Felix Salmon

I taped this bloggingheads conversation with James Kwak last week, a good time was had I think by both of us.

James would like to draw your attention to the discussion of wine at the end; he says that enjoying expensive wine when you know intellectually that there’s no correlation between price and quality is a bit like getting a placebo effect from a drug when you know it’s a placebo. He’s right — and I’d be very interested in seeing any empirical data on the placebo effect under just those conditions. Has anybody done such a study?

In the wake of Justin’s book and Cadbury’s rejection of Kraft’s takeover offer, it’s probably worth noting that the one place the efficient markets hypothesis never took hold was in corporate boardrooms. It’s commonplace for boards to say that offers significantly above the stock-market valuation “significantly undervalue the company”, or somesuch — with the clear implication that the market is not rational at all. At least when it’s your own company on the line.

Do you remember Charles Stanish’s article about how eBay was great for antiquities because it meant that there were so many fakes around, it wasn’t worth plundering actual sites any more? Well, Matt Palmquist wrote it up for the rather fabulous Miller-McCune magazine, and now, if you scroll down to the bottom of their latest letters page, you’ll find a strong rebuttal from one Bill Stelzer, of Portsmouth, New Hampshire. Anybody care to adjudicate?

Update: Stanish comments, at length, below.

The NYT has an excellent article on the life settlement industry, explaining its pros and cons in a balanced and clear-eyed manner. If you’re interested in such things, you should read it: it was written by Charles Duhigg, and published in December 2006. He mentioned that Wall Street was getting interested in such things:

Trading in life insurance policies held by wealthy seniors has quietly become a big business. Hedge funds, financial institutions like Credit Suisse and Deutsche Bank, and investors like Warren E. Buffett are spending billions to buy life insurance policies from the elderly…

This nascent market illustrates one way that investors are hoping to make money from a large and wealthy generation of Americans as they reach retirement age.

Today, Jenny Anderson covers most of the same ground but adds little in the way of actual news. What she does add is a much more ominous tone:

Wall Street is racing ahead for a simple reason: With $26 trillion of life insurance policies in force in the United States, the market could be huge…

If a small fraction of policy holders do sell them, some in the industry predict the market could reach $500 billion…

Some financial firms are moving to outpace their rivals. Credit Suisse, for example, is in effect building a financial assembly line to buy large numbers of life insurance policies, package and resell them — just as Wall Street firms did with subprime securities.

If Wall Street is really “racing ahead”, it’s been doing so for well over a decade now, and doesn’t seem to have got very far. There have been people on Wall Street trying to securitize and trade life settlements for as long as I can remember, and nothing much ever seems to happen. Is anything different now? Not really: Anderson has managed to find exactly one securitization of life settlements, and even that one she only mentions in passing:

Standard & Poor’s, which rated a similar deal called Dignity Partners in the 1990s, declined to comment on its plans.

In fact, Dignity Partners launched in March 1995, and was the grand total of $35 million in size. “Could” the market “reach $500 billion”, as “some in the industry predict”? Well, anything’s possible. But so far it’s managed to go from $35 million to zero over the course of the past 14 years. Wake me up when something happens: for the time being there’s nothing at all.

None of the big three ratings agencies is involved right now: the closest thing to a news hook in Anderson’s story is that DBRS, which she describes as “a little known rating agency in lower Manhattan”, is thinking about applying ratings to these things. Is there any evidence that investors are going to trust DBRS on this one, in the event that anything gets off the ground? No.

In general, Anderson seems to be at pains to overstate the degree to which there’s anything to worry about here. Not only does she repeatedly say that life settlements could be the next subprime, she also says that they could be damaging to America’s seniors:

“Predators in the life settlement market have the motive, means and, if left unchecked by legislators and regulators and by their own community, the opportunity to take advantage of seniors,” Stephan Leimberg, co-author of a book on life settlements, testified at a Senate Special Committee on Aging last April.

The quote could have used a bit of context. Leimberg thinks that life settlements are a good thing, in principle, and is looking for legislation to ensure that the industry grows up in a healthy and well-regulated manner, rather than being rife with predators. (And please, NYT, if you’re going to quote Senate testimony, would it kill you to link to it?)

