Felix Salmon

Derivatives datapoint of the day, OCC statistics edition

Felix Salmon
Oct 6, 2009 21:25 UTC

Many thanks to Bill, who read my blog entry on derivatives exposure and who is much better at navigating the OCC’s quarterly reports than I am. And it turns out that they’re rather misleading.

Consider this, from the executive summary:

Five large commercial banks represent 97% of the total banking industry notional amounts and 88% of industry net current credit exposure.

What are those five large banks? According to the OCC, they’re JP Morgan Chase, Goldman Sachs, Bank of America, Citibank, and Wells Fargo. Add up their “total derivatives” numbers in Table 1 of the latest OCC report, and you get $197 trillion, which is indeed 97% of the $203 trillion in total notionals.

But never mind that, and take a look at Table 2 instead. That shows the notional amounts at bank holding companies, rather than banks themselves. Suddenly, the size of Bank of America’s derivatives holdings spikes from $39 trillion to $75 trillion, while Morgan Stanley appears from nowhere to reveal itself as holding a more-than-healthy $41 trillion in derivatives. It seems that at Merrill Lynch and Morgan Stanley, the derivatives are generally held by the holdco rather than the bank, which allows the OCC to ignore them for the purposes of its headline calculations.

Add up the derivatives books at the holdcos, and the total isn’t $203 trillion any more: it’s $291 trillion — an increase of $88 trillion which is very hard to find in the OCC report unless you’re specifically looking for it. And never mind Wells Fargo, which was also something of an also-ran in the top five banks. The top five now comprise JP Morgan, Bank of America, Goldman Sachs, Morgan Stanley, and Citigroup, with derivatives holdings between them of $278 trillion. That’s 95% of the true total, or 137% of what the OCC would have you believe was the total.

Why does the OCC make the rather legalistic distinction between commercial banks and holding companies, and then concentrate on the former rather than the latter? If the object of the exercise is to add up total derivatives exposure, that doesn’t make any sense. Someone there should really start asking themselves why they’re publishing this report, and how they could make it most helpful to the people reading it.


“Why does the OCC make the rather legalistic distinction between commercial banks and holding companies, and then concentrate on the former rather than the latter?”
The OCC regulates *banks*, not bank holding companies and therefore has the power to force *banks* (not bank holding companies) to file so-called “call reports” in order to compile their derivatives exposure.
Table 1 is based in these call reports and table 2 is not (read the notes).
Normally there is very little difference between the 2 tables but as you may be aware, we have some new BHCs plus the structure of some of the old ones has been changed, so the current difference between table 1 and 2 is a temporary anomaly.

Man-cession datapoint of the day

Felix Salmon
Oct 6, 2009 18:43 UTC

Chris Swann reports that, yes, men have suffered 75% of the job losses in this recession. But look at the last recession: they suffered 86% of the job losses in that one. And the recession before that? More than 98% of the job losses. He concludes:

As the slide in manufacturing and production tails off, male workers can expect some relief. The problems of many women in the workforce are far more ingrained and harder to deal with. Man-cession aside, it’s still a man’s world.

The worlds where I live my professional life — both finance and the blogosphere/punditocracy — are massively overweight men; that’s an unambiguously bad thing. Women are more sensible than men, and less likely to take extreme risks. If we’d had more women in charge of the global financial system, I suspect that the most egregious excesses of the past decade would never have occurred. So if we must have a recession, then a man-cession is exactly what we need.


I’m unable to follow your link (stupid work firewall), but I’m gonna have to go ahead and disagree with your “women are more sensible” comment. Maybe it’s just my bad experiences with girlfriends talking, but the most irrational people I’ve ever known were all women.

Returns on art

Felix Salmon
Oct 6, 2009 18:22 UTC

Luc Renneboog and Christophe Spaenjers of Tilburg University have done their own analysis of the art market, and conclude:

Our art index has underperformed stocks since 1951 and bonds over the last quarter of a century (but at a higher risk). Moreover, there are high transaction costs associated with trading art, which reduce the reported returns. When considering the low profitability and the high riskiness of art investments, one can only conclude that art should primarily be bought for its beauty.

