Felix Salmon

The first sukuk (Islamic bond) defaults have arrived, and no one has a clue how they’re going to shake out. Which might actually be a feature rather than a bug, going forwards.

Bondholders often have a large amount of complacency derived from the fact that an enormous amount of equity needs to be wiped out before they take any hit at all. And that complacency does the system no favors in the long term. If capital structures get muddied a little, and debt takes on more equity-like uncertainty — as seems to be the case in the sukuk market — then maybe investors will be more assiduous about examining underlying risks, rather than relying on capital structures to protect them.

Binyamin Appelbaum has details of the new regulations surrounding securitization, and it all looks incredibly unworkable to me, especially the central plank:

Lenders would be required to retain at least 5 percent of the risk of losses on each package of loan pieces, known as an asset-backed security…

The plan also would prohibit firms from hedging that risk, meaning that they could not make an offsetting investment.

What on earth is a bank’s chief risk officer supposed to do with an edict that she cannot hedge a certain chunk of the bank’s balance sheet? I can see that she might not be able to explicitly create a synthetic CDO to bring that idiosyncratic risk down to zero. But if a bank has exposure from securitizing credit-card receivables, say, or commercial real estate leases, or student loans, or residential mortgages, then similar risk will reside elsewhere on the balance sheet, and the bank will — and should — just reduce the amount of that risk instead. It has the same result, from an all-over risk perspective, and the new regulation is rendered utterly toothless.

As for the idea that the ratings agencies should make it clear that ABS aren’t corporate bonds, well, as Agnes points out, that’s pretty silly: I think everybody knows that by now. The problem is that if there’s a separate second scale for ABS (and maybe even a third scale for munis), no one will have a clue what the new ratings are supposed to mean. It would be a bit like being given two apples, and told that one costs 15 foos while the other costs 17 bars.

I would rather encourage the ratings agencies to try and make credit ratings as laterally comparable as possible, and to try to set ratings so that you don’t have the enormous default-rate discrepancies that exist right now between different asset classes. Investors could then judge for themselves the degree to which the ratings agencies had succeeded.

My fear is that ratings agencies might start issuing separate credit ratings for munis, which will be considered much safer than the equivalent credit ratings on corporate bonds, just as a wave of muni defaults is about to hit. In general, the key here is to decrease the importance of the ratings agencies, rather than trying to regulate them on the grounds of how important they are.

But a couple of the proposals make sense: paying originators of securitized loans gradually, over time, for instance, rather than up-front when the loans are securitized; or standardizing contract language in the ABS market to make such securities easier to compare to each other. They just won’t make an enormous amount of difference.

Robert Teitelman joins the chorus of disappointment in the damp squib which is going to be launced tomorrow under the grand title of regulatory reform:

What we seem to be heading for is an intensely Balkanized regulatory apparatus attempting to supervise a financial system that has converged even more than before Bear Stearns Cos.’ collapse. Even if the Fed does prove to be an effective systemic regulator — and its record as a regulator is spotty at best — how this council will operate in a crisis is a little scary. Half the folks on this council are currently engaged in desperate attempts to undermine each other, or are fighting over Vikram Pandit’s future or on the oversight of derivatives. Some dislike each other; others simply want to establish bureaucratic dominance. All this will only get worse as Congress, with its cast of intense self-interested characters, swings into action.

More conceptually, the problem with having multiple regulators is that risk is fungible, and will naturally flow to whichever regulator has the lightest touch. Which is a problem no council of overseers can effectively overcome.

Pay No Attention To Morons Talking About “Money On The Sidelines”: After all, the stocks’ sellers are going to cash.

“How much the St Petersburg Times spent to win its Pulitzer prize? Probably between $0.6 and $1m a year.”

Abnormal Returns on the downside of ETFs

Duff McDonald on Steve Black and Bill Winters, “the kingpins of Wall Street“

Pico Iyer steps off the hedonic treadmill

90% Of Waking Hours Spent Staring At Glowing Rectangles (The Onion, but not really false)

Donald Trump: Not just a developer, also an expert in materials engineering!