The fact is that life settlements can be wonderful things for seniors who get seriously ill. At the same time, however, that’s not what life insurance was designed to do, and trying to make it perform that function has a raft of nasty potential consequences. For one thing, it could mean life insurance premiums rising substantially, since the price of life insurance currently is kept down by people who let their policies lapse. If they sell those policies instead of letting them lapse, that’s very expensive to the insurer.

But there’s another reason, too, why life settlements are potentially very bad for the insurance industry — and neither Duhigg nor Anderson mentions it. Life insurers, unlike most investors, pay no tax on their investment gains. That’s why buying a life insurance policy is generally a very tax-efficient way to invest money you want to leave to your heirs. But if these policies start being traded on the secondary market, with the benefits going not to heirs but rather to hedge funds and traders, then there’s a serious risk that the life insurance industry will lose its tax-sheltered status. The Wall Street banks looking at securitizing life settlements should be very worried about this: if they start showing signs of success, Congress could, at a stroke, kill their golden goose.

Update: I love Blossom’s idea of calling these things “Collateralized Death Obligations”.

Joe Nocera this week looks at eBay’s sale of Skype, and wonders who would pay $2 billion for a company with a massive lawsuit hanging over its head. With apologies for quoting at some length, here’s the nub of Nocera’s thesis:

The Skype founders’ essential complaint is that eBay tampered with their software, and in doing so, violated the terms of the licensing agreement. They were demanding that Skype be forced to stop using the technology, which, for all intents and purposes, would mean shutting down Skype itself…

The founders would have been willing to come up with a price that suited eBay — if they had been able to enter into negotiations. What is clear is that the bad blood that had developed between eBay and the founders was infecting the potential negotiations over a buyback of the company…

Not long before Index Ventures became interested in Skype, it brought on board a man named Michelangelo A. Volpi, a highly respected former Cisco executive who — hmmm — once sat on the Skype board. In fact, he was so well liked by the Skype founders that they hired him to run Joost…

Mr. Volpi told me that not long after he arrived at Index Ventures, he discussed the possibility of making a run at Skype — and he and another Index Ventures partner, Danny Rimer, in turn rounded up Silver Lake and Mr. Andreessen, who — hmmm — sits on the eBay board.

So another theory: because of his friendship with the Skype founders, Mr. Volpi believes he’ll be able to settle the lawsuit…

It is, alas, unsatisfying to delve into a mystery like this and not be able to solve it. But over time, it will become clear. Either the case will linger, and we’ll know that Silver Lake, Andreessen et al. do indeed have nerves of steel.

Or it will quickly go away, which will provide an answer of a less seemly sort.

The problem I have here is with the “hmmm”s and the “less seemly”. Nocera is clearly of the opinion that if Skype’s buyers have a tacit agreement to settle with JoltID, that would be pretty scandalous. But why?

From the point of view of eBay’s shareholders, the existence of any such agreement would clearly be a good thing: they managed to sell Skype for $2 billion as a result. More generally, it’s clearly Pareto-optimal that Skype and JoltID are on good, non-litigious terms with each other. And it’s obvious that they were never going to be on such terms so long as eBay owned Skype. If Adam Smith’s invisible hand were doing its job, then, eBay would sell Skype to someone who had much friendlier relations with JoltID. What’s unseemly about that?

For all that Harvard president Drew Gilpin Faust likes to talk about the “worrisome impact” of “America’s deep-seated notion that a college degree serves largely instrumental purposes”, she’s still happy coming out with stuff like this:

A widespread perception of the value of universities derives in no small part from very pragmatic realities: a college education yields significant rewards. The median earnings for individuals with a B.A. are 74 percent higher than for workers who possess only a high school diploma.

This is the kind of lying-with-statistics which academics should be debunking, not propagating. If you want to know what the rewards are of going to college, you need to compare the lifetime earnings of people who went to college with those who could have gone to college but didn’t. It’s trivially true that the kind of people who go to college will earn more than the kind of people who don’t. What’s interesting is whether the kind of people who can go to college benefit financially from doing so.

Here’s Rolfe Winkler:

How much more will you make if you go to college than if you don’t? Are those extra earnings enough to pay back your loans with interest, along with the opportunity cost of forgoing full-time wages while you’re a student?

A common misconception is that a college degree is worth a million dollars over the average working lifetime. But a paper published late last year by the National Association of State Universities and Land Grant Colleges pegs the value at close to a tenth of that, $121,539.