This study shows art returning 4.03% between 1951 and the top of the market in 2007. That’s low, in comparison to other findings in the literature:

The returns on art calculated in this study are lower than the outcomes in the often-cited studies by Goetzmann (1993) and Mei and Moses (2002), even though our time frame includes an extra boom period. We argue that this can be explained by the fact that our dataset has a much broader coverage than the ones used in earlier papers, and therefore not only captures the (re)sales by top artists at big auction houses.

I think this works more generally: if you could somehow include in the survey all the art that anybody ever buys, the aggregate returns would certainly be negative. Most art is bought in the primary market and is never sold, mainly because it never can be sold. To all intents and purposes, it has zero monetary value the minute that it leaves the gallery or artist’s studio.

The greatest investors in art never bought art as an investment. If you take the set of all art collectors, statistically speaking some small proportion of them will see their collections grow substantially in value. Those collectors are deemed in retrospect to have had a “great eye”. But people who buy art as an investment are almost certainly going to be disappointed — and even more disappointed if they get someone else to buy art for them.

The only time it makes sense to think in such terms is in terms of asset allocation and risk profile: if a large proportion of your net worth is tied up in art, that should be taken into account when constructing the rest of your investments and your estate planning strategy. But don’t think that art has any real chance of growing substantially in value.


In general l agree – its clear that if you buy from galleries you are very unlikely to get your money back. But there are ways to ensure you shouldnt lose much…

First rule is of course to buy where there is already a secondary market (ie check that major auction houses have a market for the artist).

If you stick to auctions its safer – but since if you eventually sell at auction you’ll not only need to allow for buyers premium but the sellers premium too – ie: appx 33% of your investment will go to the auction house (in a flat market, no inflation – buy at 10k, pay appx 12k, then sell at 10k, get appx 8k)

To do better the only answer is to really know your stuff – when buying check your market, only buy art with an existing secondary market, buy very carefully and selectively at auction or haggle with dealer/artist to buy below gross auction prices. When selling do it when you want to – not when you need to, ie: watch the market and sell when you think the market is best for the work.

I could add loads more eg: dont ever buy editions, stick to only the best works by an artists – not secondary works, select their usual style/media.

If you break even youll have done well!

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Imposing a haircut on secured bank creditors

Felix Salmon
Oct 6, 2009 16:00 UTC

Sheila Bair, in Turkey, came out with a provocative and very interesting idea which few people seem to have picked up on: when a bank fails, its secured creditors should be limited to getting only 80% of their money back:

She said curbing claims would encourage secured creditors, who are protected from losses when a bank fails, to more closely monitor the risks a bank is taking and could speed up the process when an institution needs to be wound down…

“A major advantage is that all general creditors could receive substantially greater advance payments to stem any systemic risks without the extensive delays typically characteristic of the bankruptcy process,” she said.

“Obviously, the advantages and disadvantages need to be thoroughly vetted. In any event, there is a serious question about whether the current claims priority for secured claims encourages more risky behavior,” Bair added.

I like this idea, if only because secured funding at banks is invidious, especially from the point of view of someone like Bair, who exists to protect deposits. Depositors are senior to unsecured creditors, so lenders love to jump the queue, as it were, and become secured creditors instead, thereby becoming senior even to depositors. It’s an easy way of being lazy, and not feeling the need to underwrite billions of dollars in loans.

One wrinkle might be the difficulty in separating secured lenders, on the one hand, from simple trading counterparties, on the other; Bair is surely right that any mechanism along these lines should be implemented very carefully. But the bones are good, and global regulators trying to piece together a new regulatory architecture would do well to take this idea very seriously.


Great solution: Senior debt has a whole different meaning when the gov’t serves to void moral hazzard. This 80% rule could really benefit the banking system by forcing banks to borrow more prudently and not short term. Introduces a bit of market discipline to those lending the funds as well.

