Good news on the corporate-bully front: Hertz, which was behaving abominably towards Audit Integrity, has utterly caved, dropping its libel suit on the grounds that it was “not worth pursuing now”. Or, one assumes, ever again. A small but important victory for freedom of speech in the financial markets.
Fama and French have a very long blog entry (over 5,000 words) about the latest version of their paper on mutual fund returns. As you might expect from research sponsored by an index-fund company, it shows that active mutual-fund managers fail to outperform the market. But at least it does so with pretty charts.
Here’s what happens when you compare actual before-fees returns from mutual-fund managers (the blue line) with what you’d expect if no managers had any skill at all, and the returns were simply distributed by chance (the red line).
On the left hand side of the chart, you see actual fund managers significantly underperforming what you’d expect by luck alone. On the right hand side, however, it seems that if you’re skilled at manager selection, there is a glimmer of hope that you might find a little bit of alpha. Not a lot, but something statistically significant.
Unfortunately, all that alpha — and then some — gets eaten away by fees. Here’s the chart for after-fees returns:
The red line, remember, is the distribution of returns you’d expect if all mutual-fund managers had an alpha of zero. The blue line is actual returns. Fama and French conclude:
For the vast majority of actively managed funds, true α is probably negative; that is, the fund managers do not have enough skill to produce risk adjusted expected returns that cover their costs.
Which comes as no surprise, but it’s still good to see some relatively solid empirics here. Anybody wanting to make an intellectually-credible case in favor of investing in actively-managed mutual funds is going to have to attack this paper head-on.
If a home is not an investment, what about a Treasury bond? In my comments, Dan responds forcefully to Urban Legend, who was trying to make the case that low interest rates do a lot of harm to those poor millionaires looking to live on their risk-free interest payments alone:
If you think it is reasonable to get a 5% return on top of inflation without taking risk, I have some oceanfront property in Nevada to sell you. That may have been possible in the past, but we are in a new world now.
Investing is not about loaning your funds out to a government, completely abdicating responsibility for finding meaningful uses for the capital and then expecting a substantial return above inflation. Our governments are nearly bankrupt.
If you lend to a nearly bankrupt and profligate entity, you deserve to lose a lot of money. You are like a bartender serving a drunk who is drinking himself to death. You are not innocent. You are part of the problem, and your investments are making the world worse. You don’t deserve a good return for that.
How to invest? If you really want risk fee, go for TIPs, but don’t expect much beyond inflation. Better yet, learn basics of business and investing and carefully loan out to local small businesses. Or be a landlord, watching your profit and dividends every month. Or invest in important and useful companies via the stockmarket. Or invest in making your house energy efficient. Or invest in your childrens’ and grandchildrens’ educations. Or donate it for research to invest in everyone’s future.
Whine about the Fed if you want. Your treasury buys make all these games possible.
I just made a significant investment in Apple, but I didn’t touch the stock: instead, my house now sports two brand-new computers, and already the returns on those computers are proving higher than I’d anticipated. (Although if you’re in NYC and are willing to trade knowledge of Mac OS X Server for good food and wine, I think I have a deal for you.)
There are lots of ways to invest well, and most of them don’t involve buying securities which rise in value. I often feel that stock-picker types are missing the point, rather — especially nowadays, when the future of the capital markets has never been cloudier.
If you really want to play a game where the person with the best-performing stock portfolio wins, then fine. But other kinds of investing, like for instance Dan’s idea of providing much-needed funds for a small local business, can be more rewarding in other ways. The world of securitization and capital markets turns out not to have been nearly as good at capital allocation as most of us thought it was. So maybe we should go back to making our own real-world investment decisions, rather than trusting in the markets to get it right.
Ryan Grim gets a great quote out of Treasury today, trying to explain why they’re pushing to allow banks to open branches in any state they like, despite the opposition of small banks, individual states, and Barney Frank:
“This eliminates a difference between thrifts and banks. While banks are subject to these limits, thrifts are not,” said Treasury spokeswoman Meg Reilly. “Although we are proposing to eliminate the thrift charter, this is an important step towards increased competition in banking and will reduce costs for consumers.”
One might think that eliminating the thrift charter would probably in and of itself do all that needs to be done in terms of eliminating the difference between thrifts and banks. But obviously not at Treasury. Instead, they seem to believe that allowing big banks in where they have previously been disallowed “will reduce costs for consumers”.
But big banks — and big thrifts — have been expanding across state lines for many years now. Is there any empirical evidence whatsoever that when that happens, costs for consumers go down? ‘Cos looking at the amount of money that banks are making in fee income, I’d doubt it.
