Felix Salmon

Adventures in hedging, Barrick Gold edition

Felix Salmon
Sep 9, 2009 20:22 UTC

The best kind of hedge is the one like Agustín Carstens put on in Mexico: he locked in high oil prices, and made billions when the price of oil fell. Sometimes, of course, hedges don’t work out nearly so well. Larry Summers, for instance, thought he was locking in low interest rates, but then saw rates fall even lower, and ended up losing billions of Harvard’s dollars.

And then there are the hedges which just don’t make any sense at all: like Barrick Gold, which locked in low gold prices and is now spending a whopping $3 billion to unlock them at the top of the market. Anybody care to explain that one to me?


Ditto. Barrack appears to be the stooge of the banking cartel keeping gold down. $3 billion is a small price to pay. For details of how and why Antal Fekete gives great detail.
http://www.professorfekete.com/articles% 5CAEFHaveGoldBugsBeenBarrickedByTheUS.pd f

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Where bank regulation is headed

Felix Salmon
Sep 9, 2009 18:11 UTC

I like Taunter’s idea of splitting the financial services industry into highly-regulated Boring and largely-unregulated Exciting parts, and making it very clear that the Exciting bits could never get bailed out by the federal government. I disagree however with this:

While I could easily be convinced to give Inside or Outside responsibilities to other agencies, the one agency that cannot get either responsibility is the Fed. Indeed, one of the main goals of reform should be to strip any sort of oversight responsibility from the Fed.

The big thing missing from Taunter’s utopia is any kind of macro-prudential regulation — which is exactly what the Fed is perfectly placed to do. You can’t regulate the financial system on a case-by-case, institution-by-institution basis: sometimes you need to look at the big picture — including keeping an eye on what all those Exciting companies are doing. Let’s have the Fed do that, at least.

Regulators should also be asking more questions of market participants — the kind of people who were first to realize that AIG was in trouble. Lloyd Blankfein is right about this:

We should get more questions from regulators like, “Where are standards slipping or policies being stretched? Where are pressures building up? And, where are you seeing concentrations in risk?”

It’s in everybody’s interest for banks to be very open about these things with their regulators. After all, as Jeff Cane points out, Goldman itself was essentially bailed out by the government: were it not for massive government intervention in the financial markets last year, Goldman would not exist today. At some point, banks don’t benefit when competitors fail: instead, they themselves get hit as well.

It’s also worth noting that Blankfein admits that the finance industry “let the growth and complexity in new instruments outstrip their economic and social utility as well as the operational capacity to manage them”; he also says that guaranteed bonuses “are bad for the long-term interests of our industry and the financial system”. There’s definitely a pretty large degree of consensus forming now, and Blankfein’s speech gives a good idea of where we’re probably headed. Nothing too radical — certainly nothing along Taunter’s lines — but it’s still better than nothing.


This is from Arnold Kling on EconLog on February 9th:

“Taleb, like me, wants to get rid of risk-taking by banks, and leave non-insured institutions free to take whatever risks they want, as long as they are not creating risks for others. His solution is to nationalize banks. (me: why would this mean that they would not take risks? Suppose that Freddie Mac and Fannie Mae had been fully nationalized as of three years ago. Would they have taken more risk or less risk?)”

And my response:

“Although I’d like to nationalize a few banks in this mess, I agree with you. We don’t need to run them, especially if we have narrow/limited purpose banks. I didn’t like this idea at first, but if it allows the existence of risk-taking non-insured institutions, then I’d be for it.”

Maybe we didn’t use the correct hand gestures.

Chart of the day, College tuition edition

Felix Salmon
Sep 9, 2009 16:03 UTC


This chart comes from John Caddell, and it shows the cost of attending Rensselaer Polytechnic Institute as a percentage of US median income. Scary stuff. But not as scary as David Leonhardt’s column today, which demonstrates a nasty ghettoization effect at state colleges, many of which are turning into failure factories:

Only 33 percent of the freshmen who enter the University of Massachusetts, Boston, graduate within six years. Less than 41 percent graduate from the University of Montana, and 44 percent from the University of New Mexico.

There are serious problems with incentives, here: colleges get paid according to their enrollment, not according to the number of students they graduate. And with freshmen cheaper to teach than seniors, it actually benefits a college to have more of the former than the latter.

The first order of business here is to level the playing field: at the moment, poor kids have an alarming tendency to attend colleges with low graduation rates, even when they’re more than capable of getting into colleges with higher graduation rates. They thereby essentially give their rightful place at the better schools to richer kids, who are much more likely to graduate in the first place. That’s why Joe Weisenthal is wrong here:

The authors cite students who go to Eastern Michigan University (39% graduation rate), but who could have gone to University of Michigan (88% graduation rate). But UMich is already at maximum capacity — as are other elite schools — so for one thing, an influx of new applicants, would just displace students, and we’d be back to ground zero. But beyond that, how do we know that the the UMich graduation rate would stay constant given an influx of students who used to go to Eastern Michigan? That’s a gigantic variable.