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The World Business Forum and journalistic ethics

Felix Salmon
Oct 6, 2009 14:32 UTC

This time last year, I attended the World Business Forum at Radio City. I came away with a slight ringing in my ears and a blog entry entitled “The Parallel Universe of Leadership Events”, in which I attempted to skewer the content-free nature and general mindlessness of such things. My prize was an invite to come back this year, as part of their “Bloggers Hub“, so I could repeat the whole experience. I’m not there now, but I might pop along once or twice: it’ll be interesting to see how Paul Krugman, for one, approaches such a crowd.

It’s worth asking how Krugman felt himself allowed to take this gig. This is, after all, the man who wrote this:

I do very little paid speaking now, and no consulting, because the New York Times has quite strict rules: basically I can only get paid for speaking to nonprofits that have no possible interest in influencing the content of the column. It’s a good rule – read Eric Alterman’s book “Sound and Fury” to see how speaking fees can corrupt pundits – though it meant that I took a substantial income cut to work for the Times.

The World Business Forum is emphatically not a nonprofit, and it pays its speakers very large sums of money. (That’s how it gets the likes of Jack Welch, Tony Blair, and Bill Clinton to turn up.) So what’s Krugman doing there?

In any case, this annual boondoggle — an event with zero news value, which large companies give to their middle managers so that they can feel important and have a fun couple of days in New York without really working — has managed, incredibly, to get itself an entire dedicated blog at the WSJ. This is probably a function of the fact that the Journal — along with BusinessWeek, Fox Business, and something called ExecuNet — is a “media sponsor” of the Forum. (Those middle managers are exactly the audience that the WSJ wants to reach.)

I don’t for a minute blame the business side of the WSJ for sponsoring the WBF — it’s their job to do such deals. But there’s no indication on the WSJ’s WBF blog that it’s anything other than an editorial-side effort, put together by “reporters and editors at The Wall Street Journal”.

Which leaves just two possibilities, neither of which reflect very well on the WSJ. Either the business side bullied the editorial side into putting together this dedicated blog — which would imply that the wall between the two is porous indeed. Or else the editorial side really believes that the World Business Forum is so inherently newsworthy that it should be blogged by multiple staffers over two days. In which case someone at the WSJ really needs their news judgment examined.


Maybe he was able to negotiate a better contract with the NYT? Maybe the NYT hopes that if Krugman gets highly lucrative speaking opportunitis he’ll start to write crap opinion pieces like Thomas Friedman?

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The problem with bond ETFs

Felix Salmon
Oct 6, 2009 13:56 UTC

The WSJ’s Eleanor Laise finds that the market in bond ETFs is rather messy, to say the least:

State Street Corp.’s SPDR Barclays Capital High Yield Bond ETF fell nearly 1% in the 12 months ending Aug. 31, even while its benchmark gained 6%. Part of the problem: The index contained some lower-quality bonds that the ETF couldn’t get, and when those bonds rallied, the fund got left behind, says Jim Ross, senior managing director at State Street.

The benchmark in question, it’s worth noting, is the Barclays Capital High Yield Very Liquid Index. That’s evidently “Very Liquid” as in “can’t find these bonds to buy no matter how hard we try”.

The lesson of this story is that ETFs don’t work when they’re investing in instruments which aren’t exchange-traded:

Keeping ETF returns in line with the indexes has proven to be tough in the murky bond market. For most bonds, there is no centralized exchange matching bond buyers and sellers, and different market players can assign very different prices to the same bonds. Many bonds don’t trade for days at a time, and when they do, they can be costly to buy and sell.

It’ll be interesting to see whether anybody tries to launch an ETF based on a liquid, exchange-traded CDS index. That might solve most of these problems, but I know a lot of people who would be dead-set against such a product, since its very existence would imply the dreaded “naked shorting” of CDS by dastardly speculators. Is a failed investment product better than a liquid derivatives market?


then you need a liquidity-weighted index, duh.