The study I’d love to see is the one looking at the lifetime earnings of Harvard dropouts, and comparing them to the lifetime earnings of people who graduated from Harvard. If you include Bill Gates, it’ll seem as though dropping out of Harvard makes you more money than completing your studies there. Even if you don’t, it’s far from obvious what the results of such a survey would be.

There are good non-financial reasons to go to college, as Faust says. But as the cost of going to college increases, the purely financial cost-benefit analysis is becoming non-trivial, especially if you end up having to take out enormous student loans.

From Jon Mooallem’s very good NYT Magazine article on the self-storage industry:

By the early ’90s, American families had, on average, twice as many possessions as they did 25 years earlier. By 2005, according to the Boston College sociologist Juliet B. Schor, the average consumer purchased one new piece of clothing every five and a half days.

That’s an average of 66 clothing purchases per person, per year. I’m sure that the number for men is a lot lower than the number for women, so I fear to think what the number for women is.

Mooallem is also good on explaining how the self-storage industry is essentially a way of monetizing the sunk-cost fallacy. Indeed, the industry itself is happy to admit it:

Clem Tang, a spokesman for Public Storage, explains: “You say, ‘I paid $1,000 for this table a couple of years ago. I’m not getting rid of it, or selling it for 10 bucks at a garage sale. That’s like throwing away $1,000.’ ”

Of course, you really threw away $1,000 when you bought the table. But you probably justified the purchase by considering it an “investment”. Despite the fact that if you’ll never sell something for more than you bought it for, it can never be an investment.

Jeff Jarvis is kvetching, reasonably enough, about “internet bigotry” — the idea that everything bad which happens in the media must somehow be the fault of the internet, and bloggers, and other such new-media developments. It’s a theme running through Damian Tambini’s very long and boring essay on ethics in financial journalism, which has just been published by the LSE and Polis. For instance:

The views of the journalists interviewed for this paper revealed considerable diversity of views on their basic responsibilities: views ranged from those who saw their responsibility in terms of selling newspapers (and thus focused on the shareholders of the companies employing them) – to those with a very developed idea of the social function of financial journalism and associated ethical responsibilities. Others identify with the values of the profession as a whole. And an interesting new challenge is that many of those providing services akin to financial journalism in the new media reject the label of journalist altogether, preferring to opt out of any ethical framework associated with it…

Clearly in the days of blogs, messaging and email newsletters it is important that professional financial journalists put clear boundaries between themselves and the rumour mongers.

(My emphasis.)

Tambini’s paper is not only larded with 17 footnotes and a two-page bibliography; it is also highly concerned with things like “standards of verification and sourcing”. Yet a comment like this — essentially saying with no basis whatsoever that lots of finance bloggers actively choose to “opt out of any ethical framework” — can easily and casually be thrown into the paper. He doesn’t even stop to wonder whether conflating blogs with “rumour mongers” might not be entirely fair.

As Jarvis points out, in many cases (such as Chelsea Clinton not getting married) it’s the professional journalists, not the blogs, which are the worst offenders. And in the world of finance, the most virulent rumors are those spread by the likes of CNBC, while blogs are if anything better at debunking rumors than they are at spreading them. (Alphaville, in particular, is very good at this.)

The problem is that Tambini talked overwhelmingly to old-media types: he doesn’t seem to have had any interest in even trying to approach bloggers or other new-media denizens to get their take on the ethics of financial journalism. Maybe he thought that he might catch something nasty if he got too close.

There are too many bankers, and they make too much money. How to deal with this? You can try to crack down on bankers’ pay directly, but that’s unlikely to work. You can try to fiddle with capital-adequacy standards, so that big banks become less profitable, but that’s unlikely to have much in the way of immediate effect. Or, you could follow the lead of Holland, circa 1581, as explicated by Simon Schama:

Bankers were excluded from communion by an ordinance of 1581, joining a list of other shady occupations—pawnbrokers, actors, jugglers, acrobats, quacks, and brothel keepers—that were disqualified from receiving God’s grace. Their wives were permitted to join the Lord’s Supper, but only on condition that they publicly declared their repugnance for their husband’s profession! Their families shared the taint and were only permitted to join communion after a public profession of distaste for dealing in money.

Given that Mammon has long since triumphed over God, I reckon most bankers these days would happily give up communion in order to be able to continue to make their seven-figure bonuses. Maybe we should try banning their children from attending expensive private schools instead.

