Felix Salmon

The limits of economic policy

Felix Salmon
Jul 3, 2009 18:28 UTC

Are the financial markets in denial about how soon the recovery will come and how impressive it will be? Mohamed El-Erian, for one, thinks so, and he points to the unemployment rate as a key reason why things are not going to get noticeably better any time soon:

The unemployment rate will increasingly disrupt an economy that, hitherto, has been influenced mainly by large-scale dislocations in the financial system.

In just 16 months, the US unemployment rate has doubled from 4.8 per cent to 9.5 per cent, a remarkable surge by virtually any modern-day metric. It is also likely that the 9.5 per cent rate understates the extent to which labour market conditions are deteriorating…

Notwithstanding its recent surge, the unemployment rate is likely to rise even further, reaching 10 per cent by the end of this year and potentially going beyond that. Indeed, the rate may not peak until 2010, in the 10.5-11 per cent range; and it will likely stay there for a while…

This possibility of a very high and persistent unemployment rate is not, as yet, part of the mainstream deliberations. Instead, the persistent domination of a “mean reversion” mindset leads to excessive optimism regarding how quickly the rate will max out, and how fast it converges back to the 5 per cent level for the Nairu (non-accelerating inflation rate of unemployment).

The US faces a material probability of both a higher Nairu (in the 7 per cent range) and, relative to recent history, a much slower convergence of the actual unemployment rate to this new level…

The combination of stubbornly high unemployment and growing government debt will not play well.

I completely agree with all of this. The markets seem to be having difficulty adjusting from a happy world where the key unemployment number is the first derivative, to the current unhappy world where the key unemployment number is the sheer deadweight number of unemployed Americans, who aren’t spending and who are going to be a major drag on economic growth for the foreseeable future.

As for the possibility of a higher Nairu, we’re so far away from there right now that for the time being such discussions are probably academic. But clearly the higher that Nairu gets, the higher the tail risk of a stagflationary spiral — and the less that policymakers can do to get us out of one. Governments managed to avert the most disastrous consequences of the financial crisis. But they might be powerless in the face of the current global economic crisis.


COOL, obama is going to LOVE this.I DON”T the government has NEVER given me any thing I have not earned, ALL the STUFF I have is bought and paid for was with hard work that is the American Way. why can’t this nuckle head in the whitehouse see this? oh, I for got HE IS A NUCKLE HEAD!!!!!!!

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Weekend infoporn

Felix Salmon
Jul 3, 2009 17:52 UTC

Well that’s annoying. I just wrote a very long blog entry about Brad Setser’s wonderful multimedia extravaganza over at CFR.org — click here and then click on “Chapter III: Motion Charts”. And then when I tried to post it, it disappeared entirely. So here’s the short version: all four of the wonderful Gapminder-style charts (household balance sheets, financial failures, global imbalances, and economic power shifts) are great, but my favorite is the financial failures one, which shows banks’ capital, assets, and market capitalization over time.

Check out where that financial-failures chart ends: with five European banks all having assets of more than $2.5 trillion, and none of them looking particularly well capitalized. No US bank is that dangerous, partly because no US bank is that big — and US banks are dangerous enough. All five of those European banks are too big to rescue, and none of them is particularly well regulated. How do we fix this problem? I have no idea. But I do know that it’s a huge problem, and that no one is even beginning to address it.

Update: Thanks to Alea for reminding me that European IFRS accounting standards result in significantly larger numbers for total assets than US GAAP standards. But still, the fact is those European banks are big.


Barry Kelly said it so I don’t have to. Works great.

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How driving a car into Manhattan costs $160

Felix Salmon
Jul 3, 2009 14:07 UTC

In the world of urban planning, there are few things hairier than transportation hypotheticals. When NYC pedestrianized Broadway in Times Square and Herald Square in May, the transportation commissioner said that traffic speeds would go up — but now it seems that we won’t know until December at the earliest whether that’s actually true.

At the same time, however, a smart model of what exactly would happen if you changed this or charged for that is a prerequisite for making any kind of informed improvements to a snarled-up central business district. And so, ladies and gentlemen, let me introduce you to Charles Komanoff‘s absolutely astonishing Balanced Tranportation Analyzer — a 3.5 MB Excel spreadsheet which is the product of many years of research and analysis into the question of New York City traffic.

This thing is so big and so complicated that even with all of the detailed explanations in it, it’s hard to understand — you really need Komanoff himself to walk you through it. But he recently did just that for me, and so I can point you to the “Delays” sheet, for instance, where Komanoff attempts to quantify the externalities imposed by any given car in NYC traffic.

