Felix Salmon

Credit card datapoint of the day

Felix Salmon
Jun 23, 2009 17:27 UTC

Barbara Kiviat pulls this chart from a paper by Ryan Bubb and Alex Kaufman, who have an op-ed in today’s NYT about credit cards. It basically makes the same point, in empirical and visual form, that Mike at Rortybomb made in a more theoretical and mathematical form last month.


The thing to pay attention to here are the 95% confidence intervals as much as the red and blue lines. What they show is that the lowest bank penalty rates are vastly, and needlessly, higher than the highest credit-union penalty rates. People choose credit cards based on which one has the lowest introductory APR, or sometimes based on which one has the lowest purchase APR. They don’t (although they should) choose a card based on which one has the lowest penalty APR. And as a result, banks can ratchet up those penalty APRs to eye-watering levels, and make lots of extra money, without worrying about losing market share.

Which is yet another reason why the Consumer Financial Protection Agency is an idea whose time has long since come.


Really? Everyone I know chooses cards solely based on the rewards they offer. You know why? BECAUSE WE PAY OUR FUCKING BILLS! I know, it’s a novel concept.

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Regulatory datapoint of the day, SEC edition

Felix Salmon
Jun 23, 2009 16:36 UTC

JC makes a very good point in the comments on my blog entry about how new banks are no more likely to succeed than old banks: why on earth should we think, in that case, that if we tear down the SEC and start again, we’ll end up with any improvement on what we have right now?

Well, let me point you, as Exhibit A, to the SEC’s policy on loan loss reserves in general, and those of SunTrust in particular:

For more than a decade, banks have been restricted by accounting standards and the Securities and Exchange Commission from building capital reserves for loan losses that are likely to occur but difficult to predict…

Many bankers disapprove of the current rules. J.P. Morgan Chase & Co. Chairman and Chief Executive James Dimon wrote in the bank’s annual report, “I find it absurd that loan-loss reserves tend to be at their lowest point precisely when things are about to get worse.” …

In the U.S., bank regulators such as the Federal Deposit Insurance Corp. and the Office of the Comptroller of the Currency would like banks to build big loan-loss reserves.

But the SEC worries that banks can use loan-loss provisions to smooth earnings.

The SEC has tussled twice with regional bank SunTrust Banks Inc. over reserves.

In 1998, when SunTrust wanted to make an acquisition, its loan-loss reserve came under SEC scrutiny.

At the time, the Atlanta bank held a reserve of $666 million, 1.6% of total loans. The SEC forced SunTrust to reduce its reserve by about $100 million because the agency felt the reserve was too high.

In 2004, the SEC took aim at SunTrust again.

The bank’s assets had doubled, and its loan-loss reserve stood at almost $1 billion, or just above 1% of loans.

The SEC criticized the company’s assumptions in building the reserve, among other things, and SunTrust fired its chief risk officer.

In other words, if the SEC hadn’t existed at all, SunTrust’s loan-loss provisions, as encouraged by the FDIC and the OCC, would have been eminently sensible. But instead the SEC forced out SunTrust’s chief risk officer, and forced the bank to book hundreds of millions of dollars of loan-loss reserves as operating profit, during the healthy times when any prudent bank should be beefing up its loan-loss reserves in anticipation that at some point in the future, the economic environment won’t be quite as healthy.

So yes, scrapping the whole thing and starting again might not do much good. But hey, at least it would stop the SEC from causing active harm.


One man’s “prudent… beefing up… [of] reserves in anticipation… [of a less healthy] economic environment” is another man’s cookie jar earnings-smoothing shenanigans.

I guess I come down closer to the side of the SEC in this particular case, which should not be interpreted as an endorsement. Perhaps because I never bought the argument that accounting rules can be somehow “pro-cyclical” (whatever that means).

