Opinion

Felix Salmon

Those infuriating community banks

Felix Salmon
Aug 13, 2009 20:08 UTC

I’m getting quite fed up with the Independent Community Bankers of America. First they self-defeatingly came out in opposition to the Consumer Financial Protection Agency, now they’re refusing to grant government-guaranteed loans to small businesses just because it’s not particularly lucrative and they can’t be bothered to do the underwriting.

“There’s not a lot of profit motive in a $35,000 loan stretched over six years,” said Paul Merski, chief economist for the Independent Community Bankers of America, a trade association.

Bob Seiwert, of the Center for Commercial Lending and Business Banking at the American Bankers Association, says “stringent underwriting standards” will require as much work as larger loans, making these even less economical…

It would appear that banks like M & I are using that flexibility more to deny than to approve loans. For example, Wells Fargo, one of the largest Small Business Administration lenders, has received 700 to 800 completed applications, said Tom Burke, the senior vice president overseeing small-business loans at Wells Fargo, but has approved only “several dozen.”

I’m not sure that it’s fair to M & I Bank of Milwaukee to judge it by the actions of Wells Fargo. But maybe it is. It does seem clear that with only $36.8 million of loans extended since May, precious few lenders seem to be in any hurry to get their hands on these SBA guarantees.

I wish these loans could be disintermediated somehow: I’m sure there are lots of Americans — even Americans who know how to underwrite loans — who would love to get 2 percentage points over prime on $35,000, spread over six years. (Prime is currently 3.25%, and almost certainly won’t go any lower; that puts a floor of 5.25% on the interest that these loans throw off. Try getting that from a CD.)

Instead, the banks seemingly hate to do their job, which is simply underwrite loans — the only thing they’re worried about is that if the borrower defaults, the SBA will go back and check that they bothered to underwrite the loan in the first place. In 95% of cases the bank did do just that, and the guarantee is paid out. But obviously there needs to be some check by the SBA: you can’t have banks just giving away money, safe in the knowledge that they’re bound to get it back, with interest, from the government.

There’s a subtext to this story, too, which is that banks still don’t seem to be worrying nearly enough about credit risk. The SBA is offering to bring credit risk down to zero on a large class of loans, and they’re basically saying “thanks, but no thanks”. My guess is that competent underwriting skills were left to wither away during the Great Moderation, and that they’re hard to rebuild. And that for all that they call themselves “community banks”, the smaller shops are in just the same place as the big boys. They’ve forgotten how to underwrite loans, and now they’re scared to lend to small businesses, lest the SBA find out that their underwriting was a chimera all along.

COMMENT

I think the bigger puzzle is why investors are pricing securitized SBA stuff as if they and not taxpayers were on the hook for losses. (i.e. why does SBA securitization need TALF support)

Posted by thruth | Report as abusive

When insolvent banks are worth billions

Felix Salmon
Aug 13, 2009 19:15 UTC

Jonathan Weil has a good column today leading with the fact that Regions Financial is insolvent, if you mark its assets to market; it’s not the only one. But stock-market investors don’t seem to mind — they’re valuing the equity in the company at more than $6 billion. The true market measure of how risky the bank is can be found in its credit default swaps: five-year protection written on RF’s tier-2 debt is currently trading at a spread of 722bp over swaps.

What that says to me is that bonds are the new stocks, and stocks are the new call options. Bonds give you a high return for high risk, while with stocks you’re really levering up, running the risk of being wiped out entirely in return for the possibility that your investment could multiply in value in a matter of months.

That’s not healthy. The stock market should be a way for investors to allocate their capital over the long term in fundamentally healthy companies. Right now, however, it’s a casino. And the slightly safer market, in corporate bonds, is exactly the market we want to discourage from coming back: systemically speaking, equity markets are much less dangerous than debt markets.

In any case, we’re certainly nowhere near the point at which you can judge the health of a bank by looking at its share price. Which means that we’re nowhere near the point at which requiring large shareholdings is the best way to give management a strong incentive to make their bank healthier. Maybe we should require that top executives start buying a lot of preferred stock instead.

COMMENT

Don,

the idea isn’t to discourage business fund raising. Fund raising can come in one of two forms: debt or equity. Debt has an externality it that (in large doses) creates systemic risk. That is, highly leveraged systems are brittle: a system with the same investments in the form of equity, rather than debt, is much more resilient to shocks.

