Felix Salmon

Wednesday links go underwater

Felix Salmon
Jul 16, 2009 02:38 UTC

But who would win a fight between Giant Octopus and Vampire Squid?

Google calls bullshit on newspapers who say they don’t want to be indexed

Judge dismisses Donald Trump’s lawsuit against the NYT’s Tim O’Brien

“Once again, Ben Stein distinguishes himself by how many things he can get seriously wrong in a short column”

Kevin Drum rightly hates on the Time.com redesign, including its truncated RSS

“Our report stated women who drink alcohol are more likely to be raped. In fact, the research found the opposite.”

More cracked Kindles (see also)

Harold Meyerson says that Rubin is our McNamara

Two out of three major bond-rating firms now agree: California’s credit grade should begin with a B

Krugman: Government deficits, mainly automatic rather than discretionary, have saved us from a second Great Depression

Robert Reich is worried about Goldman Sachs

How a CDO is like a rectangular bathtub

Felix Salmon
Jul 15, 2009 21:22 UTC

J, at This is the Green Room, is in the middle of a series entitled “Deconstructing the Gaussian copula”. Part 1 was here, Part 3 is on its way, and Part 2 features a really good explanation of CDOs and default correlation:

To understand why tranching compounds the correlation problem, think of the CDO as a rectangular bathtub interspaced with mines that represent each issuer’s default. The CDO investors are aboard a boat on one side of the bathtub, and need to cross to the other side. If the boat hits a mine, that issuer defaults, and the explosion of the mine will damage the boat. The equity tranche has an extremely thin hull and will sink quickly; the senior tranche has a thick hull and can withstand many blasts without taking damage. Finally, the boat moves across the bathtub via geometric brownian motion – which is to say, randomly.

In a low-correlation world, the mines are dispersed uniform randomly across the bathtub; hitting one mine does not imply or necessitate hitting any other. With high correlation, the mines cluster somewhere in the water; hitting one mine makes it relatively certain that another will be hit.

As a consequence, equity investors prefer high correlation. They are indifferent to hitting just a few mines or many, as they are wiped out in both situations. Therefore, they prefer the mines to be clustered, as this leaves more clear paths across the bathtub. In contrast, senior investors prefer low correlation – they can withstand glancing off a few mines, but hitting a cluster would wipe them out.

This helps explain why leveraged super-senior trades turned out to be so much more dangerous than simple equity tranches with a similar expected return. When an equity tranche sinks, you lose a small, light dinghy. When a senior tranche sinks, you lose an aircraft carrier.

(Thanks to Charles Davì for the pointer.)


I suppose that analogy works well to explain the importance of correlation (although the brownian motion aspect renders it a tad unintuitive). But it really doesn’t work to describe CDOs (or any securitisation) as a whole. In the analogy, it’s perfectly possible (though unlikely) for the equity boat to make it through unscathed while the senior boat gets sunk. That can’t happen in a CDO.

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Tax banks to make them smaller

Felix Salmon
Jul 15, 2009 19:12 UTC

When the WSJ editorial page proposes any kind of new tax, it’s worth paying attention to:

Another answer would be an FDIC-style bailout tax, perhaps tied to leverage ratios, for those in the too-big-to-fail camp.

Janet Tavakoli is on a similar page:

U.S. taxpayers should insist that a large part of Goldman’s revenues and profits belong to the American public.

A Goldman-specific tax might be fun to attempt, but there really is a public good to be served in taxing what you want less of — which is too-big-to-fail banks making outsize bets with other people’s money (backstopped by the taxpayer, of course) and then paying themselves billions of dollars in bonuses.

The WSJ’s bailout tax idea is a good one — especially if it rose in line with a financial institution’s balance sheet, and gave those institutions a serious incentive to shrink. If you can’t legislate a hard cap on assets, then you can at least provide some gentle encouragement to get smaller rather than bigger.


Understood. But I thought the point of our hypothetical tax was to keep the institution small, not so much the bonuses, (though the original post does mention both.)

I do agree that in short order the tax accountants would be the new Masters of the Universe!

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How journalism school is like overdraft fees

Felix Salmon
Jul 15, 2009 18:19 UTC

Overdraft fees and lottery tickets are both in their own way taxes on ignorance, or at least a lack of sophistication — which is one reason why both should be carefully regulated. Richard Sine, today, adds another item to the list: J-school tuition fees. He has a clear message for deans of journalism schools around the country:

Do not charge so much money to walk through the door that the program is open only to the rich, the idle, or the financially illiterate. That’s not a journalism school; that’s a gold-plated welfare program for your old newsroom buddies, built on the backs of starry-eyed naïfs.

