Felix Salmon

Are private schools charitable institutions?

Felix Salmon
Aug 25, 2009 21:02 UTC

In the US, I’m still holding out hope that university endowments will be taxed unless they can demonstrate that they’re actually spending their money on the public good. Thanks to the philanthrocapitalism blog, I now discover that a similar move is now afoot in England, which has told two independent schools that they will lose their charitable status unless they start educating poorer kids as well as those of the rich. The whines from the head of the Independent Schools Council are not very moving:

Private schools were already providing a public benefit by educating children who would otherwise be in state schools paid for by taxpayers, he said…

Without private schools “the public would have to pay between £3bn and £4bn a year in extra taxes,” Lyscom said.

No one’s asking to abolish private schools, or even proposing that most of them lose their charitable status. They’re just asking that they do a bit more to earn it, which seems right to me. But as ever, there’s an endowment effect: it’s orders of magnitude harder to strip charitable status from an institution than it is to confer that status in the first place. So this is going to be a long, tough fight. But it’s one worth having.


I don’t disagree with the notion that smart-poor kids are given scholarships to boost a school’s ‘grade rating’ to help draw richer families to enroll with them. What I do disagree with is the taxation of ‘profit’. These schools make very little money, and any moeny they do make is re-invested back into the school. It’s not like the CEO of private school X is taking home an eight-figure payday.

Bottom-line: the best should be given the chance to do their best, and to fill the rest of the spots available – in this society – it makes sense that those should go to those that can pay the most.

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Annals of Icelandic overspending, Kaupthinking edition

Felix Salmon
Aug 25, 2009 20:55 UTC

Baruch at Ultimi Barbarorum has uncovered this astonishing old ad for the now-highly-defunct Kaupthing bank:

Baruch has all the smart questions. I’ll just ask the stupid one: Did Kaupthing really pay for rights not only to U2′s Where the Streets Have No Name and lots of news-footage B-roll, but also to film clips from Lawrence of Arabia, The Matrix, The Incredibles, The Beach, and the music video for Fatboy Slim’s Weapon of Choice? (And does this mean that Peter O’Toole shares a first-degree connection with Leonardo di Caprio for the purposes of Six Degrees of Kevin Bacon?)


This was a internal motivational video for the staff of Kaupthing and never showed on TV.

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Private equity releverages with a vengeance

Felix Salmon
Aug 25, 2009 17:11 UTC

Warner Chilcott is paying $3.1 billion to buy the drugs business of Procter & Gamble. How much of that is its own money, and how much is debt? In the wake of the blowup of so many leveraged loans, one might expect the proportion of the sale price funded by banks to be low. After all, the banks don’t seem to be very keen to lend to anybody these days. But in fact, the banks are providing not half, not 75%, not even 95% of the total — they’re putting up a whopping 129% of the acquisition price.

Yep, Warner Chilcott not only has to put no money down to buy this asset, it also gets an extra $900 million to refinance existing debt. And there’s quite a lot of that, as you might expect from the fact that Warner Chilcott is owned by a who’s-who of the private-equity world, including Bain Capital and Thomas H Lee Partners.

This is being spun as good news. Marketplace’s Jeff Tyler interviewed Ken MacFadyen, the editor of Mergers & Acquisitions Journal:

MacFadyen sees the deal as a heartening harbinger for the banking industry.

MacFadyen: That’s a good sign to see that the lenders are active again.

Me, I’m not so heartened. I’d much rather see the banks’ money going into the real economy, where it can do some good, rather than being used to further lever up a company which was invented by private equity types and domiciled in the tax haven of Ireland.

The leads on this deal are JP Morgan Chase, Bank of America, Credit Suisse, Citigroup, Barclays, and Morgan Stanley. Remember those names, especially if and when any of them starts complaining about how little money they have to lend. Evidently they have no shortage of money if the borrower is one of their old friends in private equity.

Update: Angus Robertson has an excerpt from a Fitch report, under the headline “Investors Swarming Back Into Leveraged Finance Markets”. ‘Nuff said.


dan, that’s true, but that $900M is presumably erasing $900M in debt; ie it is going to pay someone else, who will use it for something else that is unspecified and unknown in this frame. it could be real economy, it could be who knows what. but the LBOers don’t get to keep that $900M.

what this discussion often misses is that leveraged holding companies are intermediaries. they are holding companies. they can be well structured or poorly structured; they can make good or bad investments; they are fragile in that they are leveraged which may be bad. but most of the money that they borrow goes through them, not too them.

the fees and incentives associated with the LBOers are another matter; i am sure they are getting paid too well for this.