I don’t like Taleb’s idea. But there is a halfway point. Currently the rules favor debt financing via 1) not taxing outgoing interest but taxing outgoing dividends, 2) manipulation of interest rates to make debt financing cheaper, 3) guarantees of liquidity for financial institutions so they can more easily make long term loans. These are things we have been doing for a while; the crisis management stuff has been in the same direction.

This is very strange. Why are the rules biased to favor debt? We need to work to make the rules neutral or even to give a nudge to equity instead of debt.

Posted by Joe in Morgantown | Report as abusive

The downside of speed-reading

Felix Salmon
Aug 13, 2009 18:11 UTC

Via Tyler Cowen, who reads very fast, comes a video and full instructions on how to do likewise; the trick is to stop subvocalizing.

I note that although Tyler often posts “the best sentence I read today”, it’s invariably interesting and/or provocative, as opposed to simply being a really good sentence. When you read fast and don’t subvocalize, do you start to miss the art of constructing or even just appreciating beautiful sentences? Would a speed reader, for instance, ever be able to write a book like U&I? These are genuine questions, by the way: while I read quite quickly, I don’t speed-read, and I do subvocalize.

COMMENT

That’s explains a lot. Obviously smart and prolific, but much of his output seems superficial to me. Lots of pronouncements, but not that much argument.

Posted by Steve | Report as abusive

America’s doomed small newspapers

Felix Salmon
Aug 13, 2009 17:54 UTC

Bill Wyman’s 9,000-word, two-part magnum opus laying out five reasons why newspapers are failing is a must-read — or at least the first three reasons are; the final two are a little weaker.

The first part, on how consumers have never paid for news, is the clearest exegesis I’ve yet seen of the truism that newspapers don’t sell news, they sell readers. The second part delivers some much-needed home truths about how most newspapers really aren’t that great to begin with. And the third part explains why the Gawker version of a Washington Post story is nearly always going to be much more fun to read than the original newspaper article.

Wyman doesn’t pretend to have solutions to these problems; most likely there aren’t any. He does provide a list of suggestions, at the end, for newspaper owners; they’re all good ideas, but they’re by no means sufficient to turn around the imploded economics of local newspaper publishing, and I think he implicitly overstates how effective they can be.

Wyman has provided a good analysis of why newspapers are doomed; the weakness in his article comes towards the end, when he hints that this state of affairs might have been avoided, or maybe even could still be avoided. The biggest newspapers in the land can and probably will pursue a successful last-man-standing strategy. But among the thousand-plus smaller newspapers, the number with a rosy long-term future is pretty much zero.

COMMENT

Indeed, and it isn’t just the local papers. Why on earth would you read the NY Times on the financial crisis if you can read Simon Johnson on it directly (though Gretchen Morgenstern’s a decent reporter). And why does the Times still employ *Ben Stein* — he’s the perfect example of someone resting on their laurels, although in his case, I’m not sure what those laurels are, aside from his role in Ferris Bueller’s Day Off.

Posted by PghMike | Report as abusive

Let Krugman spend his money

Felix Salmon
Aug 13, 2009 16:13 UTC

Contra Ryan, I’m perfectly happy to take Paul Krugman’s purchase of a new apartment at face value. Does it mean that Krugman thinks home prices aren’t going to fall? No, of course not. Is it a bullish indicator? Similarly, no. A home is not an investment. It’s a place to live.

Krugman wanted an extra bedroom and a washer-dryer. He had $1.4 million from his Nobel prize burning a hole in his pocket. Why not spend it on something which will make your life more pleasant? The alternative is to save/invest, which is essentially delayed gratification for no particularly good reason. So good for Paul, that he thinks of money as a means to an end — something you spend to get what you want — rather than always as something to be invested and grown.

Update: Ryan responds by saying that Krugman could just have rented. But for a busy professional like Krugman, the pain-and-suffering costs of moving house are huge, and so there’s real value to locking in the option never to have to move again if you don’t want to. Plus there’s inflation risk if you rent — the rent could rise quite a lot, even as your cash loses purchasing power. And where’s Krugman meant to park his $1.4 million in the meantime, while he’s renting? In many ways, it’s much easier to buy, if you have the money just lying around. After all, there’s no downside at all if you consider that you’ve just bought somewhere to live, as opposed to an investment.

