was along similar lines: it was all about helping first-time homeowners into low-income housing. Trying to extrapolate from that to the speculative subprime bubble is ludicrious — not least because most subprime borrowers were not low-income at all.

Carney says that I would “make a terrible mortgage lender” — actually, no. Look at the default history on mortgages issued by CDCUs around the country, and you’ll find it’s very good indeed. Partly because all these loans are scrupulously underwritten, and are generally kept on the lender’s books. There’s just no comparison to the toxic assets being churned out by subprime originators during the boom, and I can’t for the life of me work out why Carney insists on trying to draw one.


the value of a low LTV is that it reduces financial risk for the lender. if the LTV is low, then in most scenarios (including default) the lender does not lose money. this keeps lenders’ direct exposure to housing prices low.

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Why credit card interchange fees should come down

Felix Salmon
Jun 25, 2009 19:09 UTC

Juan Lagorio is right. The various proposed bills regulating interchange fees — the fees that merchants pay whenever a customer uses a credit card to pay for something — could definitely hurt Visa and Mastercard, despite the fact that Visa and Mastercard don’t actually charge those fees and claim that they would not be impacted by the legislation.

How do we know that Visa and Mastercard are worried? Well, for one thing, Shawn Miles, the head of global public policy at Mastercard, has written an essay arguing against them:

No matter how loudly the big box merchants claim the mantle of “Protector of Consumer Interests,” granting big box merchants a collusionary antitrust exemption will have the opposite effect: less credit availability, higher prices, and reduced choice for consumers.

Miles points to the precedent of Australia, which saw credit-card fees rise after the government mandated lower interchange fees. But the post hoc ergo propter hoc argument is weak: for-profit card companies will naturally raise fees as much as they can no matter how much or how little money they make on interchange. It’s the same mechanism driving penalty rates of interest. And indeed the base case in the US is for a slow yet inexorable rise in interchange fees: one purpose of this legislation is to try and put an end to interchange-fee inflation (up 14% last year to about $48 billion, averaging an eye-popping 1.75% of total purchases).

In Australia, by contrast, interchange fees are now about 0.5%, which means there’s a lot of room for current fees to fall. What’s more, as Adam Levitin points out, the bills currently being considered by Congress don’t go nearly as far as the Australians did: they don’t mandate a fall in interchange fees, but just allow merchants to get together on one side of the negotiating table, against the small and powerful card issuers on the other side. Mastercard’s Miles characterizes the bills as “interfering with competitive pricing”, but that’s not really the case at all: pricing right now is pretty much unilaterally set by the card issuers, and the bills would introduce a much-needed bit of pushback from merchants.

Would lower interchange fees mean lower prices for consumers? Probably not — I suspect that Miles is right when he says that the profits would largely go straight to retailers’ bottom lines. But there’s really no reason why card companies should take $48 billion a year out of retailers’ profits — especially not when small merchants are disproportionately hit, sometimes paying 4% or more of their credit-card revenue to the bank. (You think those reward cards are great for you? You’re right, but the merchant will probably pay a higher fee when a reward card is used than when a regular card is used. If you want your merchants to do well, maybe think twice about using those rewards cards.)

On the other hand, there’s no reason whatsoever to believe Miles when he says that credit availability will go down, that prices will rise, or that “choice for consumers”, whatever that’s supposed to mean, will be reduced. The main thing that will fall is the card issuers’ profits — and that’s by design.


“Would lower interchange fees mean lower prices for consumers? Probably not — I suspect that Miles is right when he says that the profits would largely go straight to retailers’ bottom lines.”

Actually, much of the benefits probably would be passed onto consumers. Many businesses that rely on credit cards are in fairly competitive industries – retailers, restaurants, gas stations, etc. Competition means these businesses are highly likely to pass savings onto consumers. Consider gas stations, falliing oil prices translate almost immediately to fall gas prices at the pump, not higher gas station profits. There are some exceptions – monthly billers like cell phones, cable, and utilities for instance, but even in these cases competition creates some incentive to pass savings onto consumers in the long run (actually some of the “monthly billers” already charge to accept credit cards vs. automated debit payments precisely because of credit card fees).