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Spain crumbles

Felix Salmon
Aug 25, 2009 11:25 UTC

Neil Unmack is constructive about Spain in general, and Spanish banks in particular: Santander knows its own loan book better than anyone, he says, and if it’s happy to buy back billions of euros of its own bonds at 82% of par, it probably knows something the market doesn’t.

On the other hand the notorious Variant Perception report on Spain and its banks, quoting Edward Hugh at some length, makes for very sobering reading. Read at in the light of the report, Santander’s buy-back begins to look more like an act of desperation than one of strength — and one which bondholders would do well to tender into.

It’s undeniable that the implosion of Spain’s formerly-hot construction sector is going to blow holes in a lot of balance sheets; the only question is where and when. The gist of the Variant Perception report is simple: the problems of Spain’s construction industry and homeowners have become the problem’s of Spain’s lenders, and the problems of Spain’s lenders are going to a major problem for all of Europe, going forwards. Meanwhile, Spain will become Ireland-but-worse, as real interest rates soar thanks to deflation and extreme levels unemployment, combined with low wages, depress the entire economy for the foreseeable future.

That said, it’s important to draw a distinction between Spanish banks in Spain, which are largely domestic savings banks, and Spanish banks as they exist in the imagination of the international capital markets (Santander and BBVA). Santander is a well-managed and internationally-diversified bank, which does retail banking extremely well. BBVA owns the largest bank in Mexico, Bancomer, and has built an extremely strong franchise stretching from Texas, through Mexico and central America, and down through the Andes. While neither bank will be immune to a national disaster in its country of origin, their international holdings will help to soften the blow.

At heart, however, the situation in Spain will be familiar to many US observers: consumers augmented their low wages by making huge amounts of money in a soaring property market. And now that the property market has stopped soaring, they’re left with hundreds of billions of euros in loans, an enormous percentage of which will end up in default. The problem in Spain is exacerbated by the fact that much of the property bubble was concentrated in the beach-home market on the coast, where the willingness of homeowners to pay mortgages on underwater properties is much lower than historical data would suggest.

The problems in Spain have taken longer to emerge than those in the US or Ireland for two reasons. Firstly, Spanish lending standards were generally tighter than in Anglophone countries, giving banks more of a cushion to absorb losses or refinance souring loans. And secondly, the massive influx of liquidity which hit the world in 2008 as a response to the global economic crisis is helping to hide the scale of the problem in Spain: it’s worth noting that Santander is tendering for more than $23 billion in mortgage-backed bonds “through its normal liquidity facilities”. But neither of these two factors is sufficient to withstand an economic crisis of the one facing Spain. My feeling is that the pessimists (and the other Neil) are right — the situation in the country is going to get much worse, and spill over into the rest of Europe, long before it gets better. We haven’t hit bottom yet.


Spain and Ireland differ considerably. In particular by about 10 degrees centigrade, 250 days sunshine and a few feet of rain. In Spain you have an overinflated property market built up by demand from northern Europeans in the good years. The economy turns and the last thing you need is a second home. (Most of Spain’s excess property availability is due to holiday homes.) The economy turns up (always has, always will) then guess what, people have excess cash, want a lifestyle, climate etc and… demand returns. Meanwhile it continues to rain in Ireland ! We had a lot of buyers from Ireland looking to buy at Polaris World in Spain 3 years ago but I fear the specific problems of the Irish market will hold demand back for some years.

Regulatory consolidation

Felix Salmon
Aug 25, 2009 10:22 UTC

Kevin Drum and Ryan Avent bring up the question of optimal regulatory structure, and I agree with both of them.

Kevin is right that the Federal Reserve — which is owned by big banks and whose regulatory function exists to keep them strong — is not naturally inclined to protect consumers: after all, banks which treat consumers badly are often that much more profitable. The Fed, writes Kevin, is

institutionally and culturally oriented toward the financial community and macroeconomic management. Consumer regulation will never be taken seriously there no matter how many laws we write.

Well, “never” is a long time. But I think he’s right, practically speaking: if a Consumer Financial Protection Agency were to be created under the auspices of the Fed, then its officers would be taken less seriously than the prudential regulators overseeing systemic risk.