COMMENT

The professor should have read this before buying:

If your mortgage payments are higher than prevailing rents even as your mortgage balance is higher than the value of your home, you’re not benefiting in the slightest from your decision to buy: quite the opposite. And it’s not just subprime borrowers, either: here’s a representative example of prime borrowers going through just as much pain. A mortgage is a form of financial leverage, and leverage magnifies both upside and downside; right now, it’s all about the downside.

http://www.portfolio.com/views/blogs/mar ket-movers/2007/09/10/the-downside-of-ho meownership/

The problem with the AP’s plan to goose its Googlejuice

Felix Salmon
Aug 13, 2009 15:15 UTC

The AP has a cunning plan to create “news guide landing pages” which it would force news organizations to link to. The idea is that all that linking will boost the pages’ Google ranking, and thereby bring them lots of traffic from people searching for events in the news. It’s not a bad idea, until you get to this bit:

Most of the AP’s landing pages would be automatically generated, although “editorial curation” would also be possible.

PageRank isn’t a dumb algorithm; it’s a smart algorithm, which is pretty good at working out what pages are the authoritative sources which people really want to go to. And in my experience Google is very good at pointing to pages which have a real human intelligence behind them. Every so often, an SEO-optimized automatically-generated site will pop up in the first page of Google results, and when it does, that’s a failure of Google, which the engineers at Google then try to fix.

It’s conceivable, but unlikely, that automatically-generated landing pages really would be exactly what Google’s users want to see when they search for certain terms. In that case, the AP’s plan might work. More likely, however, is that people want to see real pages built by real people. And unless the AP intends to create just that, I fear its plan is not going to work very well.

COMMENT

Topix ranks amazingly well across a wide array of search queries, and for the most part those pages are automatically generated through algorithms (with perhaps a bit of original comments and feedback from readers mixed into the page).

Thomas Crocker’s weird arguments against cap-and-trade

Felix Salmon
Aug 13, 2009 14:55 UTC

There’s something rather odd about Thomas Crocker’s opposition to cap-and-trade and his support of a carbon tax instead: all of his arguments why a carbon tax is preferable to cap-and-trade are exactly the same as my arguments why cap-and-trade is better than a carbon tax!

Let’s take Crocker’s arguments one by one, with the proviso that they’re coming second-hand, via the WSJ, rather than directly from Crocker himself.

First, Crocker says that a carbon tax “would be easier to enforce” than a cap-and-trade system. But it’s hard to see why that should be the case: both of them involve measuring the same carbon emissions. It’s certainly easier to enforce when you measure upstream rather than downstream, but that applies equally to carbon taxes and to cap-and-trade.

Crocker then gets into the meat of his argument:

Mr. Crocker sees two modern-day problems in using a cap-and-trade system to address the global greenhouse-gas issue. The first is that carbon emissions are a global problem with myriad sources. Cap-and-trade, he says, is better suited for discrete, local pollution problems. “It is not clear to me how you would enforce a permit system internationally,” he says. “There are no institutions right now that have that power.”

Yes, cap-and-trade is better suited for local pollution problems than it is for global pollution problems. But that doesn’t mean that a carbon tax is better for global pollution problems than cap-and-trade is. Indeed, the opposite is true. In theory, once a number of jurisdictions implement a cap-and-trade system, carbon traders will start arbitraging the various different carbon permits, and we will end up with something approaching a global system. Carbon taxes, by contrast, are ever and always local. Crocker is right that a US cap-and-trade system wouldn’t necessarily slow global carbon emissions if China and India refuse to play ball. On the other hand, neither would a carbon tax. But at least a cap-and-trade system has the ability to scale into China and India.

But moving on:

The other problem, Mr. Crocker says, is that quantifying the economic damage of climate change — from floods to failing crops — is fraught with uncertainty. One estimate puts it at anywhere between 5% and 20% of global gross domestic product. Without knowing how costly climate change is, nobody knows how tight a grip to put on emissions.

In this case, he says Washington needs to come up with an approach that will be flexible and easy to adjust over a long stretch of time as more becomes known about damages from greenhouse-gas emissions.

