Opinion

Felix Salmon

Stocks are rubbish

Felix Salmon
Jul 19, 2009 23:18 UTC

Quote of the day:

“Japan had the highest correlation of garbage output to stock market performance of around 90%.”

The paper referred to is this one.

COMMENT

I am sure there are many other interesting ways of measure consumption

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A turning point in the financial crisis

Felix Salmon
Jul 19, 2009 23:08 UTC

If CIT really has dodged a bullet here and avoided bankruptcy, that’s spectacularly good news. I’m assuming here that a deal has done, based on nothing but a single one-line headline on WSJ.com; these things tend to be fraught and fractious, however, so I’m not counting my chickens just yet. But if CIT has really avoided bankruptcy, that’s a major turning point in the history of the financial crisis.

It’s good news for various individual constituencies, of course, especially all the small and medium-sized businesses which will now find it easier to roll over their loans. It’s good for CIT’s shareholders, who might be left with something more than $0. It’s good for CIT CEO Jeffrey Peek, who did his best Dick Fuld impression over the past few months, refusing to raise capital even as everybody else was taking any capital they could get, and as a result almost sent his company the way of Lehman. And it’s spectacularly good news for CIT’s bondholders, who could well see the value of their holdings rise from the single digits into the high double digits as soon as the markets open.

Most of all, however, it’s good news for the system as a whole, which seems to have demonstrated that it’s possible, if not easy, for a private-sector alternative to bankruptcy to be worked out without government interference or guarantees.

I have to say that on Friday, I didn’t think such a thing possible. But with CIT’s unsecured bonds reportedly trading at less than 10 cents apiece on Friday, it was clearly in the large bondholders’ best interests to do some kind of deal, even if doing so meant other bondholders would get a free ride.

The point here is that there is almost nothing which can destroy as much value overnight as the bankruptcy of a financial institution. There were questions over CIT’s solvency, of course. But we’re talking a few billion dollars of shortfall on an $80 billion balance sheet: if capitalism worked the way it’s meant to, then maybe shareholders would be wiped out, but bondholders’ recovery would be high.

But financial-company bankruptcies don’t work that way, as we saw with Lehman Brothers, liquidating a bank is a sure-fire way of getting such low prices for your assets that even secured bondholders start worrying; unsecured bondholders are liable to walk away with little if anything.

It makes sense, then, that those unsecured bondholders would have every incentive to come to some kind of deal with CIT. The problem with any deal done outside bankruptcy court is that any creditors not taking part in the negotiations are going to have to be paid off in full. In turn, that means that the bondholders who are in negotiations are going to have to provide new money, so that CIT has the cash to service its debts. And no one likes throwing good money after bad, especially when that new money doesn’t have the protections afforded to DIP financing in a bankruptcy situation.

If bondholders managed to overcome all those obstacles over the course of the weekend and come to a deal which saves CIT, then maybe the market is starting to be able to work things out on its own, without the need for government involvement. And maybe spreads on bank debt in general will continue to tighten in, as the expected recovery in case of distress rises from the single digits to something much higher. I do hope this deal happens.

Update: The WSJ article is now up:

The deal, which was being considered by CIT’s board Sunday night, charges CIT very high interest rates, and it doesn’t permanently fix the company’s long-term financing needs, say people involved in the transaction. But it buys time for the lender to restructure itself, and minimizes bondholders’ losses. Bondholders calculated they would lose more if CIT filed for bankruptcy and sold assets at fire-sale prices than if they offered the rescue.

COMMENT

Nice article! If you’d like to know when experts anticipate the end of financial crisis check this link below:

http://www.myhowtoos.com/en/red-hot/50-h ow-long-financial-crisis-will-last

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Friday links have secret techniques

Felix Salmon
Jul 17, 2009 21:09 UTC

I’m off to Shanghai tomorrow, so blogging’s going to be light for much of next week. Do let me know if you’re in Shanghai and would like to meet up, or if there’s anything I absolutely must do when I’m there.

Lehman paid out $55 billion to employees in the decade to the end of 2008. You know what shareholders got.

Brad DeLong: “it is entirely fair for outsiders to conclude that academic economics as a profession is useless

Amazon secretly takes Orwell ebooks from Kindles

How does the Daily Show get those video clips? “We have ways of finding footage, and we have techniques that we use.”

Ryan Chittum on Jon Stewart on Jim Cramer on Lenny Dykstra. Be sure to watch the video.

Ars Technica calls me a “finance uberblogger”. Um, thanks!

