Felix Salmon

Vincent Fernando has a blog entry today headlined “It’s Time To Stop Being Scared By Derivatives’ Trillion Dollar Notional Values”. Which is a bit like saying “It’s Time To Stop Being Scared By The $6 Billion Budget Deficit”: both of them are off by a factor of 200 or more.

A decade ago, when notional derivatives exposure started being measured in the trillions, bankers started wheeling out all of Fernando’s arguments in an attempt to reassure the public that there really wasn’t all that much risk here. And if those exposures were still only a trillion or two, I might not be all that worried either. But the likes of Fernando don’t seem to understand that when the notional exposure increases by more than two orders of magnitude, whole new systemic risks can come into play.

US banks made $15 billion trading derivatives in the first half of this year. That’s real money, by anybody’s lights. And nobody believes that you can make $15 billion in the space of six months without running any risk. Indeed, as we’ve learned the hard way, in financial markets the downside tends to dwarf the upside. If US banks can stand to make $15 billion in six months, how much can they stand to lose in the same amount of time? And who would pick up the bill if that happened?

I’m no naif when it comes to deriviatives; indeed, I’ve been on the other side of this argument, explaining how it’s possible for notional exposure to increase without net exposure increasing. But I do get the feeling that far too many people unthinkingly accept that just because such a thing is possible, it must perforce be happening. Even as the revenue figures tell a very different story. (And yes, the credit-exposure figures are falling, but that’s largely a function of the declining notional quantities in the CDS market, which makes up a very small proportion of the total derivatives market.)

One of the Philanthrocapitalists (I believe it’s Michael Green, unless Matthew Bishop is prone to referring to himself in the third person) attempts a defense today of the $1 million salary being paid by the Gates Foundation to its new CEO, Jeff Raikes. It’s pretty weak stuff:

A cheap bad leader is much worse than a well-paid good one. Better pay could, with care, attract better leaders to the non-profit sector and enable valuable donations to be better used.

Well, yes, and a well-paid bad leader is much worse than a cheap good one. Is there any indication at all that increasing the pay of non-profit leaders increases their performance? I doubt it. (How well-run is MSF? How well does it pay its executives? Now, how about the Getty Foundation?) Unless and until such evidence emerges, this sort of thing rings hollow:

According to the sources quoted by the Chronicle, Raikes did not even want a salary (his predecessor and fellow Microsoft veteran Patti Stonesifer took no money) but the Foundation decided that paying the CEO was a point of principle.

Does Gates really think that Raikes will perform better now that he’s being paid a seven-figure salary? I very much doubt it. Instead, the salary just serves to underline Raikes’s position as a mere employee. As our blogger notes, the guy in charge is Gates, not Raikes, and the CEO position is clearly subservient to that of billg. If Raikes were working for free, he would surely feel more ownership of the Foundation than if all of his actions are bought and paid for.

What’s more, at a million bucks a year, Gates could have hired pretty much anybody he liked. If he wanted to demonstrate that the job would go to the best-qualified person, he could have found someone who was highly qualified, had a lot of leadership experience in the non-profit sector, and who wasn’t independently wealthy. Instead, he’s giving $1 million a year to a centimillionaire who doesn’t need the money and who joined Microsoft in 1981.

Why would he do that, beyond control issues? Bishop suggests that maybe he wanted to raise salaries all round — but it’s silly and anachronistic to assume that the CEO must always be the highest-paid person in any organization.

Bill Gates can and will, of course, pay anybody he likes however much money he likes. It’s his foundation. But let’s not turn his foibles into some kind of principled stand.

Why did the Fed refuse to police predatory subprime borrowers, as detailed in Binyamin Appelbaum’s wonderful WaPo story? Well, you could start by asking Alan Greenspan:

Alan Greenspan, then chairman of the Fed, recalled that Gramlich broached the subject at a private meeting in 2000. Greenspan said that he disagreed with Gramlich, telling him that such inspections would require a vast effort with no certainty of results, and that the Fed’s involvement might give borrowers a false sense of security.