It seems the housing speculators are back, and Daniel Indiviglio is joining their ranks, now that mortgage rates are back at record lows. “If you’re in the market for a home as a long-term investment, say at least 10-15 years, it’s pretty hard to make an argument against buying now,” he says.
It’s hard to know what to make of this. Some people are looking to buy a home — that’s understandable, given that everybody needs shelter. And some people are looking to invest money with a long-term time horizon. And some people even fall into both categories at once. But that’s no reason to desperately try to conflate the two, and to describe yourself as being “in the market for a home as a long-term investment”.
It bears repeating: homes aren’t investments, they’re places to live. If you can buy a nice house for less than you’d otherwise pay in rent, then go ahead and buy — no matter what the market looks like, or where mortgage rates are. On the other hand, if you’re looking for an “investment”, stick to securities. You can sell those much more easily when you need some money, and they won’t drive you into possible bankruptcy and homelessness if they go down rather than up.
In any event, low mortgage rates are if anything a reason not to buy: after all, the best way to make a lot of money in the housing market is generally to buy when rates are high and sell when rates are low. If rates rise from here that will keep a lid on prices, and if they fall then there’s no particular reason to buy now.
Some people have a strong emotional need to buy a house, and those people will always be able to find themselves some kind of good reason why they should Buy Now. But if you’re genuinely on the fence about whether to buy or not, then looking at mortgage rates isn’t going to be nearly as useful as looking at local rental rates, and their possible future course. Right now is one of those rare times when prevailing rents might actually fall rather than rise — in which case the rent vs buy calculator is likely to tip even further into “rent” territory. If it signals a “buy”, and you have the money to purchase a house, that’s great. Just make sure you’re happy with the house qua house, and you’re not kidding yourself that you’re making an “investment”.
Back in April, Willem Buiter called Citigroup “a conglomeration of worst-practice from across the financial spectrum”; he followed up in June with a blog post entitled “Too big to fail is too big“, in which he likened Citi’s former chairman and CEO, Win Bischoff, to Ayatollah Ali Khamenei. Which maybe explains why there’s no quote from Buiter himself in the press release announcing his arrival at Citigroup. Maybe they just thought it would be better to have him inside the tent pissing out.
Willem Buiter is joining Citigroup as its chief economist. It’s an important role — so important, in fact, that Buiter should be able to demand that he be allowed to continue to write his rather fabulous blog, either in its current location at the FT or else somewhere on citigroup.com. A widely-read and widely-respected blog is a useful tool for any economist to have, and Citi should be encouraging Buiter to keep his.
The first thing to jump out from the list is that just 5 of the 30 companies are American, and none of the six insurers: the likes of Mizuho, Intesa and Aviva are considered systemically important, while, say, Wells Fargo isn’t. (It’s not clear what the status of AIG is. Maybe it can’t be too big to fail if it’s already failed.)
The second thing of note is that there’s not much in the way of BRICs here, or even emerging-market institutions in general. Two of the four UK groups — Standard Chartered and HSBC — are about as close as it comes; there’s no Chinese bank on the list at all. Never mind all the chatter over Dubai: emerging markets are still very much the victims of financial meltdown, rather than the cause of it.
Finally, why is it only European insurers who make the cut? Two of them are Swiss; the others (Axa, Aegon, Allianz, and Aviva) are generally considered French, Dutch, German, and English respectively. What’s Berkshire Hathaway, chopped liver?
Only about one-fourth of homeowner defaults are strategic, with the other three-fourths triggered by job losses, divorce or other financial difficulties, which when combined with negative equity give homeowners no option but to let go of their homes. In other words, for the vast majority of homeowners, negative equity is a necessary but not a sufficient condition for default… Though more than 32% of U.S. homeowners were underwater on their mortgages by the end of the second quarter of 2009, the strategic default rate was roughly 3%.
Not all property owners behave like this, of course, and the best example right now of an underwater property owner walking away from his obligations is that of Sheikh Mohammed bin Rashid al-Maktoum. As Willem Buiter explains,
The shareholder (the al-Maktoum family aka the government of Dubai) will decide on ordinary commercial principles whether to provide additional financial support to these companies.
If the shareholder of Dubai World and of Nakheel believes that a further capital injection makes commercial sense, it will inject additional capital (assuming it can find the financial resources to do so). If, as I suspect is the case with Nakheel, the company is so deep under water that injecting additional shareholder capital would be throwing good money after bad, the company will not be financially supported by the shareholder. That’s how financial capitalism works.