COMMENT

Hi Felix, Living/working in Shanghai. Let’s meet up,as I’m familiar with the terrain…Regards,Jeff

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Summers speaks

Felix Salmon
Jul 17, 2009 20:59 UTC

Larry Summers gave a big speech at the IIE this morning, and his prepared remarks — all 3,412 words of them — are now up on the IIE website, maybe because the NEC’s web presence is barebones in the extreme. Of course, when you let someone else publish your remarks, you lose a certain amount of control over how they’re presented; I do wonder what Summers thinks about the fact that when you get to the bottom of his speech, you find yourself faced with a cute little button saying “twit this”.

There’s a bit more than 140 characters’ worth of stuff in this speech, though, including Summers’s explanation of how he got to $800 billion:

The size of the stimulus reflected a balance of several considerations: the size of the likely output gap that the economy was facing, the difficulties of ramping up spending and then ramping it back down after recovery in a high budget-deficit environment, the question of how much could be spent both quickly and productively, and the recognition that the Recovery Act was just one of several initiatives by the Administration that would have a dynamic impact on the state of the economy.

This seems right to me: the output gap — which was indeed underestimated — was just one of many factors, and the size of the stimulus might well have been capped by questions unrelated to GDP growth or the unemployment rate.

Elsewhere in the speech Summers proves himself a master at stating the utterly meaningless: “It is essential that stimulative policies be sustained for as long as necessary but also that they be sustained no longer than necessary,” for instance, is a classic piece of political pablum.

My favorite part of the speech, however, is the inclusion of the phrase “even Alan Greenspan asserted that” — with the clear implication that the differences between Greenspan and Summers are both obvious and large, and that the two men are definitely not the kind of pair who would pose heroically and jointly for a national magazine cover portrait. Let’s make sure no one reminds Summers of who the third man in the picture was: while Summers has taken his lumps over the past decade, and Greenspan’s reputation has declined precipitously, Rubin’s reputation has been utterly obliterated. But that’s what happens when you enter into the orbit of Citigroup.

COMMENT

In regard to the stimulus investment, my understanding is as follows:

1. The current surging fuel cost (World oil prices doubled during the last 6 months) is overwhelming the market rally.
And the pending clean energy bill might serve as a second stimulus package world-wide boosting private investments.

2. People are so worried about losing their job, coverage, denial of treatment, which seems to increase bank deposit latetly. That means stimulus funding mainly goes toward bank deposit for a rainy day increasing jobless rate. It proves again that a healthy society yields better productivity, prosperity.
It is time to ‘Change’ the notion of the public health as a fundamental human right and install ‘a safety system for all’ like all of the other industrialized nations, I think.

3. The stimulus funding begins to mobilize just 11%, meanwhile, the auto industry has undergone its restructuring with the massive job-related impact.

4. The pandemic swine flu has been hurting the global economy seriously.

Thank You !

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The Gates Foundation’s reckless risk-taking

Felix Salmon
Jul 17, 2009 18:19 UTC

Why is the Gates Foundation speculating in distressed UK equities? The foundation has received a lot of criticism for the way it invests, but put that to one side — it seems to me that charitable foundations in general should be pretty risk-averse, even when they have tens of billions of dollars. The Gates Foundation is praiseworthy in that it has a mandate to spend down its principal quite quickly. But as a result, its investment arm should be a boring place; it certainly shouldn’t be gravitating towards the riskiest parts of the capital structure of overleveraged retailers in overleveraged economies like the UK.

I suspect that the problem here is one of incentives, and that the people running the foundation’s money will get substantial bonuses if they take big risks which pay off. It’s time to find good fund managers who are dedicated to the stated aims of the Gates Foundation, and just pay them a flat salary (which can be quite large). Philanthropic foundations shouldn’t act like hedge funds, a few exceptions like TCI notwithstanding.

COMMENT

I wonder if the article Felix referenced is confusing Gates Foundations investments with Bill Gates own personal investments? Cascade Investment corp is his own private investment company and they definitely invest in risky assets. Looking through the foundation’s 2007 tax form 990 there doesn’t appear to be any references to Cascade Investment corp. See:

http://www.gatesfoundation.org/about/Doc uments/2007-foundation-form-990-pf-publi c-disclosure.pdf

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Who cares about future house prices?

Felix Salmon
Jul 17, 2009 17:21 UTC

James Kwak wonders about the housing market, and price-to-rent ratios:

The fact is that most people buying houses aren’t going to be renting them out, and what they care about is the price at which they will be able to sell that house in 10 years.