In hindsight, both of these reasons are ludicrous. Policework, by its very nature, involves a lot of effort and no certainty of results. That doesn’t mean there shouldn’t be any policing. And did Greenspan honestly believe that subprime borrowers were that much more cautious when entering into mortgages because they knew that the Fed wasn’t policing the lenders?

In reality, of course, Greenspan was simply casting about for a reason — any reason — to indulge his deregulatory instincts.

This is why we need a Consumer Financial Protection Agency working in conjunction with the macroprudential regulator: the Fed simply isn’t good at consumer protection. And, pace Zoellick, Treasury wouldn’t be much better.

Here’s a little table I put together with numbers from the OCC — page 9 of this pdf. Using second-quarter numbers for each year, I looked at the total nominal derivatives exposure of end users — the people for whom derivatives are meant to exist — and for dealers.

The results are pretty startling: while end-users have pared their derivatives exposure to a seven-year low, dealers have increased theirs to yet another all-time high. And as the OCC notes, when we say “dealers”, we really mean four banks in particular: JP Morgan Chase, Goldman Sachs, Bank of America, and Citibank.

Oh, and did I mention? The amounts here are in trillions.

What has happened in recent years that derivatives dealers now need $78 in nominal derivatives exposure for every $1 in end-user exposure? When Adair Turner talks about “profitable activities so unlikely to have a social benefit, direct or indirect, that [banks] should voluntarily walk away from them”, this is surely a prime example of what he has in mind.

When the OCC tells us that total derivative notionals are now above $200 trillion, we can’t really help but go blank: the number is so many orders of magnitude divorced from any conceivable reality that it’s almost impossible to work out what it could possibly mean. But clearly that kind of exposure wasn’t necessary a few years ago. So why is it now?

Is Nordstrom paying “a healthy $4.2 million a month” in rent for its Union Square store? No. Per year, maybe. — NY Mag

Alan Grayson tries to eat the Fed’s general counsel for breakfast. The GC doesn’t seem to enjoy it. — Taibblog

This Picabia is one of the two paintings Ed Ruscha would most like to own. — FT

Meg Whitman: Rich, not smart? — AdAge

Google Maps pixelation art — Greg.org

Bank of America is “unable” to say whether it destroyed Countrywide phone recordings. Pathetic. — WSJ

Fed staffers Glenn Loney, Michael Collins, Joan Cronin, John Yorke: What were you thinking? Rorty’s on your case — Rortybomb

If pro sports teams can employ their own announcers, I see no problem with them hiring their own journalists. — NYT

“Essentially, the slut list is the Goldman Sachs daughters list… It’s a celebration of machismo, but for girls only.” — NYT

Why would anybody bring their own shovel to a groundbreaking so they could crash the official photo? — Statesman

Ivanka Trump has written a “self-help memoir”. Of course. — Trump

Zubin Jelveh posts Hyun Shin’s great chart showing Wall Street’s growth post-1980 “like a big tumor” — TNR

The NYT’s very good Safire obit — NYT

Dan Bull’s open letter to Lily Allen, in song form — YouTube

Allen Stanford’s wife sues her divorce lawyer for $200 million — Stanford Watch

The WaPo Twitter/FB guidelines are unrelentingly negative. It’s clear editors would be happier with no use at all — PaidContent

Stop imposing bikers on the pedestrian part of the Brooklyn Bridge. Put them on the road instead, in a protected bike lane! — NYT

“Although some White Zin drinkers suffer from arrested development and never move beyond it, I am persuaded many do.” — Wine Economist

Judge Orders Google To Deactivate User’s Gmail Account. Scary. — MediaPost

The best bit of this idiotic Tyler Brule column? The links to 9 different social-networking sites at the bottom. — FT

It’s amazing how a few strategic bleeps can spice up an advertisement — FakeSteve

After Kennedy obit appeared on WSJ.com, editors inserted Limbaugh slam in print version. — Hillman Foundation

Park Slope repels Westboro bigots with spontaneous hora dancing and shofar blasts — F’ed in Park Slope

Katie Couric asks Glenn Beck to define “white culture” and refuses to let go — YouTube

Arrrg! Pirates seize a wall near you — WalletPop

Buried in Joe Hagan’s 5,500-word profile of Zero Hedge is the news (at least to me) that it’s the latest home of Equity Private, a/k/a Finem Respice. She started posting at Zero Hedge under the pseudonym “Marla Singer” in May, and even brought her radio show over there (she moonlights as a DJ). Now, however, she has been subsumed into the Borg:

“Tyler Durden isn’t one person,” she said, but up to 40 different people allowed to post under that name. “We are all Tyler Durden,” Singer claimed.