Agreed, 100% — which is exactly why we need a flexible cap-and-trade system rather than an inflexible carbon tax. A cap-and-trade system can be tweaked much more easily than a carbon tax, both in terms of the level of the cap and in terms of the proportion of the permits which is auctioned off rather than given away. Crocker says it’s hard to adjust a cap once it’s in place — but he neglects to mention that it’s harder still to adjust a tax once it’s in place.

In the first instance, the important thing is to get something in place, which can then be improved over time. A cap-and-trade system fits the bill perfectly; a carbon tax, by contrast, doesn’t.

COMMENT

Cap & trade and carbon tax are failed concepts as carbon prices have been pathetic both in US ($ 3.5) and Europe ( Euro 8.0) during most of last year. CER has stopped issuing new carbon permits to prevent prices to fall sharply during the Bonn Conference. Australian parliament has rejected carbon trade, India refuses to consider it. I agree with those who say that Governments of U.S. and Europe have been fooling the people for last 15 years on climate change, delaying investments in Clean Energy on the pretext of huge revenues that will be generated by the Carbon Trade. One such show in slideshare.net “COP15: Bullshiting 15 years on climate change ” is an eyeopener.

Posted by Rachel Sigfreud | Report as abusive

Short-selling conspiracy documentary of the day

Felix Salmon
Aug 13, 2009 14:42 UTC

Oh yes: there’s now a documentary, featuring a lot of talking heads wearing bluetooth headsets, all about people who bought stock in Sirius XM because it was going up and then lost money because it went down. Of course, it wasn’t their fault. Blame instead the evil short sellers! And do be sure to give the filmmakers $15.99 for their DVD. If they sell enough of these things, they might be able to recoup their losses!

COMMENT

I hope you watch the entire movie

Richard, Narrator – Stock Shock

Don’t invest in microfinance

Felix Salmon
Aug 13, 2009 13:30 UTC

It’s good that the WSJ is taking a skeptical look at the excesses of PE-funded microfinance institutions, even if the newspaper still feels the need to put the word “microfinance” in scare quotes in its headlines.

I’m a fan of genuinely local, bottom-up microfinance. But what the WSJ is talking about — which is where the real growth is — is top-down microfinance, driven by external funds from the developed world. Ethical funds, in particular, love these investments, partly because they have very little correlation with any other asset class, and partly because everybody loves to think they’re investing in the next Grameen. The problem is that Grameen never took foreign money, for a very good reason.

At heart, a lot of these investments are a gussied-up carry trade. Developing-country financial institutions borrow dollars, and invest them in the local markets, with little if any currency hedging. A few organizations are beginning to offer hedging services to microfinance institutions, but such services are unlikely to prove particularly popular, because it’s that implicit FX risk which accounts for a huge proportion of these institutions’ profits. Much better that microfinance organizations grow a little more slowly, and much more organically, either by getting grants rather than loans, or by funding themselves locally.

It’s undoubtedly true that microfinance could be a lot bigger than it is now. But the way to get there from here isn’t to throw for-profit private-equity dollars at it. The real constraint is finding and training good local women who can underwrite well and who know their customers on a personal level. There’s a reason that these PE-backed microfinance dollars are concentrated in cities right now: it’s the only way to scale up quickly. But speed is the enemy of quality, as the WSJ’s Ketaki Gokhale demonstrates, and in Ramanagaram it has resulted in the local mosque successfully urging its congregation to default on all their loans, with stubborn uncooperativeness on both sides:

The mosque leaders are also demanding that lenders give them an accounting of their finances. The lenders say they’re not about to comply with that.

Any microfinance institution which so easily angers and refuses to cooperate with local religious institutions is walking on very dangerous ground. If western do-gooders want to support microfinance lenders, they should simply donate their money to grassroots organizations in the developing world. If they want to make a profit, they should stick to more conventional investments.

COMMENT

Investment of PE in MFIs is a must. Otherwise micro-finance industry would never be able to serve 4 billion people at BOP globally. There are number of instances where MFIs became sustainable in a reasonable time frame and started generating profit.

Now at the early days there might be some hick up. But does not justify the urge like “don’t make investment in MFI”.

Posted by AsifurRahman | Report as abusive
  •