The point is that the displaced students would be richer students who would be much more likely to graduate in any case, even if they went to Eastern Michigan University. And even if the UMich graduation rate fell from 88%, it would still be much higher than 39%.

This, from Weisenthal, is also silly:

While the educators complain that high schools aren’t doing enough to prepare students for college, the goal of “improved matriculation” sounds just as silly. Just as graduating from high school doesn’t automatically make you prepared for college, graduating from college doesn’t automatically make you ready for the real world.

No, but it makes you much more employable, and it does wonders for your lifetime earnings. Lots of companies simply won’t employ a college drop-out, no matter how qualified they are, and will employ a less-able college graduate instead. It’s often the first filter applied: companies won’t even look at people without a degree.

Improving the matriculation rate therefore improves the range of choice presented to employers, and improves the overall quality of the white-collar workforce. It benefits everyone, except for maybe dubiously-competent graduates who right now don’t really need to compete, in the job market, against smarter applicants who unfortunately dropped out of college. If those smarter applicants get themselves degrees, the less-competent will find it harder to get jobs.

Update: Ryan Avent seems to think that dropouts are dropouts, wherever they attend university. I don’t think that’s true. For one thing, the presence or absence of a campus makes a big difference: students are much more likely to drop out if there isn’t one. And for another thing, there are all manner of peer effects: if most of your peers are dropping out, you’re more likely to follow suit than if nearly all of them are graduating.

Update 2: Oops, Charles Kenny just pointed out that Caddell was using the wrong numerators in his chart, he was using the top line when he should have been using the second line. So I’ve deleted the chart, as it stood it was very misleading.

Update 3: Caddell has fixed the chart, so it’s back.


I have to agree with Michael. More selective colleges admit students who in general are more likely to be ready for the academic standards of that college. These colleges have the ability and luxury to filter out students they don’t think will make it through in 4-5 years. Less selective institutions have to deal with a much wider range of preparation. If these institutions conduct remedial classes (as many community colleges do), they know that they will have a low success rate at high cost to the institution. Less selective colleges have a more difficult educational task ahead of them vs. the more selective colleges, which can let its students run on autopilot, so to speak. Why do you think professors at research universities (like UM) have such terrible reputations as teachers?

Tuition is an important factor for a student choosing where to go, and would involve socioeconomic factors very directly. Here’s a comparison of EMU and UM tuition:

EMU, resident tuition, undergraduate: $238.50/credit hour; EMU estimates tuition and fees cost for freshmen as $4188.50.

UM, resident tuition, undergraduate: $805/first credit hour, $449/add’l credit hours; full time enrollment for lower division undergrad (12-18 credit hours) $5735 + 95 in various fees. The total increases by about $700 per term for upper level undergraduates.

Either is expensive, but EMU would be an easier choice for someone without a large pool of financial and social support.

Another factor to consider for students who must work to support their education is to what degree institutions accommodate people who work during the day and/or have to get childcare. Institutions like EMU and community colleges have much more available in those regards than more selective places like UM or the University of Iowa, where I teach. Getting an undergraduate degree at either one of these places would be extremely difficult to do for someone with a full-time job. The undergraduates I have who are returning students leave full-time work when they get to upper division courses, which are scheduled at the convenience of the college and faculty, not the student.

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Chaotic BofA

Felix Salmon
Sep 9, 2009 14:39 UTC

How dysfunctional was Bank of America around the time of the Merrill Lynch acquisition? Dysfunctional enough that it felt the need not only to fire its own general counsel at the very point at which the acquisition was at its messiest, but also to do so in the most abrupt and inexplicable manner. The lawyer in question, Timothy Mayopoulos, is now the general counsel of Fannie Mae: he seemed to get that job quite easily in the wake of his high-profile defenestration. It’s all very odd, and even Andrew Cuomo, armed with subpoenas, seems to be incapable of getting to the bottom of what exactly happened and why.

What’s clear is that the upper echelons of the largest bank in the country have been in a state of chaos for some time, and that Bank of America’s board, in particular, is doing absolutely nothing to rectify the situation. Where the board has failed, regulators have to step in: this can’t continue indefinitely.


Follow the real puppeteers Felix: Ed Herlihy and the Wachtell boys must be protected. Cuomo manages to write a 7-page letter that never mentions BofA’s primary outside counsel during the Merrill deal.

William Cohan in his big story on the BofA/Merrill merger in The Atlantic, notes in one paragraph that Herlihy was a big factor in making it happen. Yet curiously he never bothers to discuss Herlihy or the role of Wachtell again.