I don’t see the point, frankly. I’ve been following EP for a pretty long time now, and if I knew which ZH posts were hers, I’d place much more weight in them. That’s what I meant when I said that ZH should be disaggregated. But at least now I understand why it seemed as though she hadn’t posted since July 12 — she just moved over to ZH.

Greg Mankiw, when it comes to cap-and-trade, is more or less on the side of the angels: he’s quite right that permits should be auctioned rather than given away to polluters. But is the tax code really the best way to compensate consumers for the higher energy prices they’re going to end up paying? Mankiw writes:

From the standpoint of economic efficiency, the price of carbon emissions should be passed on to consumers in the form of higher energy prices, so that consumers can make optimal decisions regarding energy consumption. Consumers should be compensated for paying these higher prices via cuts in income or payroll taxes. Those tax cuts would be financed by the revenues received from the auctioning of carbon rights (or, better yet, a carbon tax).

The first sentence is right, it’s the second I take issue with. If you cut income or payroll taxes, you end up giving more benefit to high earners than to low earners, and people who pay little or no taxes at all (eg the unemployed) get precious little benefit at all.

Better would be a flat refundable tax credit: the government essentially gives every taxpayer a flat amount each year, passing on the revenues it gets from the carbon auction.

Even that, however, would create inequities: three college roommates sharing a small city apartment would get three times the amount going to a single mother trying to raise three kids in the countryside — someone whose energy consumption would naturally be much higher.

There isn’t a simple and fair way of doing things — even channeling fixed payments through the energy companies themselves would unfairly advantage people who use say electricity and natural gas and heating oil. Instead, I fear that the fair method is going to be complicated, based on ZIP codes and size of household at the very least.

But the compensation should certainly be capped at no more than the average energy bill for the area. If people use less energy than the average, then it’s fine for them to profit from that. But there’s no reason to use a carbon-pricing mechanism to give high earners yet another tax break.

Bob Zoellick will say in a speech tomorrow that central banks have proved that they can’t be trusted with regulatory authority, and that in the US Treasury, rather than the Fed, should be the main risk regulator.

It’s an interesting idea, and I’d love to read his argument; weirdly, however, the World Bank has released only excerpts from the speech, rather than the speech itself.

I can understand why the Bank might not want to release the speech until after it’s been delivered. But in that case, why release the excerpts now? It smacks of trying to artificially manipulate the news cycle in a manner unbecoming to a major multilateral institution. On the other hand, Zoellick clearly doesn’t think the Bank’s present form is sustainable:

Bretton Woods is being overhauled before our eyes. This time, it will take longer than three weeks in New Hampshire. It will have more participants. But it is just as necessary. The next upheaval, whatever it may be, is taking form now. Shape it or be shaped by it.

Maybe trying to manipulate news coverage is part of Zoellick’s attempt to shape the new World Bank?

Mike Konczal says that all mortgages should be prepayable without penalty. He’s right — but in fact he doesn’t go far enough. As Tyler Cowen notes, it would be even better if mortgages could be prepaid at a discount when mortgage rates rise — or property prices fall.

The result would be a sharp rise in mortgage prepayments: you’d repay when mortgage rates rise, by repurchasing your mortgage at a discount, and you’d repay when mortgage rates fall, by refinancing. Mortgage rates in general might have to go up somewhat in order to make up for all this new prepayment risk, but to offset that there would be significantly less default risk. And right now, when mortgage rates are low, is a good time to implement something like this: the damage you cause to a bank when you prepay a low-rate mortgage is very limited.

It’s true that prepaying at a discount doesn’t work as easily in the heterogeneous US as it does in the more homogenous Denmark, but there are ways around that; at the very least, homeowners should be given the opportunity to offset their mortgage liabilities in the broader capital markets. There’s got to be some way of doing that, and I’m not talking about zero-sum games like Bob Shiller’s housing futures.