Adventures in causality, WSJ edition

Felix Salmon
Jun 23, 2009 16:04 UTC

An eagle-eyed reader spotted this pair of headlines on the WSJ home page this morning:


It seems that the dollar is falling because oil prices are going up, and oil prices are going up because the dollar is falling. Clever!


that is a lot financial journalism, including reuters’. when you don’t know why things happen or can’t find anything interesting to peg a market event to, just shove two different events together, joining them with an ‘as’ or ‘amid’.
reporting can be pretty boring sometimes.

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Nuclear power: Going fast

Felix Salmon
Jun 23, 2009 15:28 UTC

I was offline most of yesterday attending a high-intensity series of presentations hosted by Esquire magazine in the magnificent suite of rooms at the top of the new Hearst tower. GE’s Eric Loewen was there, talking about nuclear power, and specifically what he calls a PRISM reactor — a fourth-generation nuclear power station which runs on the nuclear waste generated by all the previous generations of nuclear power stations.

PRISM is GE’s name for an integral fast reactor, or IFR, and it’s a pretty great technology. The amount of fuel which already exists for such reactors would be enough to power the world for millennia — no new mining needed. Fast reactors also solve at a stroke the problem of what to do with the vast amounts of nuclear waste which are being stockpiled unhappily around the world. They’re super-safe: if they fail they just stop working, they don’t melt down. And they can even literally replace coal power stations:

One nice thing about the S-PRISM is that they’re modular units and of relatively low output (one power block of two will provide 760 MW). They could be emplaced in excavations at existing coal plants and utilize the same turbines, condensers (towers or others), and grid infrastructure as the coal plants currently use, and the proper number of reactor vessels could be used to match the capabilities of those facilities. Essentially all you’d be replacing is the burner (and you’d have to build a new control room, of course, or drastically modify the current one). Thus you avoid most of the stranded costs. If stranded costs can thus be kept to a minimum, both here and, more importantly, in China, we’ll be able to talk realistically not just about stopping to build new coal plants but replacing the existing ones, even the newest ones.

And best of all they’re eminently affordable: Loewen showed that they could be profitable selling energy at just 5 cents per KwH — which means that you don’t need to price carbon emissions at all to make these power stations economically attractive. With pricing on carbon emissions, of course, they become even economically compelling.

So what’s the problem? They’re untested, and the regulators in the US will take many years and many billions of dollars before they will approve such a project. And legislation is needed, too — including legislation allowing the use of nuclear waste as a fuel. But mainly all that’s needed is political will. It’s unclear the degree to which Steven Chu, the US energy secretary, supports this technology. But if he puts the weight of the Obama administration into supporting this technology and trying to make it a reality, then a lot of private capital will start flowing into the area. And it might be much, much easier to achieve ambitious carbon-emission reduction targets than many people currently think.


The biggest commercial problem with nuclear power, and especially from breeder reactors, is that it costs next to nothing to run.
If you count on the energy companies to embrace it, you’re asking them to put all their other businesses out of business.

Plus, for too many liberals, the distinction between nuclear weapons and nuclear power is emotionally too difficult. Any decent American knows that we should be ashamed of the bomb we dropped on Nagasaki, three days after the Hiroshima bomb for which we might have an excuse.

For my part, ascoss, I’d rather live next to (or downwind of) an Integral Fast Reactor power plant that’s got a few tens of tons of radioactive fuel, none of which can escape, than a comparable coal burner emitting millions of tons of poisonous gases, aye, and even radioactive thorium fly ash.

And I’d rather have a 1000 MW nuclear power plant at the bottom of my favorite range of mountains than 800 wind turbines, each 600 feet tall, over the same mountains, generating maybe the same total annual amount of energy, but without regard to the actual demand.

The crucial advantage of nuclear power is that chemical processes involve the atom’s electron energy, which is about a millionth of what holds the nucleus together.

So a very small amount of uranium, which produces an even smaller amount of waste products, gives you as much energy as millions of barrels of oil.
Or put it another way:
Uranium and Thorium are the product of the violent cataclysmic death of a huge star, an event that we call a supernova.
Fossil carbon was laid down during about 64 million years, by energy from our quiet little sun.
Our rate of consumption of fossil carbon could use it up, and all of the oxygen in our atmosphere, in a few hundred thousand years.