The number jumping out at me from this morning’s employment report is 6.9 million: the total decline in employed people since December 2007. The macroeconomic effects of that kind of change are huge: if each person ends up spending $20,000 less a year on average, that adds up to $138 billion in lost economic activity.

Over 10% of US males, and over 15% of US blacks, are now unemployed — and those are percentages of people who aren’t so demoralized that they’ve simply stopped looking for work altogether. Then there’s the “marginally attached” — here’s the Labor Department’s press release on the official “discouraged workers”.

About 2.3 million persons were marginally attached to the labor force in August, reflecting an increase of 630,000 from a year earlier. (The data are not seasonally adjusted.) These individuals were not in the labor force, wanted and were available for work, and had looked for a job sometime in the prior 12 months. They were not counted as unemployed because they had not searched for work in the 4 weeks preceding the survey.

Among the marginally attached, the number of discouraged workers in August (758,000) has nearly doubled over the past 12 months. (The data are not seasonally adjusted.) Discouraged workers are persons not currently looking for work because they believe no jobs are available for them.

The U6 measure of broad underemployment spiked up from 16.3% to 16.8% — yet another all-time high. I’m well aware that these figures are a lagging indicator, but the absolute levels alone should be more than enough to depress anybody looking for any sign that the US economy is looking remotely healthy. Markets, of course, are still high, and can always go higher. But the fundamentals look much less pretty.

The Geithner plan is out!

PayPal is opening its platform to Third Party Developers. But do they need to use that music?

Best law-firm memo ever

Is Spain crumbling? The debate continues

Robert Peston is skeptical that the Brown/Sarkozy/Merkel plan to restrict bankers’ pay is either workable or a good idea.

It’s pretty difficult to put a lid on pay in the wider financial industry, especially a globalised one.

Remuneration in finance is like a blancmange. If government and regulators squeeze one part, it will bubble up somewhere else.

If big banks are restricted in the cash rewards they can pay their top staff, they will reward them in other ways – with increased pension contributions perhaps, or cheap loans. Or they’ll pay a fortune to the best ones by hiring them on rolling short term contracts, to keep them off the official books.

He’s basically right — which is why the Europeans might be interested in the Geithner plan (warning: 14-page PDF) to impose higher capital standards on systemically-important banks.

The insight here, I think, is that the biggest banks — Goldman Sachs, Morgan Stanley, Merrill Lynch, etc — are the price-setters when it comes to banker remuneration. If they are socked with higher capital ratios, then their profitability will fall, their bankers will be paid less, and prevailing remuneration expectations in the industry as a whole will decline accordingly. Which would be a most welcome development.

Larry Elliott and Jill Treanor have a big story today, although I’d love to see it re-reported elsewhere. Remember the tick-tock on why Lehman Brothers was allowed to fail: although there was a bid on the table from Barclays, it required government funds, and neither the US nor the UK government were willing to provide them.

One hurdle remained: To ink a Lehman deal, Barclays needed a shareholder vote. There was no way to get one on a Sunday. Barclays would need the U.S. or British government to back Lehman’s trading balances until a vote could be held.

Government approval never came, though there are diverging views on why. Some blame the U.S. government for refusing to commit resources. Others say the British government refused to entertain a deal they worried would expose England to unnecessary risk.

From the other side of the pond, it seems that the Brits were convinced all along that the US money was there for the asking:

In London, the Treasury, the Bank of England and the Financial Services Authority all believed that the US government would step in with a financial guarantee for the troubled Wall Street bank…

The UK tripartite authorities – the FSA, the Bank of England and the Treasury – had expected the US government to stand behind Lehman in the way that it had backed two crucial mortgage lenders the previous week and helped to orchestrate the bailout for Bear Stearns in March.

No explanation has ever been given for the lack of government funds offered in the final weeks of the Bush administration, which had to step in to prop up the insurance company AIG days after Lehman’s demise.

That final paragraph is not strictly true. An explanation has been given, repeatedly: that Treasury had no legal authority to provide such funds. It’s just that nobody really believes it. In any event, it’s pretty clear that no one in Treasury was making its inability to provide funds clear to anybody in the UK. Treasury should have been saying “look, gents, we’ve saved the world three times now, but we’ve come a bit unstuck on this Lehman thing, we’re not going to be able to do it ourselves, do you think you could step up this time, give those Barclays chaps a bit of a helping hand, we’ll owe you one, it’s rather urgent”.