James Fallows has a correspondent who drives a lot, and is overweight, and who writes:

Car culture is terrible for public health. Again, I’m significantly overweight. Always trying new exercise and diet programs that never result in sustained weight loss. What has? Spent two months in London without car, relying on public transit and walking, no attempt at dieting or exercising. Weight loss: 22 lbs. Six weeks in NYC without car, relying on public transit and walking, no attempt… Weight loss: 19 lbs.

In general, the urban no-car diet is a very good one, and not just because you’re getting incidental exercise from walking more than you otherwise might. If you don’t have a car, you generally have much less food at home, because you don’t have access to “free” transportation in which you can transport hundreds of dollars’ worth of food from your local supermarket and deposit it in a monster-size refrigerator.

Dense urban centers also tend to offer much more expensive dining options. Sure, you can find fast food if you want it. But the fast food is surrounded by restaurants you actually want to go to, and since they’re just as convenient, you don’t have the “no choice” excuse that you have when you stop off next to the freeway. So you gravitate to the more expensive (and generally intrinsically healthier) options. And as any economist will tell you, the amount you consume goes down as the price goes up.

More generally, living car-free in a dense urban environment forces you to spend effort and money on eating, which makes you appreciate food more, rather than absent-mindedly shovelling down an unknown quantity of something random while watching the TV. Which makes me wonder: could even suburban people with cars lose a significant amount of weight simply by getting rid of their televisions?

Welcome back Steve! That’s not me welcoming Steve Waldman back to the blogosphere, it’s me urging you to go and welcome him back by reading his latest blog entry, on the end of the vanilla option. It’s magnificent stuff:

Extracting the vanilla from the CFPA is not, as Felix Salmon put it “the beginning of the end of meaningful regulatory reform”. It is the end of the end. Vanilla products were the only part of the CFPA proposal that was likely to stay effective for more than a brief period, that would be resistant to the games banks play…

Rather than being anti-market, vanilla financial products would help correct very clear market failures that arise from imperfect information and high search costs. It is the status quo that is anti-market.

I’m sympathetic to the principled libertarian objection to having the government require private parties to offer a product they otherwise might not. No one should be forced to offer vanilla financial products. Small-enough-to-fail boutiques should be free to offer only the products they wish. However, if an institution wishes to avail itself of government-provided deposit insurance or to access Fed borrowing facilities, it is perfectly legitimate for the government to set requirements. The government can choose not to offer its safety net to institutions that don’t offer vanilla products, just as banks currently choose not to offer me a credit card unless I sign up to binding arbitration and unilateral contract changes. I fail to see why one is coercive and the other not.

As they say, go read the whole thing. And then call up Barney Frank and ask him to read it, too. It’s not too late for him to change his mind!

Threatening to file for bankruptcy is a good way to get the attention of your lenders — it makes them that much more likely to agree to restructure your debts, just because bankruptcies are expensive, time-consuming, and unpredictable things. But how much money do you need to owe before your lenders will take you that seriously? In Kent Swig’s case, the number seems to be $28 million:

Developer Kent Swig is close to filing personal bankruptcy because he can’t afford to pay a recent $28 million judgment on his defaulted Sheffield57 condo conversion project in Midtown.

“We are exploring all options,” one of Swig’s advisers told The Post. “No one wants to do it but it’s certainly a play on the chessboard that we are considering at this time.”

I think most people are likely to be a little disgusted, when reading such a quote, that an extremely wealthy man like Kent Swig would cavalierly consider bankruptcy to be little more than “a play on the chessboard”. How come he gets to play chess with bankruptcy filings, when for the rest of us such a filing is ruinous in many ways? It’s just another way that the rich are different from you and me — and it reinforces my belief in some kind of wealth tax.

Joe Nocera explains one downside to having a single powerful regulator:

Our problems would have been much, much worse if we had implemented Basel II. I guess this is one of those times when the paralysis created by all our overlapping bank regulators saved us.