Baruch on why it’s idiotic to follow the smart money

Patron Bordeaux (whatever that might be) is $2200 the bottle at THOR. Makes the $22 margarita seem cheap.

Noam Scheiber asks how Sheila Bair seems to have managed not to hold on to her job (that can be explained by reference to the fact that she has powerful protectors in Chris Dodd and Barney Frank) but on top of that seems set to emerge the big winner from the coming regulatory overhaul — despite the fact that few senior administration officials seem to like her very much.

The answer, I think, is pretty simple: she who has the gold makes the rules. And when you follow the money, it invariably comes from the FDIC: she provided the guarantees necessary for the Citigroup and BofA bailouts, as well as the hundreds of billions of dollars in additional guarantees necessary (although, as we’ve seen, not sufficient) to get PPIP off the ground.

In a world where Congress will give exactly $0.00 for any further financial bailouts, the bottomless pockets of the FDIC are hugely valuable, and the FDIC chair is therefore incredibly important. What’s more, the FDIC can raise substantial funds through charging banks money for the insurance it provides. No other regulatory agency, bar the Federal Reserve itself, is an outright profit center in that way. (And guess what, it seems that the Fed itself is going to be an even bigger winner than the FDIC in all this.)

By Ockham’s razor, Bair is powerful ‘cos she’s rich. There’s no need to resort to explanations requiring her to have particular political prowess or economic foresight.

Will Hutton interviews Paul Krugman:

PK: How is it possible that Germany, which did not have a house price bubble, is having a steeper GDP fall than anyone else in the major economies?

The answer is that they depended upon exporting to the bubble regions of Europe, so they actually got side-swiped by the loss of those exports worse than the bubble regions themselves got hit.

It’s Germany on a global scale that is the concern. We worry about the drag on world demand from the global savings coming out of east Asia and the Middle East, but within Europe there’s a European savings glut which is coming out of Germany. And it’s much bigger relative to the size of the economy.

WH: And on top there is an unique and unaddressed huge potential banking crisis. The Germans pride themselves on their three-legged banking system, but it is incredibly interlinked. The IMF warns that Germany could have to take at least $500bn of writedowns, which its banks have not begun to recognise. German banks hold a trillion dollars – maybe more – of maturing collateralised debt obligations that can only be refinanced by crystallising the losses. We’ve had RBS and you’ve had Citigroup. Germany’s GDP will fall 6% this year – before the banking crisis has hit it.

And that’s just the CDOs — it doesn’t include probably another trillion dollars of loans to central and eastern European corporates and sovereigns, which are nowadays looking extremely toxic. Meanwhile, the political leadership in Germany is in denial, acting for all the world as though the loss of central bank independence is the biggest problem facing the global economy.

The base-case scenario, then, is that Germany goes Japan — and drags the rest of the Eurozone, if not the entire world, into a Japan-style Lost Decade. How do we stop that from happening, especially absent political will in Berlin? I have no idea.

My fingers weren’t crossed hard enough. I did end up buying a folding bike this weekend — a Montague DX — and proudly carried it, folded in half, into 3 Times Square this morning, after having been told by a security guard that folding bikes were OK to bring in to the office. Except, it turns out, they’re not. The only way you’re allowed to bring a folding bike into the building, it turns out, is if it’s packed up into a bag. Otherwise, no dice.

I suppose my next hope is that NYC’s bike-friendly new transportation commissioner will install some permanent bike parking in the acreage of Times Square she recently pedestrianized. But I’m not holding my breath. In any case, I hope my bike shop accepts returns. They did say they would, but I’ve just learned how much I can trust verbal promises.

Update: I just popped down to check on it — I realized I’d left the quick-release seatpost open to easy theft when I chained the bike up outside. The back tire’s completely deflated. As am I.

Do you like pretty charts comparing this recession to the Great Depression and to other recessions in US history? How about 21 such charts in the same place? Here’s one, from the CFR’s new chartbook. Enjoy!