Has anybody ever quantified this? Let’s say that you have a choice between renting and buying. If you rent, you just pay $1,000 a month. Alternatively, you can buy a house for $200,000, with a $40,000 downpayment, and pay that same $1,000 a month to service your $160,000 mortgage. (Let’s keep things simple and ignore things like property taxes and mortgage-interest tax relief and maintenance costs and what have you.)

Which do you choose? That’s up to you, of course, and will probably be related to the amount of money you have, and your desire to spend or invest that $40,000 on something other than a house downpayment. But to what degree does the value of the house in ten years’ time affect your decision? After all, you may or may not have any desire to sell in ten years’ time. And even if you do sell, there’s a very good chance that you’ll just end up buying another house elsewhere, which will be similarly more expensive. In that sense buying a house isn’t an investment, so much as it’s a way of permanently covering your built-in short position when it comes to the shelter market.

Similarly, if you’re inclined to rent, the key number you’re worried about when it comes to the future is not house prices in ten years, but rather prevailing rents in ten years. Buying a house can be thought of as paying $40,000 up front to lock in that $1,000-a-month rent in perpetuity. You don’t particularly mind if house prices go up, so long as that’s a function of rising price-to-rent ratios, and not a function of rising rents with a constant price-to-rent ratio.

The point is that in a normal market, the only people who really care about the nominal value of their house in ten years are the people who are essentially timing the market: buying now, with the intention of cashing out in ten years, making lots of money in capital gains, and then going back to renting. That’s a tiny proportion of the housing market. Everybody else is just paying whatever they can reasonably afford.

In a bubble, of course, things change. Then you get a much larger number of speculators, and you also get an added advantage to rising house prices: the ability to refinance your mortgage on a regular basis, taking out cash each time. In general, when a very large number of people think of houses as an investment, that’s a good sign that you’re in a bubble. When most people think of houses just as somewhere you need to pay money to live, either in rent or in mortgage payments, then that’s a much more normal housing market.

Update: Great minds, etc. Karl Smith:

When people asked me about the wisdom of home buying during the bubble my stock response was, “think of your house as a place to live.”

That is, overwhelming the returns that come from owning a home are going to come from the “real dividend” of actually living in the house. In the long run prices may rise and prices may fall but your primary concern has to be keeping your family warm and dry.

COMMENT

The comments re nasty landords are relevant, but it is a trade off. Career advancement is difficult without mobility. The high cost of buying or selling and the trap if local values fall (like in an area that loses it’s industry)should be considered. Also it costs 2% per year to own a house and also 1% per year of the reported gain in values is actually improvements. If you are young and high income upwardly mobile etc I suggest you look first at salary sacrificing into superannuation and then getting very well informed about how to exercise the almost globally unlimited investment choices within that. You will slash your tax and stay mobile and when you are ready to retire you can take the tax free money and buy a home that suits your situation at the time. All the capital gains made inside super convert to tax free after age 60 and there is no upper limit on how much your super can grow to. Looking back, deciding to be a tenant for a long time would change the way you went about it. You would get good at it and have the right gear to just move into anything and make it comfortable.

Annals of fictional market manipulation, cont.

Felix Salmon
Jul 17, 2009 16:05 UTC

Rick Bookstaber, after mentioning that “we have no clue” how Goldman is making all that money, then adds:

I am in the middle of writing a novel that begins in the midst of the 2008 crisis. In the novel there is an investment bank where one of the trading units gets requests from its clients to price their illiquid inventory. (This is an exercise that occurs in real life, because the clients have to mark to market, and for some assets there is no market. So they go out and get bids from a couple of banks, and then mark at the average of these two prices). This trader puts in incredibly low-ball prices. One bank prices a security at $92. He prices it at $50, leading to a mark to market price of $71. The trader knows that with such a low price, the client will be forced into liquidation mode. The trader positions his book for the forced sale that he helped precipitate, generating big profits from his scheme. This is fiction.

I just can’t wait for the movie. Any chance of getting Dan Aykroyd and Eddie Murphy back together?

Citicorp: Not very American

Felix Salmon
Jul 17, 2009 14:43 UTC

Beyond a vague notion that Citicorp is the “good bank” and Citi Holdings is the “bad bank”, I’ve been a little unclear on exactly where Citi is going with this cleavage. But today’s quarterly report is helpful in that it gives not only the Q2 2009 numbers for Citicorp, but also the Q2 2008 numbers. That helps us see how the good bank is structured, especially as regards its geographical balance. And the result might be surprising: North America is much less important to Citicorp than you might think.