It’s not likely that we can find ways to use solar energy to keep up with that rate.

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Are CDS holders dooming Gannett?

Felix Salmon
Jun 23, 2009 14:20 UTC

Are you ready for 3,000 words on Gannett newspapers, credit default swaps, and the negative basis trade? In that case, Richard Morgan is your man. But boiled down to its essentials, Morgan is making a strong form of the same argument we’ve been hearing for a while — that when bondholders are fully (or more-than-fully) hedged in the CDS market, they can have an incentive to push a company into default.

In the case of Gannett, there are likely quite a lot of such bondholders, thanks to the negative basis trade: if traders buy Gannett debt, buy the same amount of default protection, and hold to maturity, then they’re pretty much guaranteed a substantial risk-free profit (putting to one side, for one minute, the question of counterparty risk).

Now the negative-basis trade is a dangerous thing, for people who mark to market: it can move against you drastically, and it was probably responsible for a very large chunk of Merrill Lynch’s devastating fourth-quarter losses. But large arbitrage opportunities are rare things, and it makes sense to assume that a lot of Gannett’s debt is held by arbitrageurs rather than anybody with a particular interest in Gannett’s long-term health.

That said, of course, for every buyer of Gannett default protection, there’s a seller. And if the people who bought Gannett CDS have an incentive to see the company default, then the people who sold Gannett CDS have an incentive to buy up the bonds (which are now very cheap) and help the company avoid default.

And for all the length of Morgan’s piece, he doesn’t seem to have talked first-hand to Gannet bondholders, or anybody on either side of the Gannett CDS trade. Which makes the whole thing weirdly speculative. I’m sure that the CDS situation is complicating Gannett’s liability management operationds. But I’m not convinced that it’s quite as harmful as Morgan makes out.


Who is writing these CDS’s on Gannett? Is it more CDS junk left over from AIG?

In that case, the government would be actually helping to pay for companies to be destroyed. Beautiful. That needs to stop. If the government is paying on CDSs through AIG, it should at least do so at a level far lower (say 50 cents on the dollar, purely to help resist deflation) that pushes creditors to the table.

It should be that creditors and business managers struggle hard together to find value and savings.

Felix, you are a good man for bringing this to the attention of so many.

Pray tell, who is the ultimate payer on most of these Gannett CDS contracts?

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Monday links are constrained

Felix Salmon
Jun 23, 2009 04:35 UTC

David Warsh on fiscal corsets

The Pension Benefit Guaranty Corporation takes over Lehman’s pension obligations

Some gloriously nerdy stuff from Rortybomb on options-within-options in reverse converts

And does anybody have any advice for a reader looking for an ETF or other easy way to get exposure to Nordic stocks?


There is a Swedish market iShare, but not Nordics in general.

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Hubbard on Kenny

Felix Salmon
Jun 22, 2009 23:07 UTC

One of the great things about making your entire book available for free online is that it gets read by all types — even Glenn Hubbard. And since Hubbard has a book of his own to plug, he’ll even enter the aid debate in public. He doesn’t have his own blog, so here’s Glenn Hubbard on Charles Kenny.

Economists and policymakers have engaged in a lively debate over the past quarter century on how best to encourage economic development. Much of this discussion centers on the economic woes of sub-Saharan Africa.

It’s not hard to see why.

Roughly equivalent to the per capita GDP of South Korea in the mid 1950s, the economies of most sub-Saharan African nations have fallen steadily behind since 1960. As South Korea became a high-income OECD country over this time frame, most of Africa remains mired in dire poverty. In throwing out the bathwater of colonial rule, many of the new nations of Africa threw out the baby, too – the liberal business system with it.