Interesting…maybe an intrepid reporter could look deeper into this. Also recall that it was Wachtell (via a NYTimes story on the Merrill merger) that pressed for John Thain’s bonus package to get set in stone. Whose Thain? Yep, that guy that helped Wachtell earns hundreds of millions of dollars in fees for the NYSE deal (or should I say deals, Euronext, etc.). Curious why Wachtell would be so hot to worry about the head guy on the OTHER side of the negotiating table…except for the fact that Wachtell believed Thain would inherit the BofA blob and continue the happy marriage between dealmaker and deal lawyer.

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Greenspan’s apology: Still MIA

Felix Salmon
Sep 9, 2009 14:00 UTC

Alan Greenspan has admitted he was “partially wrong” in deregulating the financial sector. But he doesn’t seem to be able to take the next logical step:

The former Fed chief said the current economic crisis was a “once in a century type of event”, and one that he did not expect to witness.

Blamed by some for not doing more to prevent the crisis, Mr Greenspan denied any responsibility for the problems gripping the global economy.

“It’s human nature, unless somebody can find a way to change human nature, we will have more crises and none of them will look like this because no two crises have anything in common, except human nature.”

Well yes, I suppose that there will always be financial crises, in much the same way that there will always be homicides. But the inevitability of homicide doesn’t mean that murderers can’t be held responsible for causing them.

Financial crises, no matter how inevitable, have causes, and certain people caused this one. Greenspan was one of those people. It’s about time he admitted it, and apologized.


Totally agree. The next couple years should be interesting.

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Overdraft fees revisited

Felix Salmon
Sep 9, 2009 13:37 UTC

What’s Eric Dash, chopped liver? He had a great article on bank overdraft fees back in July, but now the NYT has gotten two more journalists — Ron Lieber and Andrew Martin — to re-report pretty much exactly the same article, at greater length.

Still, there is some new stuff here. The main thing I learned is that there’s a big split between biggest banks in the US. On the one hand Citibank is on the side of the angels, one of the few banks which doesn’t have automatic overdraft protection on its checking accounts (if you want it, you have to ask for it). On the other hand, Bank of America and Wells Fargo are among the very worst banks, often refusing even when asked to turn overdraft protection off.

Given the large differences between banks, it’s a bit odd that the article contains no response from individual banks, just from industry groups like the Financial Services Roundtable. There’s also no debunking of this kind of thing:

Michael Moebs, an economist who advises banks and credit unions, said Ms. Maloney’s legislation would effectively kill overdraft services, causing an estimated 1,000 banks and 2,000 credit unions to fold within two years. That is because 45 percent of the nation’s banks and credit unions collect more from overdraft services than they make in profits, he said.

This simply doesn’t follow: just because a bank currently has more overdraft revenues than it makes in profits does not mean it’ll fold in the event those revenues go away. Especially not at credit unions, which don’t exist to make large profits: at most of those 2,000 credit unions, overdraft revenues are probably a very small proportion of total revenues and won’t make much of a difference if legislated away.

And while back in July I said that 20% of bank customers pay 80% of the overdraft fees, in fact, according to the most recent FDIC report, it’s worse than that: the 13.9% of customers who get charged 5 or more fees per year pay a whopping 93.4% of the banks’ total fee income. And the 4.9% of customers who get hit 20 or more times per year are paying an average of $1,610 apiece in these fees. That’s money they really can’t afford.

What should be done about this? My idea is pretty simple:

  • Banks are allowed to offer automatic overdraft protection, but only if it’s free. (They can charge an annualized interest rate on the overdraft, but no set fees.)
  • If a bank wants to charge fees as well as an interest rate for overdraft protection, then that protection has to be opt-in rather than opt-out, and the fees should be prominently disclosed at the opt-in stage.
  • Fees should be be capped at $20, with a limit of one such fee per day.

Would implementing this drive thousands of banks into insolvency? No. But it would make banking much less expensive for the people who can least afford to pay huge fees for it.


Also, in the “triangle” situation I mentioned, I have pretty intimate knowledge of the bank’s motivation…I was the merchant in that situation. We put through an erroneous charge, the person came to us crying (and I mean that literally, not sarcastically), and despite our admission to the bank that the charge was in error they wouldn’t reverse the fees. They basically told me that SOMEBODY was going to pay those charges, that was the bank’s money now, and my bosses wouldn’t budge either…they weren’t about to hand Wells Fargo a few hundred bucks for nothing.

It’s not like there was a physical product lost, there. What costs, exactly, were there that prevented them from removing the charges? The entire system is automatic. Again, revenue enhancement, nothing more.

Felt bad for the customer, that’s for sure. She was pretty much screwed.