Instead, there seems to have been a complete breakdown in communication, with the UK team convinced that the US could and would bail out Lehman. After all, the Yanks had given them every indication that they were perfectly capable of dealing with such things on their own, and didn’t need any help from abroad:

The UK tripartite authorities were concerned about the financial system in the spring of 2007 and asked their American counterparts to participate in a “war game” to prepare for the collapse of a major US bank and develop a response to a financial crisis. However, the war game, which was to have included the UK, Switzerland, the Netherlands and the US, never took place because of a lack of willingness to participate by the US regulatory bodies.

The enormous global costs associated with the chaotic Lehman bankruptcy were entirely avoidable, and to my knowledge no one in power has ever apologized for letting it happen. Maybe Hank Paulson could be the first, in his upcoming memoir.

A fantastic catch from Nemo after Paul Wilmott appeared on CNBC this morning to make a very good point: that there’s still a huge amount of model risk in the system, that the sheer size of financial institutions still poses a massive potential systemic risk, and that high-frequency trading, in particular, does a bad job of efficiently allocating long-term capital, which is the primary purpose of the markets.

Larry Kudlow then proceeded to respond in the the only way he knows how:

Is there an asset class that looks cheap to you from a pricing standpoint?

Let’s look at gold, energy, commodities. Let’s look at stocks, let’s look at bonds, for example… I’m just asking you, off the top of your head, what looks rich and what looks cheap now?

Let me rephrase it. Is there an asset class that looks cheap to you right now?

Your judgment. Somebody gives you a billion dollars. What looks cheap? What would you buy?

Poor Paul eventually gets bullied into some semblance of an answer: essentially he says “buy options”, since there’s a significant chance of a huge move, one way or the other. Which of course garners the only possible response, from Trish Regan: “I, I, I don’t understand…”

Two of the most popular blog entries I ever wrote were on the subject of AFA press. AFA is a publisher of sleazy advertorials, targeted mainly at companies in developing markets. (In the US, they operate under the name “Summit Communications”, when producing inserts for the New York Times.) Between my original March 2006 blog entry and its July 2006 follow-up, there are now more than 50,000 words of comments from people either involved or thinking about getting involved in this business.

But finding the good stuff amidst so much volume is not easy, so it’s great that Alan Furth has now blogged his own experiences working for this kind of company.

I was in charge of the editorial for the supplements, so I had to “interview” CEO’s and key government officials on their views about the attractiveness for business of their countries and companies.

A typical “interview” was structured as a 30-minute conversation that had to strike a delicate balance between gathering information for the copy of the supplements, and most importantly, making the interviewee say the right things that would allow my accompanying colleague — invariably an attractive, sharp, aggressive saleswoman as most people in positions of power in the developing world are still men — to construct the arguments for selling him an expensive ad in the supplement…

I became totally focused on listening attentively to my interviewee’s answers, taking notes, and coming up with witty comments for sparkling the space between questions and adding flavor to the conversation. I had to pay close attention to my interlocutor’s body language to gauge his emotional state: if he was tired, bored or angry, the pressure was on. I needed to wake him up somehow, to find which buttons to press in order to put him in the right frame of mind for a sale, while still feeling he had been “interviewed” by a journalist. Seeing his mood change subtly in the right direction was exhilarating, each favorable micro-expression getting me a bit closer to signing an advertising contract, and a commission of several thousand dollars.

The problem with this kind of thing is that once the big guys have been burned once or twice, they’re unlikely to fall for the same scam again. So Furth had to go lower and lower on the food chain, looking for unpicked-over companies:

In our hunt for “virgins”, we scoured the countries searching for them, storming into office buildings, taking advantage of relaxed, unstructured, friendly local cultures to steal 30 minutes of the boss’s time, and walking out with a 25,000 USD ad contract from a small stock brokerage firm that didn’t make a million USD in yearly turnover. Or for that matter, from a truck-manufacturing company that had no exports, no international expansion plans, or any other minimally rational reason for advertising with us.

I guess that the good news here is that this business model contains all the seeds of its own demise: according to its own website, Summit Reports has published nothing since February. With luck, it’ll be a long while until such things re-emerge.