We worry too much about GDP growth, says Charles Kenny in his provocative new book THE SUCCESS OF DEVELOPMENT: The quality of life is improving around the world. Says Kenny, “A greater focus on proven approaches to more rapid improvement in health and education may have a significantly greater impact on the quality of life of poor people in poor countries than yet another quest for the grail of GDP growth.”

If only.

There exists no consensus on the merits of Kenny’s arguments for a new big push for quality of life. In the 2004 report of the Barcelona Development Agenda and the 2008 report of the World Bank-sponsored Growth Commission concluded that there is no single set of policies that can be guaranteed to ignite sustained growth. By contrast, much more consensus among economists exists for the power of a vibrant business sector in making possible entrepreneurship, innovation, and growth. The largest sustained per capita growth outliers in recent years are the East Asian tigers, India, China, and Africa’s Botswana and Mauritius, all thank to business, not aid.

In a forthcoming book, THE AID TRAP, Bill Duggan and I focus on BUSINESS as a driver of both growth and economic and social well-being in Africa, just as it has been in the west. Aid focused on charity may still be worthwhile – though that, too is the subject of debate, as Dambisa Moyo’s book DEAD AID points out. But it is reducing barriers to business that can lift prospects for growth and innovation. And the creation of a vibrant domestic business class thrusts forth a political constituency for reform and support for education.

Policy has made advances here beyond the siren calls of rock stars. I admire the Bush administration’s U.S. Millennium Challenge initiative for its attempt to condition additional aid on institutional reforms that could promote business development. Upon closer inspection, though, the Millennium Challenge Account reverts to a top-down approach.

Kenny intends his insights to change the global policy agenda. While defending aid as “(playing) a part in improving quality of life outcomes,” he argues for more support for “global technology and the spread of ideas.”

Yes, but…

As Duggan and I argue, it is a vibrant domestic business sector with supporting business institutions that enables a country to seize the benefits of globally available gains in science and technology.

And to what end? No less than Abraham Lincoln furthered this thought in his famous historical recapitulation:

The advantageous use of steam power is, unquestionably, a modern discovery. And, as much as two thousand years ago the power of steam was not only observed, but an ingenious toy was actually made and put in motion by it, at Alexandria in Egypt.

What appears strange is that neither the inventor of the toy, nor anyone else, for so long a time afterwards, should perceive that steam would move useful machinery, as well as a toy.

The answer to President Lincoln’s question is the ability of business and business institutions to seize the day. To bring President Lincoln’s point to the present, aid can help promote access to drivers of a better life. But it can best do so through advancing business. In THE AID TRAP, Duggan and I argue for a Marshall Plan for Africa.

We cannot and should not stop the flow of aid. There will always be a role for charity, as there is in all rich countries. Giving food, clothing , shelter, and medicine to the poor is a long and noble tradition. That is a good thing. But it is very different from aid for economic development, to bring people out of poverty. For that, we must direct aid to support the business sector – as in the Marshall Plan of post-World II Europe.

Many people think the Marshall Plan was charity aid – food, clothing and medicine for war-torn Europe. But that was the United Nations Relief and Rehabilitation Administration. The Marshall Plan came later. Its single aim was a thriving domestic sector in every single country. And it worked. Aid can indeed help to end poverty, by helping the business sector. The Marshall Plan shows how, as Duggan and I spell out in THE AID TRAP.

Kenny’s very interesting book is right about two big things.

The first is the need for modesty: Aid advocated from Rosenstein-Rodan’s “big push” to Jeffrey Sachs’ call for ambitious global spending aim at nothing less than top-down transformation of economies and societies. Not only is such an approach at variance with the west’s trajectory toward prosperity, it has not worked. After nearly one trillion dollars of aid since World War II, much of sub-Saharan Africa remains mired in dire poverty.

The second is attitude of optimism: As global citizens, we should not accept the consignment of tens of millions of Africans to extreme poverty. And we can make progress. But it will be more in the way of Friedrich Hayek than Selma Hayek (to borrow a phrase from Bill Easterly). It will be through a concerted effort to promote a vibrant business sector from the bottom up.