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Felix Salmon
Oct 6, 2009 04:59 UTC

Clay Risen says Goldman Sachs will never be able to get to grips with the realities of the blogosphere — Faster Times

Olympic voting was “a win for prediction markets, not a failure” — Sabernomics

Surowiecki on the “palpable longing among pundits for Americans to become more frugal” — TNY

Backwardation in tin! — Telegraph

Hempton unleashes his analysis of BBVA’s US subsidiary, on the grounds that it might give an insight into BBVA — Bronte Capital

This is what you pay McKinsey for: the decision to axe Gourmet rather than Bon Appetit. — NYT

“You may already be drinking box wine and not know it”: wine is shipped in bladders in containers, then bottled — Wine Economist

Overdraft fee datapoints of the day

Felix Salmon
Oct 6, 2009 04:54 UTC

The Center for Responsible Lending has a new report on overdraft fees, which has some startling numbers on the degree to which these things have increased in recent years:

Overdraft fee income for banks and credit unions rose 35 percent between 2006 and 2008, going from $17.5 billion to $23.7 billion. Add in non-sufficient fund fees, and the totals rise to $25.3 billion and $34.3 billion, respectively. (The difference between an overdraft fee and an NSF fee is that an overdraft fee is charged when the payment is made; an NSF fee, or bounced-check fee, is charged when the payment is not made.)

The Center also notes that “as recently as 2004, 80 percent of all institutions denied debit card overdrafts” — it’s astonishing how quickly such charges went from the exception to the rule.

Overdraft fees now dwarf the actual overdrafts themselves:

For 2008, we estimate that checking account holders receive only $21.3 billion in credit for the $23.7 billion they pay in overdraft loan fees. Put another way, consumers were obligated to repay $45 billion for $21.3 billion in extremely short-term credit.

The Center has some good recommendations, including this one:

Require that overdraft fees be reasonable and proportional to the actual cost to the financial institution of covering the overdraft. On average, overdraft fees exceed the amount of credit extended, which is particularly troubling given the short time period until repayment—usually only a few days. Since banks are able to repay themselves out of the accountholder’s next deposit, these loans carry a low default risk relative to their high cost. Overdraft fees should be proportional to the actual cost to the institution of covering the overdraft, taking into account the cost of funds, default risk, and a reasonable profit margin. Indeed, a product designed to be proportional to the cost to the institution of covering the overdraft already exists—an overdraft line of credit at a reasonable interest rate.

In fact, the status quo is even worse than the Center here implies. Yes, it’s true that banks are able to repay themselves out of the accountholder’s next deposit. But they never do.

Where I come from (England), an overdraft is simply a negative balance on your checking account. You pay interest so long as the balance is negative, and if you put in enough money to bring the balance back into the black, you stop paying interest. Not here. In the US, there’s normally no such thing as a negative balance on your checking account: instead, when you go into overdraft, you not only pay the usurious overdraft fees, but you also start running up a debit balance on your overdraft account. If you then deposit money into your checking account, it’s entirely possible (and indeed common) to have a positive balance in your checking account and an overdraft, all at the same time. In order to get rid of the overdraft, you need to actively transfer money from your checking account to pay off your overdraft — which of course you’re never going to do unless and until you find out that you’re overdrawn in the first place. Which might not happen until you get your next month’s bank statement.

If I may, then, I’d like to make one addition to the Center’s recommendations: that all deposits into checking accounts be put first towards any overdraft, and only then towards a new positive balance. But that of course would be consumer-friendly, so it’s probably never going to happen.


I work at Which?, the Consumers’ Association in the UK. Following the conclusion of a high profile court case about bank charges last week, there have been plenty of debates about them this side of the pond. We’ve just done some research which shows that almost half of UK current account holders would prefer not to have an unauthorised overdraft, and instead, would prefer that any payment which carried them into an unauthorised overdraft was blocked. Our view is that we want banks to show they’re willing to respond to what their customers want by only making unauthorised overdrafts available to those who ask for them. We’ll let you know how we get on. But if you want to hear more, then check out our campaign – Britain needs better banks – http://www.bnbb.org.

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The benefits of too big to fail

Felix Salmon
Oct 5, 2009 18:41 UTC

Ryan Chittum applauds Gretchen Morgenson and Dean Baker for trying to calculate what they all refer to as the “costs” of having a too-big-to-fail “policy”. But I don’t like this lens at all.