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John Carney’s bizarre crusade against the CRA

Felix Salmon
Jun 25, 2009 15:02 UTC

For some unknown reason John Carney has decided that the Community Reinvestment Act was partly responsible for bad lending practices “spreading like wildfire across the country”. His first big blog entry on the subject, yesterday, declared that “the evidence is unequivocal” — without actually presenting any such evidence at all. His second attempt finds something concrete: an OCC pamphlet from 1996 — a good decade before the fullest flowering of the subprime bubble. The pamphlet praises banks for working with local housing authorities to help low- and moderate-income individuals buy affordable housing.

The problem with the subprime bubble was not with people trying to buy affordable housing, it was with people trying to buy unaffordable housing. Default rates on people buying into affordable-housing developments have always been very low, partly because those houses are generally cheaper than neighboring market-rate developments. As a result, it’s generally cheaper for families to make their mortgage payments than to rent elsewhere.

Carney’s third entry on the subject is the most obnoxious. His headline is “Government Pamphlet Taught Banks How To Finance A $70,000 Home With A $500 Downpayment”. Again, the pamphlet dates from before the housing bubble — 2000, in this case. Carney hones in on a table showing how banks can work with local authorities to help borrowers own their own home and end up saving money in the process. Here are the full numbers from the case study, which he disingenuously elides:

  • The borrower needs $1,200 in cash: $500 downpayment, and $700 for making minor repairs.
  • The bank loan is for $45,000 — a loan-to-value ratio of just 64%.
  • The bank loan is a sensible product: a 30-year fixed-rate mortgage at 7.5%. Nothing explodes.
  • The bank loan is carefully underwritten with full knowledge of the borrower’s income and financial affairs.
  • The borrower is taking advantage of many local assistance programs, including 0% mortgages and a waiver of permit fees.
  • The borrower’s current monthly rent payment is $750. The new monthly housing expenses — not only mortgage payments but also taxes and insurance — are $550, which will rise to $613 in five years’ time.
  • The borrower has participated in extensive prepurchase education and counseling.

There is nothing dangerous about this loan — it’s safer, and has a lower LTV, than most prime mortgages. If this is the kind of product which lenders pushed during the subprime boom, there would have been no problem at all. Instead, predatory lenders started pushing unsuitable mortgages which had no chance of being repaid as opposed to prepaid or refinanced. Yes, some of those products involved low or no downpayments. But that wasn’t the main reason why they were so toxic.

The fact is that the CRA did not encourage banks to extend the kind of toxic loans which ended up being such an important component of the financial crisis. Indeed, most of those loans weren’t made by banks at all — they were made by unregulated subprime lenders who had no CRA responsibilities whatsoever. But don’t take my word for it: ask Fed governor Randall Kroszner, who comprehensively demolished these meme in a speech last December. Why Carney is looking to resuscitate it I have no idea.


I am still astonished at how stupid the “cra is not responsible because mortgage brokers made most of the bad loans” people are!

Let me introduce you morons to a little basic economics. Mortgage brokers are not BLIND to what’s going on. They see the lousy type loans getting the go ahead, and then they jump on it. You actually think that morgage brokers are going to see no doc loans and the like being made and NOT jump on it? ARE YOU THAT STUPID?

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Mutual fund datapoint of the day

Felix Salmon
Jun 25, 2009 13:48 UTC

Leslie Wayne reports:

As the stock market plummeted last year, some 2010 funds — which many investors thought would be invested safely by then to protect their nest eggs — lost 40 percent of their value. That showing was even worse than that of the Standard & Poor’s 500, which fell 38.5 percent.

Clearly, these target-date funds — which are likely to become much more popular if and when the Obama administration enacts opt-out rules for 401(k) contributions — could do with a bit of regulation: many of them seem to be designed to maximize fund-management fees, through a fund-of-funds structure, while doing very little to actually reduce risk as the target date approaches.

But who’s going to regulate these funds? They seem to lie outside the narrow remit of the Consumer Financial Protection Agency; while they might be looked at by the Financial Consumer Coordinating Council, which is a committee including the CFPA, it’s unclear whether the FCCC will have any teeth at all.