It’s probably inevitable that all presidents reach the point at which they run into Congressional roadblocks. But given the mandate which was handed to Barack Obama in November, and the fact that Democrats control both the House and the Senate, it’s disappointing to see the way in which both cap-and-trade and regulatory reform are being changed out of all recognition in a desperate attempt to make them acceptable to the Senate.

David Roberts has an excellent column on the political realities of cap-and-trade (and bear in mind here that all the major Republican presidential candidates supported some kind of cap-and-trade bill; John McCain even sponsored one):

Republicans have settled on a strategy of blanket opposition to both the health care and climate legislation… They’ve decided that Democratic successes on either of these major initiatives could fuel further electoral losses, and that’s their worst fear…

It can’t be overstated how much unified Republican opposition is shaping things. The debate is entirely between Democrats, entirely along regional lines, and “moderate” Democrats (i.e. those hailing from carbon-intensive districts) have been accorded enormous power…

In the Senate, there are maybe two Republican yes votes—the last moderates standing, Olympia Snowe and Susan Collins from Maine. That means to get cloture, Dems can lose no more than two votes from their own caucus. Meanwhile, there are far more than two senators on the fence (at best) or likely nos (at worst): Mary Landrieu (Louisiana), Evan Bayh (Indiana), Ben Nelson (Nebraska), Blanche Lincoln and Mark Pryor (Arkansas), and several others.

Meanwhile, John Gapper has concluded, reasonably enough, that “the US administration has clearly decided that it simply cannot get any large-scale consolidation of regulation through Congress, given the vested interests involved.”

How did Obama manage to spend all his political capital so quickly? Did it all go on the stimulus bill? Wasn’t the whole point of bringing Rahm in as chief of staff that he could work constructively with Congress to pass an ambitious agenda? And isn’t Obama himself the first president since JFK to have entered the White House from the Senate? I’m not sure when everything went wrong here, but I fear that the damage is now irreparable — and that Obama’s agenda is going to be severely scaled back as a result.

How to structure a gas tax? You could make it a flat X cents per gallon; alternatively (and this is essentially what a cap-and-trade system does, too) you could make it Y%, with the tax increasing with the price of gasoline.

Today, Jim Surowiecki comes up with a third option, where the tax decreases when the price of gasoline goes up:

Rather than leave so much of our fate to chance, we’d be better off doing what politicians always say they want to do: lessen the U.S. economy’s dependence on oil. One step toward that would be to phase in a gas tax designed to smooth out oil’s spikes and plunges by keeping the price of gasoline fixed (the tax would rise when the price of gas fell, and vice versa).

Surowiecki makes a strong case that consumer behavior, when it comes to reducing gasoline consumption, only really changes when there’s a spike in gas prices. As a result, his proposal would seem designed to have the least possible effect on gasoline consumption, and on our dependence on oil. Sure, it’s a sensible way of raising government revenues and reducing the fiscal deficit.

Either you want to effect consumer behavior and reduce gasoline consumption — in which case you actually welcome price spikes. Or else you want to smooth out price spikes, in which case you slowly boil the frog (to use one of the stupidest metaphors ever) and keep consumption high. But you can’t have it both ways. Which is it to be, Jim?

I’m a bigger fan of this morning’s Geithner/Summers op-ed than Simon Johnson is. As a statement of where we want to be it’s a good one; I especially like the way that, by regulating OTC derivatives trades, Geithner and Summers are taking a rather more sensible route than trying to make all derivatives (or all credit derivatives) exchange-traded. I also like the way in which capital requirements for banks will rise with banks’ size — it’s a good incentive to stay small(er), rather than, Lewis/Weill-style, going on massive acquisition rampages.

I do however share Johnson’s disappointment with respect to the “council of regulators with broader coordinating responsibility across the financial system” — we need a powerful single regulator with teeth, not a council of bickering sub-regulators. And if Johnson is right that Geithner and Summers are backing away from the creation of a consumer-facing financial product safety commission, that’s also a bad sign.