Except, of course, that’s not how financial capitalism works in the US. Here’s White:
Luigi Guiso, Paola Sapienza, and Luigi Zingales found that 81% of homeowners believe that it is immoral to default on a mortgage, and that homeowners who hold this attitude are 77% less likely to declare their intention to default than those who do not. Indeed, once the equity shortfall exceeds 10% of a home’s value, the study found that “moral and social considerations” are the “most important variables predicting strategic default.” So strong are these variables, in fact, that only 17% of homeowners indicted that they would default if the equity shortfall reached 50%…
Moreover, foreclosure rates are considerably lower than would be suggested by the Guiso, Sapienza, and Zingales study, as the percentage of people who actually default is much lower than the percentage that indicated they would default in the survey, moral qualms or not.
White goes on to enumerate an astonishingly long list of institutions, up to and including the president himself, which are speaking with a single voice on this question, and saying that paying an underwater mortgage in full is the morally correct thing to do. Hank Paulson did it, despite the fact that he would have fired anyone at Goldman who behaved similarly; Neil Cavuto likened people who walk away from their mortgages to people who would have “quit” and handed over Europe to the Nazis.
Even Gail Cunningham, of the National Foundation for Credit Counseling, declared in an interview on NPR that “Walking away from one’s home should be the absolute last resort. However desperate a situation might become for a homeowner, that does not relieve us of our responsibilities.” If you’re thinking of walking away, you’ll almost certainly do so while overcoming enormous feelings of guilt. And where there’s guilt, there’s belief in dire consequences:
Most people simply do not believe they will escape punishment for their moral transgressions. Guilt and fear of punishment go together. Thus, the notion that one will suffer great consequences for walking away from one’s financial obligations not only seems possible, but feels quite right. It just can’t be that one can walk away from their mortgage with no significant consequence. As such, people rarely question apocalyptic descriptions of foreclosure’s consequences.
The result is a system tilted enormously in favor of institutional lenders who exist in a world of morality-free contracts, and who conspire to lay the world’s largest-ever guilt trip on any borrower who might think about joining them in that world. It’s asymmetrical, it’s unfair, and it’s about time that homeowners started being informed that a ding to their credit score is not the end of the world; that no one would expect a capitalist company to behave in the way that individuals are being told to behave; and that their options are in fact broader than they might believe. White’s paper is the perfect place for them to start their reading.
Most people, if they’ve hired a legendary fund manager on a multi-million-dollar salary to look after investments and liquidity, would listen to the advice of that person. But most people aren’t Larry Summers:
It happened at least once a year, every year. In a roomful of a dozen Harvard University financial officials, Jack Meyer, the hugely successful head of Harvard’s endowment, and Lawrence Summers, then the school’s president, would face off in a heated debate. The topic: cash and how the university was managing – or mismanaging – its basic operating funds.
Through the first half of this decade, Meyer repeatedly warned Summers and other Harvard officials that the school was being too aggressive with billions of dollars in cash, according to people present for the discussions, investing almost all of it with the endowment’s risky mix of stocks, bonds, hedge funds, and private equity. Meyer’s successor, Mohamed El-Erian, would later sound the same warnings to Summers, and to Harvard financial staff and board members.
“Mohamed was having a heart attack,’’ said one former financial executive, who spoke on the condition of anonymity for fear of angering Harvard and Summers. He considered the cash investment a “doubling up’’ of the university’s investment risk.
But the warnings fell on deaf ears.
Summers, amazingly, wanted to invest 100% of the university’s cash in the endowment, and had to be talked down to investing a mere 80%. No wonder Meyer and El-Erian tried to talk him out of it: the Harvard endowment was never designed as a place to invest sums of cash which might be needed immediately. Instead, it’s designed to invest for the very long term, taking advantage of the higher returns on illiquid investments.
Summers was playing a high-risk carry-trade game with Harvard’s cash:
The aggressive investment of cash accounts is part of how the university has long run its “central bank,’’ an account that holds funds from its various schools and pays them a modest US Treasury rate of return. The “bank,’’ in turn, has invested the lion’s share of that money with the endowment, generating returns that are used to pay for shared needs, like graduate housing and financial aid.
No one had the stones to stand up to Summers when it came to this high-risk strategy of essentially borrowing at Treasury rates and investing the proceeds in an illiquid long-term endowment — certainly not James Rothenberg, Harvard’s part-time, unpaid, California-based treasurer.
After Summers left, sheer inertia took over, and nothing happened — maybe because El-Erian was soon on his way out as well. The result was that the university ended up losing 27% of its $6 billion in “cash”: a whopping $1.8 billion. There’s no indication, of course, of any kind of apology from Summers.