But will bottom-up approach improve the quality of life.

Yes. As my Columbia colleague Edmund Phelps noted in his lecture accepting the 2006 Nobel Prize in Economics, workers are more satisfied in dynamic economies with a robust entrepreneurial sector and support for research and development.

So economic growth may not be so removed the good life after all.


Neither of these guys are thinking big enough.

One grand scheme to advance the economic growth of sub-Saharan and Saharan Africa is to divert a portion of the Congo and Nile Rivers into the Sahara. This would serve several purposes:

1. It would turn the Sahara into arable land – more food and living space.
2. It would stop desertification.
3. It would help offset the melting of polar ice caps and glaciers, since less water would be flowing into the ocean from these giant rivers.
4. It would create large economic development zones where there are none.

How to tell if your hedge fund is misbehaving

Felix Salmon
Jun 22, 2009 15:42 UTC

Hedge fund managers have very similar incentives to rogue traders: both of them, if they have a big loss, are going to be tempted to take a huge risk to get back into the black. If they succeed, they’re lauded as a genius; if they fail, they’re out of a job anyway.

Rick Bookstaber asks whether and how one might be able to tell if one’s hedge fund manager is taking the rogue-trader path; his answers are curiously unsatisfying. Really you need a professional looking under the hood, or ideally two — one looking at trading risks, and the other looking at operational risks. The chances that any given investor will be likely to uncover suspicious activity are so low that it’s probably not even worth trying; most likely they’d just end up with false confidence in the fund manager.


The only way to tell is if they fail in their recovery gamble.

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New banks: No better than old banks

Felix Salmon
Jun 22, 2009 15:17 UTC

When the TARP was being unrolled last fall, a simple question was often asked: rather than pouring good money after bad into banks which clearly had inadequate risk controls, why not just use that cash to start up fresh new banks unencumbered by toxic assets?

Well, for one thing, the banks needed to be saved, to protect the economy from the systemic consequences of them failing. But more to the point, no one had any particular reason to believe that fresh new banks would be any better at banking than the old ones were. And Daniel Massey has a great example: Herald National Bank, which opened up last fall with an impressive $62 million of initial capital.

In its first full quarter of operation, its return on average assets was negative. Which might be predictable, for a startup. But it wasn’t just negative, it was -27%. Which is insane. Oh, and despite the fact that the bank has only been operating for a few months, it has already started laying people off, including nine managing directors.

And that’s not all:

The loss of Executive Chairman Daniel Healy, an industry veteran who is believed to have attracted many of the bank’s initial investors, may loom even larger than the one on the balance sheet. Mr. Healy had been the chief financial officer at North Fork Bancorp. for 14 years before it was sold to Capital One Financial Corp. He resigned his post at Herald on May 19, leaving for “personal reasons,” according to a regulatory filing.

Mr. Healy did not return several calls seeking comment.

In general, scrapping failed old firms and replacing them with something new is something which is often very attractive in theory, but which can be highly problematic in practice. During the airline rescue after 9/11, for instance, there was a strong case made that the lumbering old legacy airlines should be allowed to fail: small nimble upstarts would surely take their place and be much more successful. But the history of, say, JetBlue since then has hardly been particularly glorious.

The fact is that most startups fail. As a result, placing one’s hope in startups to replace large and established institutions is generally foolish. They can help drive change at the margins, but it’s rare indeed for the mammals to overthrow the dinosaurs entirely, and it’s a bad idea to enshrine such an overthrow as part of public policy.


Really? You are going to pick one of the 97 banks that started business in 2008 as THE PROOF that a clean bank plan wouldn’t have worked? And one that didn’t even open its doors until the end of November 2008? Even though it is admitted in your cited article that profitability usually isn’t achieved until after a year and a half of operation?

I’ll admit the grocery list of errors since opening would suggest poor management, but Herald isn’t exactly representative of new banks.

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