And what about “requir[ing] the originator, sponsor or broker of a securitization to retain a financial interest in its performance”? Johnson is unimpressed:

Reality: It was a big unpleasant shock when everyone realized that Lehman, Bear Stearns, and others had retained a large exposure to dubious financial products, some of which they had issued. We are back to the Greenspan fallacy here – if financial firms have an incentive not to screw up on a massive scale, they won’t.

I think the point here is that although the big banks thought they were selling off their credit exposure, largely by selling synthetic CDOs, in point of fact they weren’t: the unfunded super-senior tranches which remained on the banks’ balance sheets were meant to be risk-free but ended up imploding. By contrast, I read the Geithner/Summers proposal as saying that banks will have to obviously retain risk assets on their balance sheets, and account for them — that never really happened before.

The big question, of course, isn’t about the ends — about which we can broadly agree — but rather about the means. Do Geithner and Summers really believe we can achieve all this by tinkering around the edges of the present regulatory system and keeping most of the present regulators in something approaching their current form? I don’t buy it. But I fear that on Wednesday that’s what they’re going to be selling. And that is going to be the real failure.

I’ve been glued to my Kindle all day, reading Charles Kenny’s compelling and important new book, The Success of Development: Innovation, Ideas and the Global Standard of Living. Kenny is a great writer, and his book is a true pleasure to read; it’s also a crucial addition to a development literature which has gotten bogged down in debates which will never be satisfactorily resolved.

The Success of Development acts like a sword through many of the Gordian knots plaguing the development community, especially those surrounding the rate of economic growth in many developing countries. Put that question to one side, says Kenny, and suddenly a lot of much more interesting questions, about issues like education and healthcare and clean water and human rights, come into a lot more focus. And if you use those metrics, rather than GDP growth, to judge the success or failure of developing countries, then things look rather more optimistic than you might think.

Wonderfully, Kenny has made The Success of Development available as a free download from his website, so you have no excuse not to read it — or at least the short 5,600-word introductory chapter which lays out substantially all of the themes of the book. Here’s a taster:

Thousands of papers and articles attempting to divine the causes of long term economic growth around the world, testing hundreds of possible determinants, have produced results that are contradictory and inconclusive. Perhaps this isn‘t surprising given the heterogeneity of countries that have seen fast growth. Between 1929 and 1988, eight countries in the world managed to more than quadruple their per capita GDP: Japan, Taiwan, South Korea, Italy, Norway, Finland, Bulgaria and the USSR. It might be hard to come up with a single policy explanation which could account for rapid growth in all of these very different economic regimes…   

Related to this, looking at almost any measure of the quality of life except for income suggests ubiquitous improvement. The general picture is of rapid, historically unprecedented progress in quality of life –progress that has been faster in the developing world than the developed. This is true for measures covering health, education, civil and political rights, access to infrastructure and even beer production. Since 1960, global average infant mortality has more than halved, for example. Nine million children born in 2006 celebrated their first birthday who would have died before then if mortality rates had remained at their 1960 level. And the vast majority of those children lived in developing countries…

the proportion of the population of Sub-Saharan Africa affected by famine over the 1990-2005 period averaged less that three tenths of a percent. The proportion who were refugees in 2005 was five tenths of a percent. The number who died in wars 1965-2001 was one one-hundredth of a percent. These figures add up to stories of despair for many millions in Africa –but they remain stories of the small minority. For the rest, progress has been considerable. Take literacy, for example –the percentage of Sub-Saharan Africans who could read and write doubled over the period 1970-1999, from less than one in three to two thirds of the adult population… Between 1962 and 2002, life expectancy in the Middle East and North Africa increased from around 48 years to 69 years.

The biggest success of development has been in making the things that really matter – things like health and education—cheaper and more widely available… We do not appear that knowledgeable on the subject of increasing the speed of income growth, as we have seen. In contrast, we appear considerably better at improving the broader quality of life for everyone, at whatever income. 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.   

Kenny is soliciting feedback from anybody who downloads and reads the book; I very much hope that among that feedback will be an email from a literary agent who hopes to be able to place this book with a major publishing house who will put some serious effort into promoting it. Given the success of simplistic books on development by the likes of Jeffrey Sachs and Dambisa Moyo, this more subtle, more realistic, and much more readable book should by rights do really well commercially. And when it does, you can be one of those smug people saying that you read it back when it was a free download from blogs.com.