That said, however, a lot of the time all of those officers would be pulling in the same direction. Subprime mortgages are only the most obvious example: what’s bad for consumers can be systemically dangerous, too. And there would be advantages, as well as disadvantages, to a CFPA being part of the Fed: once senior Fed officials were convinced that the CFPA had legitimate concerns about a certain institution, there would be no question that the bank in question would reform its activities sharpish.

Which brings us to Avent, who has “a tough time seeing how a more fractious regulatory environment is a better one”. There are very good reasons why a single regulator is much better than an alphabet soup, where senior management at the various different agencies spend more time fighting with each other for power and influence than they do actually regulating. Ryan misunderstands my earlier blog entry: I don’t for a minute think that regulatory authority should be distributed. To the contrary, I think that it should be consolidated: the CFTC should merge with the SEC, the combined agency should become part of the Fed, and eventually, as the Tories are suggesting in the UK, the central bank should regulate everything.

Is such a thing realistic, or would the resulting behemoth be too big to manage, a bit like Citigroup? I think the answer would be to make the different arms of the super-regulator largely autonomous, but to encourage employees to move from one part of the institution to another quite regularly. Infighting within an institution is generally easier to manage and minimize than fighting between institutions.


Dollared, Is there something you disagree with that I wrote? I can’t imagine what. You would do well to read the Truth in Lending Act at: http://www.fdic.gov/regulations/laws/rul es/6500-1400.html . You will read at 226.1(b) that the purpose of the act is stated: “Purpose. The purpose of this regulation is to promote the informed use of credit by requiring disclosures about its terms and costs.” To validate your pugilistic-loving fervor, you might want to read the whole act including the Appendices. Google, and I think that you will find that that the President has appointed Elizabeth Warren (Harvard Professor and winner of consumer awards) Czar of over-sighting the financial governing.

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The good news about Bernanke

Felix Salmon
Aug 25, 2009 09:00 UTC

It’s a sign of the severity of the financial crisis that Barack Obama is re-nominating Ben Bernanke as Fed chief now, in August, despite the fact that his term doesn’t end for another five months. It’s one of the few sources of potential uncertainty which the White House can address and resolve unambiguously, and it’s good that it’s happening.

Obama is following Bill Clinton’s lead in reappointing a Republican Fed chairman who was appointed initially by a Republican president. In fact, by the time Bernanke’s second term expires, it will have been 28 years since a Democrat, Paul Volcker, held the post. But the good news is that Bernanke isn’t party-political: it’s pretty unthinkable that he would ever pull a stunt like Greenspan testifying before Congress in favor of tax cuts, on the grounds that things get a bit complicated when the government reaches zero debt. (Ha!)

It’s also good news, in its own way, that Bernanke has some opposition in Congress: it’s right and normal that the Fed chief should upset lawmakers. But now that he’s been renominated (and his confirmation is a slam-dunk), maybe those noises about the central bank losing its independence might die down a little.


Good Move Obama keep up the good work..

Monday links have it both ways

Felix Salmon
Aug 24, 2009 21:05 UTC

Krugman’s latest graph of U.S income inequality is fairly eye-popping

Noether’s theorem says a conservation law is a consequence of invariance, but in Santa Fe it’s the other way around

A $3 wine at Safeway: “how can it be any good?” A $3 wine at Trader Joe’s: “how bad can it be?”

The KFC Doubledown? Yes, it’s real. And 1,228 calories.

Does having an MBA or CFA lead to superior portfolio performance? CFA – yes, MBA – no

Larry Lessig’s blog is retired.


Rolfe Winkler has the CFA.. next time the commentary group huddles around the water cooler, ask him how hard lvl2 is… RESPECT those CFAs

may not be the rich, or the best business people but can’t deny they are smart!

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Reader’s Digest is still leveraged

Felix Salmon
Aug 24, 2009 17:26 UTC

The implosion in the enterprise value of Reader’s Digest is astonishing — from $3.8 billion two years ago to somewhat less than $1 billion now, depending on how much the equity of the new company will be valued at when it emerges from bankruptcy, and assuming, generously, that the new debt is valued at par. Chelsea Emery talked to lawyer Richard Mikels:

“One way to deleverage is by turning debt into equity. That will happen more and more throughout the economy over the next several years,” said Mikels.

That’s true. On the other hand, when private-equity shop Ripplewood bought the magazine company for $1.6 billion in 2007, layering on $2.2 billion in debt, the simple debt-to-equity ratio was 1.375 — not enormous. The new Reader’s Digest will have $550 million in debt, which means that if the equity is worth less than $400 million, it will actually be more levered than the old, height-of-the-credit-bubble deal.