This is true: power can always be used for good or for ill, to regulate or to deregulate, to give the banks more of what they want, or less. But that doesn’t mean that paralysis is a good thing. It just means that governments have to be super-careful not to let regulators be captured by the banking industry. Which, in places like New York and London, is much easier said than done.

Newsweek.com is doing a big month-long series on the end of the decade, and, inevitably, it’s going to feature lots of listicles. One of them is a list of the top ten “history altering decisions” — seemingly-small moves that had massive consequences. Each one is going to be written up, and Newsweek has asked me for a very short essay (just 200 words or so) on the consequences of Bill Clinton signing the Commodity Futures Modernization Act in 2000.

Top of mind at Newsweek are the Enron collapse and the unregulated rise of the CDS market — can those fairly be ascribed to the CFMA? Are there any other key consequences of the CFMA’s passage which I should include? Newsweek has given me full freedom to crowdsource this, so if you ever thought you might have a CFMA blog entry in you somewhere, now’s the time to write the thing, or just leave a comment here. Thanks!

I enjoyed the discussion last night about financial regulation between Joe Stiglitz, Jesse Eisinger, and Roberta Karmel.

Stiglitz and Eisinger, especially, were on form. Stiglitz has an interesting and rather international take, having chaired a panel with a typically long UN name: the Commission of Experts of the President of the General Assembly on Reforms of the International Monetary and Financial System. And Eisinger seems to be getting increasingly curmudgeonly — a very good thing too, in this world of ultra-short memory spans and massive releveraging.

Stiglitz is a fan of the Polish framework. Poland, he says, has one overall regulator, which then has separate commissions with solid institutional knowledge for each of the areas, like insurance and banking, which need to be regulated. He also like the way that the Poles index the salary of the regulator to salaries in the financial sector. Financial-sector salaries are taxed at a set percentage to fund the regulator’s salary, ensuring that the regulator’s salary keeps up with financial-sector wage inflation.

He’s not a fan of the Fed, however, and had a good one-liner:

The Fed had more powers than it used before the crisis. Saying that we’re going to give them even more powers not to use doesn’t seem to me to solve the problem.

Eisinger, too, had his share of one-liners:

It’s a question of regulatory will to regulate. We had a problem not of deregulation but unregulation: we had somebody like Harvey Pitt, who had an attitude of being against regulation; we had Chris Cox who, as far as I can tell, had an attitude of pro sleep. All the structure in the world can’t really remedy these problems.

Stiglitz agreed. “The problem of regulatory capture is persistent and real,” he said, adding that one way to address the problem is to move to a rules-based rather than a principles-based system, hardwiring the regulatory system and giving the regulator less leeway.

Stiglitz’s most contentious view is probably the idea that the entire financial bailout was unnecessary:

We’ve really extended the safety net beyond to big to fail, and my view is that there’s been no convincing argument that any of this was ever needed. It was based on the notion of fear — that if you didn’t do it, the whole financial set of markets would fail. Economics would have suggested that if you did a debt to equity conversion, converting long-term debt into equity, the financial institution would be well capitalized, there would be no reason to panic, and there would be more confidence in the market. But those who saw an opportunity to use scare tactics to get what they wanted did use those scare tactics, and it worked.

Eisinger largely agreed:

There’s a crystallizing conventional wisdom, certainly out of Washington, that it worked. It was ad hoc, it was messy, it was poorly planned, but in the end all this fumbling from Bernanke and Geithner and Paulson ended up working. The evidence for this is that the stock market is up: people have this idea that the stock market represents the economy. That’s a very dangerous consensus forming, because the regulatory reforms do really nothing to address too big to fail. If everybody’s thinking that these gifts to Wall Street banks really got us out of the crisis, then it’s not really hopeful that they’ll address this in any serious way.

Jesse asked Joe whether he thought there was more systemic risk now than there was a year ago. “Yes,” said Joe, “very much so. Things are much worse now than they were a year ago. Structurally things are worse.”

If there was a problem with the panel, it was that the lefty pessimism of Stiglitz and Eisinger wasn’t really counterbalanced at all by anybody more constructive about what had happened. But that’s fine by me: my feeling is that we need all the lefty pessimism we can get right now. It’s our only hope at substantive regulatory reform