I hope that Wayne continues to report this story, and asks giants like Fidelity and AllianceBernstein why their 2010 funds were 50% and 57% in stocks, respectively, over the course of 2008. But for real regulation of these beasts, I think the SEC is our only hope. The good news is that Schapiro is on the case. The bad news is that she’s asking “whether it is necessary to improve SEC regulations to address any deficiencies with respect to target date funds”. In other words, she doesn’t have the requisite teeth yet, and it’s unclear whether Congress is minded to give her those powers.

Update: ajw, in the comments, finds one official rationale for keeping target-date funds overinvested in equities: that the idea is for the investors in these funds to hold on to the funds even after they have retired, rather than selling them for cash or converting them into an annuity or something like that. So retirement could, on this view, be decades before you actually need the funds. As ajw notes, this is self-serving and unconvincing.


You might be interested in reading John Rekenthaler’s M* response to your post at http://advisor.morningstar.com/articles/ blogentry.asp?id=16767&email=pb0702A3. My response to John appears below. I would only add to my M* response, in further response to the ICI, that the issue is not about disclosure. It’s about a fund naming itself “2010 Fund” and then investing 70% to 80% of its assets in equities. The solution is not to hold investors who are looking for a one-stop solution responsible for reading the fine print in the prospectus. I challenge the ICI to utter the words: “There is nothing misleading about a ’2010 Fund’ investing 75% of its assets in equities.” Go ahead. Make my day.

Mercer Bullard

The following is my response to Rekenthaler’s critique of Salmon’s post:


I am usually cheering after reading your analysis, but this time I have to disagree. Investors did not experience the average performance of 2010 funds. They experienced the performance of the 2010 fund in which they invested, and some of those funds had 70% to 80% of their assets in equities. I think that you would agree that this is a very aggressive allocation for someone retiring next year, especially for a fund that specifically labels itself as a “2010″ fund. You’re absolutely right that the date 2010 refers to the date of retirement, and that is precisely why it is misleading for a so-named 2010 fund to take such an aggressive equity position. Investors looking for a one-stop fund are most likely to rely on the allocation that is implied by the name, and the implied allocation is decidedly not 70-80% equity for a 2010 fund. The name is inherently misleading. Salmon is correct that fund managers have incentives to overweight equities because of the higher profit margins that equity funds typically earn. They also have incentives to overweight equities because after strong equity performance an equity overweighting will have generated higher returns and create the (misleading) appearance of superior management. As Don Philips often quips, the best way to outperform your investment category is to invest outside of your investment category. That’s precisely what they have done. My and the CFA’s comment letter on the SEC/DOL target date fund hearing provides a fuller analysis of the issue at http://www.funddemocracy.com/targetdateh earing6.18.09.pdf. I think that you make an excellent point, however, that we need to look at rolling performance, not just 2008 performance. The investors who lost their shirts in a 75%-equity 2010 fund in 2008 actually had experienced superior performance in prior years (assuming that they were invested then) that should be taken into account when evaluating the performance of specific funds. But they still were misled and experienced lower performance as a result. And then there are the 529 college savings plans that offered investment options for 17- and 18-year-olds with a 50% equity allocation. Now many of them won’t be going to college. But that’s another story.

Mercer Bullard
President and Founder
Fund Democracy
Associate Professor of Law
University of Mississippi School of Law

The SEC/CFTC carve up emerges

Felix Salmon
Jun 24, 2009 21:26 UTC

Swaps asks if I missed the bit of Mary Schapiro’s testimony on Monday in which she proposed how to carve up the world of over-the-counter derivatives — the answer is that yes, I did. But here it is:

Stated briefly, primary responsibility for “securities-related” OTC derivatives would be retained by the SEC, which is also responsible for oversight of markets affected by this subset of OTC derivatives. Primary responsibility for all other OTC derivatives, including derivatives related to interest rates, foreign exchange, commodities, energy, and metals, would rest with the CFTC.

This seems to be eminently logical and intuitive to me. Might it be that what could have been shaping up to be a massive fight between the SEC and the CFTC is in fact set to be settled amicably and sensibly? Or are big turf fights over exchange-traded options still to come?


So where does GLD fit in seeing as the actual metal is the udnerlying?

Her definition is quaint, but will probably require about 100 pages of lawyer tongue.

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