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Carstens’ task

Felix Salmon
Sep 8, 2009 21:22 UTC

Many congratulations to Agustín Carstens, who, according to Javier Blas, has managed to make Mexico $8 billion by putting on some smart oil hedges last summer:

Traders joked on Monday that Mr Carstens was probably 2009’s “most successful, but worst paid, oil manager”.

Of course, it helped that Carstens had $1.5 billion lying around last summer to pay for the hedges in the first place. But really all this financial cleverness only puts off the day of reckoning: Mexico is running out of oil revenues fast, and has no visible means of replacing the taxes currently paid by Pemex.

The tax burden on Mexican individuals and companies is low in theory and lower still in practice, and the kind of tax hikes which would be needed to even partially compensate for falling government oil revenues are politically impossible to pass. No one is more aware of Mexico’s coming fiscal crunch than Carstens, and if anybody can do something constructive, he can. I suspect, however, that no one can do anything constructive, and Mexico will be in serious fiscal pain sooner rather than later.


“….to make Mexico $8 billion…”

I having a real problem with your verb choice.

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Consumer deleveraging datapoint of the day

Felix Salmon
Sep 8, 2009 20:17 UTC

Straight from the Fed:

Consumer credit decreased at an annual rate of 10-1/2 percent in July 2009. Revolving credit decreased at an annual rate of 8 percent, and nonrevolving credit decreased at an annual rate of 11-3/4 percent.

That’s huge, and it’s good news: individuals are clearly getting their fiscal houses in order. I am interested that nonrevolving credit is falling faster than revolving credit (ie credit cards): that might well be a function of the sharp drop in auto purchases, and will spike back up when people start buying cars again.

Total consumer credit is now $2,472 billion, down more than $100 billion, or 4%, from the $2,578 billion level seen in the third quarter of last year. Revolving credit is down more than 9% from its end-2008 level.

And get this: consumers aren’t just deleveraging, they’re also getting more sensible about where they’re borrowing. Look at the numbers for credit unions: total consumer credit extended from credit unions has now hit a new all-time high of $238 billion. No deleveraging there — even credit-union credit cards are being more used than ever.

With any luck, the US consumer’s new habits — of thinking hard about one’s financial situation and trying to minimize debt — will last long. Would that Corporate America thought the same way.

(Via Conaway)

Update: Jake has a very pretty chart.


not so fast. these stats can be mis-leading and not necessarily a good thing. first of all deleveraging can ultimately lead to a decrease in us growth. Secondly, non-revolving deleveraging can occur due to charge-off, foreclosure and bankruptcy on guess what mortgage loans.

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Why we should beware cheaper mortgages

Felix Salmon
Sep 8, 2009 18:57 UTC

My distant cousin Dominic Lawson (I was named after his grandfather, Felix Salmon) has a column saying that cutting bankers’ bonuses would do more harm than good. He might be right, but his argument is a little bit odd:

When people get a cheaper mortgage because some financial whiz-kid on the trading floor did some clever forward buying in the currency markets, they don’t feel any particular sense of gratitude to the bank. Even in the good times, politicians are not likely to be misjudging the public mood if they propose to do something a bit nasty to bankers…

If a Treasury minister tells a Today programme interviewer that “we are imposing greater capital requirements on super-senior tranches of securitised mortgage obligations”, it is unlikely to resonate with the bleary 7am listener wanting to hear the noise of a banker having his head rammed hard into a wall.

The problem here is that never in the history of finance has a bank reduced its mortgage rates because it made lots of money in the currency forwards market. Banks aren’t charitable institutions which cross-subsidize their consumer-facing products from profits elsewhere: to the contrary, they will constantly attempt to maximize their profits in every business.

On the other hand, it was commonplace for people to get cheaper mortgages because banks had stupidly low capital requirements on super-senior tranches of securitised mortgage obligations. Thanks to those stupidly low capital requirements, banks could sell off “all” the risk associated with the bonds they originated, and keep billions of dollars of leftovers for themselves, without having to hold much if any capital against them. Since banks love to think of themselves as being in the business of buying and selling risk assets, they were happy to originate low-interest mortgages just so long as they could flip them for an immediate profit.

In other words, it’s systemically-devastating things like badly-structured regulatory structures and capital requirements which are likely to bring down mortgage costs and otherwise directly benefit the public. Large bonuses for traders, by contrast, will not benefit the public at all — they just benefit the traders in question.

More generally, anything which contributes towards people getting a cheaper mortgage is equally likely to contribute towards a housing bubble. Sometimes it’s very hard to tell whether a certain financial product is good for consumers or not.


> never in the history of finance has a bank reduced its mortgage rates because it made lots of money in the currency forwards market.

If currency forwards and mortgages can share a bank’s fixed resources, then raising the profitability of currency forwards will both lower the costs of being in mortgages and will increase the competitiveness of that market.