Being a cyclist, I’m acutely aware of the issue of externalities — it generally costs you nothing to blindly step off the sidewalk and into the bike lane, or to open your taxi door without looking behind you, but it can affect me greatly. Komanoff’s a cyclist too, but he’s concentrating in this spreadsheet mainly on vehicular traffic. After crunching the numbers, he calculates that on a weekday, the average car driven into Manhattan south of 60th Street causes a total of 3.26 hours of delays to everybody else. (At weekends, the equivalent number is just over 2 hours.) No one car is likely to suffer excess delays of more than a few seconds, of course, but if you add up all those seconds for the thousands of affected cars and trucks, it comes to a significant amount of time.

Many of those hours are very valuable things, especially when you consider big trucks, staffed with two or three professionals, just idling in traffic. Komanoff calculates (check out the “Value of Time” tab) that the average vehicle has 1.97 people in it, and that the average value of an hour of saved vehicle time south of 60th Street in Manhattan on a weekday is $48.89. Which means, basically, that driving a car into Manhattan on a weekday causes about $160 of negative externalities to everybody else.

Of course there are lots of variables here; for one thing, the externalities associated with driving your car into Manhattan go up with the total amount of traffic in the CBD. If you think there’s 5% less traffic in New York now than there was a year or two ago, for instance, the cost imposed goes down by 14%, from 3.26 hours to 2.79 hours. Or, to put it another way, if you could somehow implement a policy which resulted in 10% fewer vehicles driving into Manhattan, any given vehicle would impose “only” 2.38 hours of externalities — an improvement of about $43 over the base case.

Komanoff, of course, isn’t just analyzing the present, he also has a plan for the future. First of which, necessarily, involves congestion pricing. To drive into Manhattan south of 60th Street, you pay a toll: on weekdays, the toll is $3 at night, then rises to $6 for most of the day, and for peak periods (6am to 10am, and 2pm to 8pm) goes up to $9. At weekends, there’s a similar but smaller toll, at $1/$3/$5 prices.

Then there’s the subway fare: that too changes according to the time of day. At night subways are free; sometimes they’re 50 cents, and most of the time they’re $1. At ultra-peak hours (between 8am and 9am, and between 5pm and 6pm) a subway fare rises to $2, dropping to $1.50 the following hour.

One of the most interesting parts of Komanoff’s plan is the bus fare: always $0, all the time. That speeds up buses considerably, since it basically eliminates long lines at the fare box as people hunt for their MetroCard. In turn that makes buses more attractive, and a lot of people, attracted by the free fare and faster speeds, will start taking the bus rather than driving or taking a taxi or a subway. In-city commuter rail, on Metro-North and the LIRR, also goes free.

Medallion taxis do not pay the congestion charge, but there is a 33% taxi-fare surcharge. One tenth of that (around 3%) goes to the taxi drivers and owners; the rest (30%) goes to the MTA; the taxi surcharge alone raises enough money to make in-city commuter rail free.

Add it all up, and it’s pretty much revenue-neutral, says Komanoff: the biggest line items are that you lose $1.46 billion in transit fares, while gaining $1.31 billion in congestion charges. But total time savings are the biggie: implement this plan and New Yorkers get over $2.5 billion of time back which would otherwise be spent wasted in traffic. Vehicle speeds in general rise about 20%, and as much as 25% between 9am and 10am.

All in all (see the “Cost-Benefit” tab), Komanoff sees $5.3 billion in gains and just $2 billion in losses. Sounds good to me. What’s more, it’s politically more acceptable than the last attempt to introduce congestion pricing into NYC, where the brunt was disproportionately borne by Brooklyn. This plan puts much more of the cost of the plan onto Manhattanites, largely thanks to that taxi surcharge. Here are Komanoff’s charts (from the “Incidence” tab):



Komanoff’s still working on this spreadsheet, but the main message is pretty clear — that smart congestion charging would be great news for New York, and probably for most other dense cities as well. If you’re feeling really ambitious, you can even try playing around with the numbers yourself. Enjoy!


wow i work for enterpriseautotransport.com and for $160.00 I could get a car moved $160 miles!

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Thursday links take a different tack

Felix Salmon
Jul 3, 2009 03:24 UTC

Morningstar’s John Rekenthaler defends target-date funds from my attack

Richard Florida celebrates the past and future decline in homeownership

Weird: the iShares California Municipal Bond ETF is up this year, even as the Aggregate Bond Fund is down

What is Seaweed Survival, how did it end up being owed lots of money by Crabtree & Evelyn, and why does it seem to have zero online presence?