I think it’s fair to say that going to journalism school increases your chances of getting a job in journalism. If J-school graduates are almost by definition financially naive — if they weren’t financially naive they’d never have spent so much money on J-school — then maybe J-school is only serving to increase the number of innumerates working in journalism. Which is a sobering thought.


well… I for one never taken journalism school. Don’t need to… I am a domainer and webdeveloper… currently I’m looking forward into the development of ” PutaSockInIt.com ” (aka “epogger”) for a microblogger… Bill O’Reilly eat your heart out :P

The Chinese stock-market crash: July 22

Felix Salmon
Jul 15, 2009 16:27 UTC

Josh and Tyler have found a piece of ever-so-scientific research which calculates that the Shanghai stock market will crash somewhere between July 17 and July 27. Which is convenient for me, since I’ll be there personally from July 19 through 25; I should have a front-row seat!

If I had to pick a single day for the crash, of course, it would have to be July 22. When the predictions of a Log Periodic Power Law are ratified by a solar eclipse with the longest totality of the century, how could stocks possibly behave otherwise?

Update: Zubin has found a paper about the effect of eclipses on the stock market.

Chart of the day: Goldman VaR

Felix Salmon
Jul 15, 2009 15:22 UTC

Remember September, when Goldman Sachs and Morgan Stanley became bank holding companies? The WSJ reported at the time that the banks were “taking steps to reduce their leverage”:

It had become increasingly clear to Fed officials in recent days that the investment-banking model couldn’t function in these markets…

Goldman — and to a lesser extent, Morgan Stanley — has maneuvered through the credit crisis better than other investment banks. But its business model, which relies on short-term funding, is under attack. Some stockholders worry that its strategy of making big investments with borrowed money will go wrong someday, which would make it more difficult for the firm to get favorable borrowing terms…

The most fundamental problem is how to generate profit growth in a world that no longer tolerates high leverage.

Now my colleague John Kemp has published a wonderful little chartbook of Goldman’s value-at-risk, which includes this. The annotation is mine:


I guess Goldman Sachs worked out how to generate profit growth in a world that no longer tolerates high leverage. It just increased the amount of capital it puts at risk every day.


As a currency trader named DeRosa said back in the ’90s, VAR is a lighthouse for the soon to be shipwrecked. It gives me the jim-jams to believe that major-league trading operations are still depending on it to estimate market risk.

Baker-Samwick does allow rental properties to be sold

Felix Salmon
Jul 15, 2009 14:44 UTC

John Carney thinks that the Baker-Samwick plan would create “havoc” in securitized mortgages, and points to Tom Lindmark:

I suspect that more than a few of the investors that own these mortgages might not be thrilled to see their contractual rights to foreclose on the property and dispose of it are going to be real happy to learn they’ve just been turned into long term investors in real property. They probably just want to get whatever is left over from a bad investment and lick their wounds for awhile. Instead, the government is going to make them stay in the game.

Let’s nip this one in the bud: there is nothing in this proposal which says that the owner of the property can’t sell it. Indeed, quite the opposite: Baker and Samwick write that “the mortgage holder is free to hold or sell the property as they choose”. Which in turn means there will be no havoc wreaked in securitized mortgages.

Banks, once they’ve foreclosed on a property, are still free to sell it, if they so desire, to the highest bidder. But the buyer of the house will have to continue renting it, at market rates, to its current inhabitants, until they either fall behind on their rent or move out. Which is no great hardship — that’s what landlords do.


Lindmark’s blog is weak

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MBA datapoint of the day, Harvard edition

Felix Salmon
Jul 15, 2009 13:48 UTC

This year’s class size at Harvard Business School — 942 students — is a new record, up from 900 last year. Most of HBS’s costs are fixed, of course, so a marginal increase in enrollment is likely to drop straight to the bottom line — something Harvard’s in desperate need of these days.

The value of the Harvard brand doesn’t seem to have diminished — I doubt it had too much difficulty scaring up those 942 students — and similarly I doubt that a 5% increase in class size will have any effect on the market value of a Harvard MBA. But there’s no doubt that value has gone down substantially over the past year or two, especially given that Harvard’s MBA is one of the more finance-heavy courses out there.

The pendulum’s swinging back: senior managers will need to manage more, while doing much less in the way of financial engineering. I wonder whether and how that fact is going to be reflected in the Harvard curriculum


The real index is the value of a University of Chicago MBA, which is even more finance-focused than Harvard.

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Tuesday links work for peanuts

Felix Salmon
Jul 14, 2009 21:44 UTC

Someone is hiring writers and paying $10 for 600 words

Eliot Spitzer on Matt Taibbi’s Goldman Sachs piece: “good journalism, and good reading”

“Asset allocation will work most of the time in the future but not always” — that’s just saying it’s certain to fail.

This can only be good

Nice gapminderish source for OECD macroeconomic data

I’ve made the Power Grid! But they massively undercount the number of unique visitors that Reuters gets.


Of course, there’s nothing wrong with writing for glory rather than money. I’ve contributed probably a few thousand words to Wikipedia for zero dollars, and my Dad used to do software reviews for an old PC magazine for something like twenty bucks and a copy of the software. If they’d phrased the advert a bit differently, perhaps it wouldn’t look so crass. Then again…I’m guessing they don’t credit contributors, and their aim is to make money. So, yeah, screw ‘em.

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