Citicorp shares its revenues between two big buckets: “Regional Consumer Banking” (retail banking) and “Institutional Clients Group” (wholesale banking). On the retail side, North America accounts for 31% of the revenues and none of the profits; Latin America, by contrast, is 32% of the revenues and 32% of the profits, while Asia accounts for 29% of the revenues and a whopping 125% of the profits. The small EMEA group is troubled: it had revenues of just $394 million in the quarter, but still contrived to lose $110 million.

On the wholesale side, there’s another pair of buckets: “Securities and Banking”, which is self-explanatory, and “Transaction Services”, which is the boring (but extremely profitable) back-office stuff. On the banking side, Asia once again is punching well above its weight, with 20% of the revenues but 32% of the profits. North America had 28% of the revenues, but didn’t manage to make any money.

If you add all the line items together, North America had 29% of Citicorp’s revenues, and 5.5% of its profits.

I’m all in favor of geographical diversification, but this looks almost as though Citi is giving up on the US. JP Morgan and Goldman Sachs have shown that there are billions of dollars to be made in this country, but North American profits at Citicorp totaled just $169 million, of which $181 million came from Transaction Services.

When Citi lost Wachovia to Wells Fargo, that was pretty much the end, I think, of its ambition to be a major consumer bank in the US. There are three big retail banks in America now: Bank of America, Chase, and Wells Fargo. Citibank, while enormous globally, is a distant fourth domestically. And it seems as though Citigroup is positioning Citicorp similarly. That’s in line with Citicorp’s heritage: Citi was always concentrated overseas before it was bought by Sandy Weill. And the departing CEO of Citibank NA, Bill Rhodes, is the epitome of globe-trotting Davos Man: it’s not easy to imagine him talking about branch strategy in west Texas. And in general you’re much more likely to find a Citibank in some dusty foreign capital than you are in any US flyover state.

Citigroup is based in the US, of course, and the US government is its largest shareholder. But if its plan to divest itself of Citi Holdings ever happens, the remaining company won’t be particularly American.

COMMENT

Citi corp get out of the U.S. and go to the countries where you can make money and pay back the small investors! It’s the same story, money talks. The big boys over the weeekend sure cut themselves a deal. Double diget interest and 3 to 1 on secured assets. I have 50k invested aqnd get s—t. The person in the White house who won’t even prove that he is a native born American citizen and is NOT my president untill he proves so, refused any aid to Citi Corp, but is going to shove gov med care up ourws. People in America are just plain STUPID they are letting our country go to hell, and don’t give a damm.

double diget

Thursday links spell it out

Felix Salmon
Jul 17, 2009 03:10 UTC

TED on how bankers’ obsession with growth caused the mess we’re currently in. (He doesn’t use the word “mess”.)

Now that’s a cool new Goldman Sachs logo.

Denton: “They take the slickest lofts, the hottest gold-diggers – and leave us with the bill. It’s time for Goldman to pay.”

A violated neckline and retested right shoulder, check, but is there such a thing as two right shoulders?

A sensible proposal for how HuffPo might pay some of its bloggers a relatively modest amount of money, occasionally

Jim Cramer is now an internet hack shill

Taibbi on Goldman’s earnings: Possibly even better than his Rolling Stone piece. (But no squid, unfortunately.)

Treasury should hire James Kwak to explain the CFPA. He does a much better job than they’re doing.

Which unemployment numbers to look at? And how much of the pain is being borne by men?

Is there anything in the WSJ’s econoblogosphere article which couldn’t have been written a year ago?

Ben Goldacre on why the Telegraph’s rape correction is insufficient

Choire eviscerates the NY Post’s idiotic story on the healthcare surcharge

Bailing out CIT would benefit strip-and-flips, not mom-and-pops

“Cabernet costs more than any other wine, even if it tastes like a dead seagull spewing maggots

Yet more wars between US and Antiguan authorities over Stanford. Lawyers always win.

COMMENT

Ken, the question is whether they actually needed that money. At least according to GS (as well as Felix and others), the company was fully hedged. In that case, the $13bn was a gift, but not vital to their survival.

I agree in general that it was a bailout for counterparties (though I’m sure the Fed would argue that if those counterparties weren’t bailed out, we’d face a systemic collapse). But there were a lot of other banks there too, many (especially the Euros) who likely weren’t well-hedged.

My problem isn’t so much with his style (though I’m not a huge fan of that). It’s that he’s vastly oversimplifying a complex discussion. It’s easier to say Goldman is evil and runs the world, but it’s also not nearly as useful.

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