For one thing, what Baker is totting up here aren’t costs at all, they’re benefits to the banks concerned. At no point is the key logical step spelled out: if a big bank benefits by being too big to fail to the tune of say $1 billion a year, then there must be an equal and opposite $1 billion a year cost to taxpayers. What’s more, Morgenson implies, that cost can be compared directly to other government spending:

If Mr. Baker is correct about the estimated size of the subsidy, the costs of too-big-to-fail are substantial when compared with other government programs. At $34.1 billion a year, the subsidy is more than twice the grant given under Temporary Assistance to Needy Families, a $16.5 billion program that helps recipients move from welfare to work. A $6.3 billion subsidy would be roughly what the government spent in 2008 on the Global Health and Child Survival program, an initiative aimed at preventing malaria, AIDS and tuberculosis.

What Morgenson’s talking about here aren’t contingent liabilities, they’re cash outlays. The government isn’t giving that level of cash to the banks; there’s not even an explicit government guarantee on the banks’ unsecured debt. Instead, there’s an implicit government guarantee, which, being implicit, can’t really be charged for. Instead, the government is seeking to increase large banks’ minimum capital ratios so as to reduce their profits by at least as much money as the extra profits that Baker is calculating.

Conceptually, then, I don’t like the idea of painting this benefit to the banks as a cost to the government, because it really isn’t. After all, if the government were forced to bail out any of these banks’ bondholders, the sums involved would be vastly greater than the numbers that Baker is throwing about. In that sense, the cost to the government is either zero, or it’s in the hundreds of billions of dollars. It’s not somewhere in between.

I also don’t like the idea of painting too-big-to-fail as a “policy”, as though it was a decision implemented by some technocrat somewhere down the line. It’s not. Pretty much every major economy in the history of capitalism has had too-big-to-fail banks. It’s a natural state, which governments can try to manage, but doing so carries its own costs. Morgenson quotes Baker:

“There is a subsidy here, and we either have to say we are going to break up the banks and get rid of the subsidy, or if we don’t do that, then we have to be confident that we have put in enough regulation to offset the subsidy.”

Breaking up too-big-to-fail banks is, in the best-case scenario, an extremely costly and disruptive thing to do. That doesn’t mean it shouldn’t be done, of course. But there is absolutely a cost-benefit tradeoff here. What’s more, it might not even be possible: if you break a trillion-dollar bank into two $300 billion parts and one $400 billion part, all three parts are still too big to fail, especially in a time of crisis. How big is small-enough-to-fail? And is it possible to grind America’s largest banks into chunks that small? These are non-trivial questions, especially when you’re dealing with broker-dealers which need large balance sheets just to be able to make liquid markets.

Baker’s alternative involves offsetting subsidy with regulation — how is that supposed to work? Can you calculate regulatory costs and debit them from too-big-to-fail benefits? Goldman Sachs currently has a tier-1 capital ratio around 16%; if the government increases its minimum capital ratio from 8% to 12%, what is the associated cost to Goldman? Yes, it loses a certain amount of option value — the ability, if times turn tough, to reduce its capital ratio sharply while still remaining in regulatory compliance. But how would you even begin to calculate that option value?

I think that Baker’s exercise is a useful one, especially when he comes to the conclusion that in the case of a bank like Capital One, all of its profits and then some might be a function of the implicit government guarantee. (Although, is Capital One really too big to fail? When WaMu and Lehman were not?) But let’s not pretend that we could, at a stroke, take the benefits that accrue to banks when they get too big to fail, and spend that money on something entirely different. We can’t.


“The subsidy is free insurance and the right way to measure the cost to the government is the ex ante correct premium not the ex post losses that actually occur.”
FDIC insurance is not free. Banks pay premiums. It covers depositors against two eventualities. A bank run is costless to ensure against because the assets are worth more than liabilities if properly unwound. The government can just print the desired cash and then unwind the position. A bank failure from asset loss is also insured, but this insurance is costly to provide.