How Goldman Sachs is like the delivery guy from Empire Szechuan


It’s typical of Richard Florida to dance on the grave of homeownership. We should all be wandering minstrels in Floridaland, dancing from creative center to creative center as the whim strikes us.

But this is grossly oversimplified. I say this as someone who has moved frequently, but is semi-permanently planted now (“for the children”), while looking forward to someday flitting off again to greener pastures. In other words, sympathetic to the premise but not convinced.

First of all, frequently flitting is a major underlying cause of this economic crisis, in ways that are not yet acknowledged. People moving from one city or country to another have no real understanding of the local market, and tend to overpay. I don’t know how much this contributed to the bubble, but it was not insignificant. People moving or investing from overseas REALLY got gouged. Ordinary people are not good at currency arbitrage or real estate speculation, it seems. We got screwed.

Secondly, homeownership makes a huge difference in the level of commitment to local communities, schools, and institutions. What’s the old saw about no one in the history of the world ever washing a rental car? It’s not a good analogy–renters often care about the same things owners care about. But on the whole, the sheer “we’re in this together” mentality of owners makes a huge difference, especially in local politics where so much unacknowledged work goes on (for better or ill).

At the heart of the bubble years, if you were unhappy with the local schools, the crime rate, the traffic, etc. what did you do? Sold stake and moved. Today we are stuck in place. This sucks in so many ways, but one thing it improves is our commitment to fixing things where we are. That’s a silver lining, isn’t it? I think it is. Something to celebrate on this, the eve of our greatest national holiday.

Happy Fourth Felix, Fellow readers!

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Why bank fees need to be regulated

Felix Salmon
Jul 2, 2009 21:25 UTC

Whenever I write a blog entry advocating more and/or better regulation, the laissez-faire types, like Vincent Fernando, have a tendency to come out of the woodwork:

I believe we need to keep holding people responsible for their decisions and personal management…

While overdraft fees are quite high, at the same time they are usually easy to see once they hit you. I’ve been hit by them in the past, I got burned, and I became double vigilant not to get burned again. If someone is hard up for cash, there are better ways to get short term loans, actually a credit card, though expensive, is probably cheaper than overdraft using the numbers Mr. Salmon mentioned. I doubt the majority of people who pay frequent overdraft fees don’t have an alternative method to manage their cash, or aren’t able to see these fees by checking their statements. If they managed a budget they would notice some money missing. As seen with credit cards, some people just need to manage themselves better…

Note that the normative modal verbs here: I wrote that the banks “should be stopped”. In response, Fernando says that “we need to keep holding people responsible” and that “some people just need to manage themselves better”. But here’s the difference: stopping banks is, conceptually, possible. But the $38 billion in annual overdraft fees are clear proof that Fernando’s “people” just aren’t going to magically start managing their finances in an optimal manner.

Empirically speaking, it’s clear that the 20% of checking account holders who pay, on average, $1,374 in annual overdraft fees apiece are precisely the people least able to afford them. They’re probably also the 20% of people who, for whatever reason, find it very difficult to manage their personal finances. Not everybody is as numerate and sophisticated as Vincent Fernando — a lot of people can’t even manage simple addition and subtraction. Is it fair for the highly-sophisticated and numerate executives at international banking giants like Bank of America to take advantage of that financial illiteracy in order to line their own pockets with multi-million-dollar paychecks? Or should people be able to trust their banks implicitly?

The fact is that we don’t live in a world or a country where everybody with a checking account has the ability to critically check their statement and see what’s going on. In many cases, including the one detailed today by Karen Blumenthal, that’s because the bank clients concerned are elderly or otherwise vulnerable. Truth be told, I don’t spend all that much time checking my bank statement myself, and I certainly don’t “balance my checkbook” — the rather anachronistic term of art for keeping an independent record of your income and expenditure and therefore how much money you’re supposed to have in the bank.

It seems to me that we’ve tried Fernando’s solution — trying to exhort people to work this stuff out on their own, and to keep one step ahead of the predatory banks — and it has clearly failed. So now we go to Plan B, which is regulate the banks directly. Since they’re clearly incapable of keeping their fees under any kind of control.


July 2nd, 2009
10:10 pm GMT

One way to avoid overdrafts is just to keep an extra $1000 or so in your checking account.

- Posted by Jon H

Um, Jon, people dont have that extra $1000. Thats why they overdraft.