Alex Tabarrok wonders why no stores stock cheap (as opposed to expensive) HDMI cables, and Kevin Drum — who used to manage a Radio Shack — recounts his own tale of looking for a simple patch cable:

Last year I made the rounds of every retail store in the area after I got annoyed at the price of a simple Cat-5 network cable, and there wasn’t a single place that sold them for a reasonable price. Not one. It was almost like there was a cartel or something. (And the cartel worked! I didn’t feel like waiting the few days it would take to order online, so I went ahead and bought an expensive one. Their fiendish strategy turned out to be remarkably effective.)

I think there are two very simple explanations of what’s going on here. Kevin hints at the first: if you need an HDMI cable or an ethernet cable or a USB cable, you generally want it now, and you don’t want to faff around with ordering it on the internet and wondering when it might arrive. (Note that Alex’s example of HDMI cables being sold for “virtually nothing” turns out to be one of those examples where next-day shipping — still decidedly less convenient than just walking home with the cable in your bag — costs $30.)

But more to the point, your local retail outlet will quite rationally try to maximize the profit it makes on its HDMI cables. Alex I think is wrong here:

Ordinarily, we would expect competition to push prices down but in this case it seem as if the mere existence of Monster is anchoring high prices everywhere but online.

I think what we’re seeing here has almost nothing to do with anchored expectations. Instead, consider this: most remotely educated consumers will simply buy the cheapest cable on sale, and so there’s a very strong incentive to ensure that item is as expensive as possible.

Why would we expect competition to push prices down? Well, let’s say you’re managing a Radio Shack down the street from a Best Buy. You could, if you were so inclined, start selling HDMI cables at a fraction of the cost of the cheapest cables available at Best Buy. Would that be a good idea? Well, it would get you the business of the kind of people who shop around different stores for the cheapest HDMI cable, and it would improve your reputation as a store which doesn’t needlessly rip people off. On the other hand, people would pretty much stop buying expensive cable from you overnight, and all the associated profits would simply evaporate.

I’ve recently been shopping around for a folding bike — one which (fingers crossed) the security guards at 3 Times Square will let me bring in to the office. There’s a sweet little folding-bike shop in my neighborhood, stocking a pretty wide range of different brands, although they do tend to push Bromptons over everything else. And they don’t stock the cheapest brands. Could it be that the cheaper bikes are simply not very good? Maybe. Or maybe it’s just that if their customers have the option of buying a cheap folding bike for a few hundred bucks, they’ll be much less inclined to drop $1,000 on something else, and the store’s total profits will go down.

I suspect you’ll see the same thing at say kitchen stores: while there might be a big range of pots or knives, most shops selling the high-end stuff will be reluctant to stock very cheap stuff alongside it. Doing so just makes it far too easy for the consumer to decide that the extra cost isn’t worth it.

Nafta infoporn

Pie charts: Pretty boring things. But add some white dots and some black dots, and they become videogametastic!   

Foreign holdings of US debt are staying high

Finally: “We should stop using the metaphor about the war on drugs,” says the drugs czar. Next up: the “czar” metaphor

Current TV censors its own employees

The NYT Article Skimmer is better than ever, make sure to play around with the Settings. I love it!

GM CDS auction looks to settle around 11 cents on the dollar

Citi’s bond traders’ salaries should be capped at whatever traders at Freddie Mac are making, it’s all you need to pay

A cute counterintuitive empirical analysis of the effect of new tennis balls

Is Murdoch selling the Weekly Standard to ensure that Wendi doesn’t get the opportunity to kill it when he dies?

Basic anatomy baffles Britons. Would USAians do any better?

The official Ecuador success rate on its bond exchange was 91%. Lower than I expected, but still a win.   

“The Bloodcopy blog has attracted more than 11m page views” — Can this possibly be true?

I always knew that Nouriel Roubini was quite volatile. I just never thought to chart it.