So what is the enterprise value of Reader’s Digest? In the 12 months to March 31, it had Ebitda of $280 million, which sounds impressive until you notice that the number is made up of a $995 million net loss, plus $1.24 billion in “adjustments”. In other words, it’s useless. If you look at the slideshow for the most recent quarter, you’ll see some more useful numbers. Revenues were $479 million — down 17% year-on-year. “Product, Distribution & Editorial Expenses” were $207 million, down 15%; “Promotion, Marketing & Administrative Expenses” were $270 million, down 19%; and the operating loss for the quarter was stable at $7 million.

In other words, Reader’s Digest isn’t making money even with zero debt, let alone $550 million, and it wasn’t making any money a year ago, either. How much money would you pay for the privilege of losing $7 million a quarter before interest payments?

It’ll be interesting to see where the market values that $550 million in new debt: I suspect it’ll be somewhere less than par, depending on what kind of coupon it carries. And I suspect too that the value of the equity will be rather less than $400 million. Nothing’s really changing at this company: there’s no talk of layoffs, or closing unprofitable properties, or anything like that. The owners have an interest in keeping the company big, because that’s the only way it’ll ever be able to pay off $550 million in debt. Essentially, they’re keeping the company’s embedded leverage, and buying themselves an option: if the advertising market takes off, then the new, leaner Reader’s Digest could become very profitable very quickly.

But that’s not the base-case scenario: print media is hardly a growth industry these days. So don’t be too surprised if this isn’t the last we hear about this particular company’s troubles.


agree, over the years they have been spending more on gimmicks and less on providing good content. The articles have got shallower and not much substance in them. If they go back to delivering value content then there’s a chance the loyal subscriber base will stay on

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Looking at banking in Switzerland

Felix Salmon
Aug 24, 2009 14:27 UTC

I’m in Zermatt, Switzerland, where I’ve been invited to attend a symposium on the second anniversary of the financial crisis. I’ve only been to one presentation so far, but I’ve already learned two things: (a) that a lot of private bankers in Switzerland have degrees from the country’s famed hospitality universities (service culture is service culture, I guess), and (b) I can actually comprehend the gist of a speech given in German, if the slides are in English, and the points made are conventional enough.

On the way up here I worked my way through the latest edition of The Atlantic, which has an 11,000-word essay by David Goldhill on the US healthcare system, and 7,000 words by William Cohan on the acquisition of Merrill Lynch by Bank of America. Goldhill’s piece is spot-on in terms of diagnosing the problem, and his proposed solution, if implemented ex nihilo, sounds pretty good. Unfortunately, he gives no reason to believe that we can get there from here: healthcare is path-dependent, and we’re far too far down one path to be able to switch over onto a completely different one.

As for Cohan, I’m very unimpressed by the way in which he strongly implies that the government was going around abrogating contracts when it bullied Ken Lewis into acquiring Merrill Lynch. The fact is that Bank of America had signed a contract saying that it would buy Merrill; if anything, it was Ken Lewis, with one eye on the infamous MAC clause, who was looking desperately for a way to get out of that contractual obligation. And Cohan’s reading of the Detroit bailouts is contentious indeed: he says for instance that Chrysler’s senior creditors “were contractually entitled to a much better deal” than the one they got. Which simply isn’t true: when it comes to bankruptcy, the party providing the financing (in this case, the government) calls substantially all of the shots, and in any case the bankruptcy judge has a large amount of judgment in terms of who gets what.

Cohan concludes by raising

the possibility that Treasury and the Fed will continue to simply manage the financial industry informally for some years to come, confident in their ability to pull the right levers and twist arms when necessary behind the scenes. That’s a scenario that seldom ends well; we should hope it doesn’t come to pass.

I’m on the other side of this argument. Banks, left to their own devices, brought the entire national economy to the precipice of disaster. They had their chance to operate outside the realm of political interference, and they flubbed it, massively. Now that Treasury and the Fed are keeping a closer eye on things, there might be less opportunity for bankers to make enormous profits by risking the whole system. If there is, that’s a good thing.


Cezmi, sorry, not in Zurich this time around.

ab and Dave, you’re both right. We need radical reform along the lines that Goldhill suggests. But, as you must know in your heart of hearts, we’re not going to get it.

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