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The banks’ cunning MBS plan

Felix Salmon
Jul 2, 2009 20:25 UTC

Heidi Moore has 1,200 words on bank bonuses in The Big Money. But it being a holiday weekend and all, I know you can’t be bothered to read the whole thing. So here’s the shorter version:

All those bonuses can’t be coming from banking. But it turns out that the banks have been buying up billions of dollars of subprime mortgages, driving up their price. If they carry on doing that a bit longer, the market price will go higher than the price the banks have on their books, and they can then mark their mortgage book to market and report lots of lovely profits. What could possibly go wrong?


“the market price will go higher than the price the banks have on their books”

Then they short them, dump them and make a fortune.

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How AIG FP brought down the world

Felix Salmon
Jul 2, 2009 18:24 UTC

Michael Lewis is back in Vanity Fair, with a really good article about Joseph Cassano and AIG Financial Products. Or half of a really good article, at any rate — the second half of the story is fantastic, and gives by far the best English-language account of what happened at FP and how Cassano, by commission and omission, enabled it. (The piece isn’t online, just a précis — I do hope VF gives up this annoying habit soon.)

There’s a bit too much irrelevant throat-clearing at the beginning of the piece, though, and there’s also this very peculiar passage:

The public explanation of AIG’s failure focused on the credit-default swaps sold by traders at AIG FP, when AIG’s problems were clearly broader. There was the mortgage-insurance unit in North Carolina, United Guaranty, that had taken on all sorts of silly risks in the past two years, lost several billion dollars, and replaced their CEO. There were the fund managers at AIG, the parent company, who had blown nearly $50 billion in trades in subprime mortgages — that is, they had lost more than AIG FP, whose losses stood at around $45 billion.

Later on in the piece, after it starts getting good, Lewis explains how “if it hadn’t been for AIG FP the subprime-mortgage machine might never have been built, and the financial crisis might never have happened”. So doesn’t it make perfect sense for the public explanation of AIG’s failure to focus on FP? After all, as Lewis shows, FP literally had no idea what it was doing. He tells the story of Gene Park, who examined FP’s business at the end of 2005 and found that it was insuring deals which were 95% subprime:

Park then conducted a little survey, asking the people around AIG FP most directly involved in insuring them how much subprime was in them. He asked Gary Gorton, a Yale professor who had helped build the model Cassano used to price the credit-default swaps. Gorton guessed the piles were no more than 10 percent subprime. He asked a risk analyst in London, who guessed 20 percent. He asked Al Frost [FP's main liaison to Wall Street], who had no clue.

Cassano simply trusted the models (which were built with a lot of Gorton’s help), even when the models weren’t designed for subprime in particular, or even really for mortgages.

I guess the message of Lewis’s piece is that FP caused the global financial crisis, even if it didn’t necessarily cause the complete downfall of AIG — that AIG ended up buying in to the bubble created by FP, just companies like Citigroup and Bear Stearns did. Or, to put it another way, FP brought down the financial markets, and the crashing financial markets brought down AIG. You can blame the end of the world on Cassano, but there were a lot of people inside AIG but outside Cassano’s little group who ended up buying into the markets he helped to create and inflate.


Felix – Michael Lewis’ piece on AIG FP was good but it was far from original reporting. In fact the picture he put together has been out there for some time now in bits and pieces…he seems merely to have aggregated it all while also deeming it the “original story as told by insiders at AIGFP”.
For instance, the Washington Post ran a 3 part series late last year charting the evolution and denigration of AIG FP’s corporate culture from the time of Howard Sosin to the time of Joe Cassano.
Part 1 – http://www.washingtonpost.com/wp-dyn/con tent/article/2008/12/28/AR2008122801916_ pf.html; Part 2 – http://www.washingtonpost.com/wp-dyn/con tent/article/2008/12/29/AR2008122902670_ pf.html; Part 3 – http://www.washingtonpost.com/wp-dyn/con tent/article/2008/12/30/AR2008123003431_ pf.html
Carole Loomis took great pains to detail how AIG thought there was no default risk but did not even contemplate market risk (fall in the value of these securities would expose it to massive collateral calls); others have made this point too; Carol also pointed out how AIG’s securities lending ops and other insurance units also made stupid bets on subprime mortgage bonds – http://money.cnn.com/2008/12/23/news/com panies/AIG_150bailout_Loomis.fortune/ind ex4.htm
And finally, you explained in your regional broker dealer conference speech how a whole lot of risky subprime mortgage bonds got crammed into these CDOs that through a faith-in-models approach adopted by everybody got rated AAA and how AIG was the main counterparty that helped make the market for these trades
I generally admire Lewis’ work – his Iceland piece and his take on the whole subprime debacle in Portfolio were excellent. This article though, despite all the hype around it, is really not that original – it’s as you said a lot of throat clearing and beyond that simply a summary of all the various issues underlying the collapse of AIGFP that have already been reported.

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The scandal of overdraft fees

Felix Salmon
Jul 2, 2009 16:43 UTC

There’s been a lot of noise about overdraft fees of late, or NSF fees as they’re known in the industry. (It stands for non-sufficient funds.) Bank of America will now assess such things ten times a day, and the NYT’s Eric Dash has a good overview of the problem using data from Moebs Services:

The most unexpected change has occurred in overdraft fees — the industry’s most lucrative and controversial charge — where the typical fee rose to $26 after five years at $25.

The Washington Post, too, uses the Moebs data, but I’m a little bit suspicious — the chart accompanying Dash’s article shows total NSF fee income rising so steadily over the past five years that it’s hard to believe fees haven’t risen at all.

In March, by contrast, Michael Flores put out a detailed 22-page report on overdraft fees which shows them rising steadily over that period, from $27.04 in 2005 to $28.95 in 2008.

According to an FDIC study of bank overdraft programs, the median dollar amount of the transactions which triggered overdraft fees was just $36. The implicit interest rate on these “loans”, then, is in the thousands of percent.

Flores also has even scarier datapoint:

Active households (defined as the 20.2 million households with bank or credit union accounts who write the majority of NSF items) pay $1,374 in annual NSF fees.   

This is a tax on poverty, it’s substantial, and it ought to be stopped: the 20% of bank customers who pay 80% of the overdraft fees are the banks’ poorest customers.

The WSJ’s Karen Blumenthal explains what’s going on in personal terms:

When our relative began to fall behind on bills, he agreed to give power of attorney to a son, who started paying the mortgage and other big bills, as well as reducing the amount available in his dad’s checking account.

What the son didn’t count on was that the bank would automatically cover up to several hundred dollars a month of his father’s overdrafts, which essentially gave him more money to send to scammers. In addition, he was charged $33 for every overdraft—running up hundreds of dollars in fees. When the son called Sovereign Bank, his father’s longtime bank, he was told that the protection was standard and that he couldn’t turn it off.

It’s the biggest banks who are the worst offenders here, making much more money off noninterest income (ie fees) than their smaller counterparts:


They should be stopped — what they’re doing is unconscionable. Whether you believe Moebs’ numbers or Flores’s, these fees account for the lion’s share of bank fee income, and are already running at well over $30 billion a year. Yes, America’s banks should be profitable. But not because of things like this.

(HT: Chittum)


I recently became a victim of overdraft fees. A whopping $400.00 worth, even though I have overdraft protection. I’ve researched the issue at length, confronted bank officials and compiled a report. I intend to file a claim against Regions Bank in Small Claims court. Nowhere in their on-line documentation could I find the exact amount of their fees, nor did I get any satisfaction from their employees. In fact, the employees spent considerable time on the phone with their back office departments trying to get answeres to my questions. They couldn’t. They went on a screen they jokeingly call the “dark side”, (I don’t consider my money or my transactions a joke)their on-line interface to my account(s) and it doesn’t show the same information I see on-line. It comes down to really bad customer service. Why, because they are allowed to get away with it. I don’t have extra money to support the bank. It seems the government is doing a good job of that.

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Modelling model risk

Felix Salmon
Jul 2, 2009 15:46 UTC

Paul Wilmott has words of wisdom for anybody in the financial-services industry who’s putting a model together:

At every stage of valuation and model development you must be asking questions about risk and robustness. It is dangerous to come up with some fancy model and only afterwards start asking questions about model error. Anyone who has ever calibrated a model knows that the methods used to mitigate model risk almost come as an afterthought, and are totally inconsistent with the original model. This need not be the case.

The problem is that developing a model is the sort of thing which (a) quants are trained to do, and (b) can, eventually, make money. While mitigating model risk is a very recondite field which very few people have any expertise with; what’s more, it doesn’t really make money in and of itself. Where will all the model-risk modellers come from?


I aint no hotshot at all, just debating ideas…which seems to be how these forums typically work. If I can bend my head around others ideas, perhaps there’s can bend around a few of mine as well.

If market policy and climate policy can intersect without egregious and/or superficial economic cost I’m on board. But as we’ve seen with ethanol mandates (Grow corn. grow corn now!) there is / can be decidedly after-effects which aren’t always fully considered on the interim prior to implementation.

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