Update: Brad DeLong, in the comments, does some back-of-the-envelope math and reckons that Harvard came out ahead of the game, on net, even after accounting for that $1.8 billion loss. But that’s exactly the difference between a long-term endowment, on the one hand, and a “cash account”, on the other. If you have money in a cash account, you spend it. And money you’re spending should be liquid, not tied up in an endowment which can drop 27% in one year.
Jackie Ramos was fired by Bank of America for being too nice to their customers. Of her three commandments — do the right thing for the customer; think of yourself as a customer; and do the right thing for the company — it turns out that only one mattered.
Consumerist has the transcript:
Every day I came to work and did just as I was supposed to: I collected. In fact, I was one of the top performers of my department, even outdoing those who were more tenured than I was. But something was wrong. There was something inherently evil about my job…
All the people that I’ve had to deny [repayment] programs to–they kept me up at night. All the people that I’ve pissed off with a $15 “convenience fee”–they kept me up at night. All the people who were dying, lost a child, husband, mom, dad, all the people who lost their jobs and sat on the phone sobbing to me that if we just gave them a little bit of help, they could make ends meet–they kept me up at night…
As my manager was escorting me outside she told me that if I needed a reference, she would highly recommend me to everyone. I received nothing but accolades while I was at Bank of America. Even while I was getting fired my boss told me that out of anyone she’s ever met I’ve had the highest morals and biggest heart she’s ever seen, and that means more to me than my job.
At the end of the day, I don’t have anything keeping me up at night. I did the right thing in God’s eyes and I’m sure that He’ll bless me. But [boss], can you say the same?
Why was Ramos fired? She stopped denying BofA customers the ability to convert their debit balance into an installment loan, while closing the account. (It’s called Fix Pay.) It doesn’t wipe out the debt, it just stops lots of extra fees being piled on top. One 24-year-old mother had just lost her own mother and her husband in the same week — and found out that she had cancer. According to BofA’s rules, she wasn’t earning enough to qualify for Fix Pay, which meant of course that she had to pay much more in the form of a 30% interest rate and $39 over-the-limit fees.
Let’s hope that John Carney is right and that Ramos becomes a star on next week’s morning-TV shows. Maybe they could invite her ex-boss on at the same time, to explain why Bank of America deliberately makes it as hard as possible to pay off your debts after you rack them up.
Banking shouldn’t be some kind of cat-and-mouse game where the bank tries to squeeze as many fees as possible out of you while you try to avoid them. Banks are treating their customers like the enemy (see Peter Goodman today on Chase, or of course the famous IndyMac case), and that’s not something which goes down well in today’s economy, where banks seem to be the only individuals or businesses making vast amounts of money. And yes, all of those profits were formerly our money.
Bob Ivry has the definitive obituary of Mark Pittman, a giant in the world of financial journalism, who died far too young on Wednesday. Ivry is polite enough not to call me out by name, although I deserve it:
His June 29, 2007, article, headlined “S&P, Moody’s Hide Rising Risk on $200 Billion of Mortgage Bonds,” was excoriated at the time by Portfolio.com for “trying to play ‘gotcha’ with the ratings agencies.”
“And that really isn’t helpful,” said the unsigned posting.
Pittman’s story proved prescient.
I wrote the blog entry in question, and it hasn’t stood the test of time nearly as well as Pittman’s article. At the time — between the collapse of Bear Stearns’s subprime hedge funds and the collapse of the bank itself — I was well aware of subprime alarmism, not only because of the Bear news, but also because I’d spent five months working for Nouriel Roubini. So I concentrated on the way that the story tried to back up its headline, dismissing its damning litany of problems with subprime credit ratings more generally as “2,000 words of throat-clearing”.
Sorry, Mark. In hindsight, your story was indeed prescient, and helpfully aggregated a lot of the well-founded worries that the subprime crisis was going to get much, much worse, and that none of the ratings on subprime CDOs could be trusted. It wasn’t until a good six months after your article was published that I finally understood the importance of what you’d been saying.
Pittman was an aggressive, old-school journalist, who was in his element going after big Wall Street institutions. Like most of the journalists I’ve criticized, he never responded to my blog entry, and I never met or spoke to him. That’s very much my loss: I’m sure I would have learned a lot. But Pittman had bigger fish to catch. His loss to the profession is irreplaceable.
Paul Krugman today argues in favor of a financial-transactions tax on the grounds that it would discourage over-reliance on ultra-short-term repo markets, among other reasons. In other words, reliance on repos is a bad thing, and it’s a good idea for government policy to “nudge” financial institutions away from it.
The repurchase agreement, or repo, market is a critical source of financing for dealers, hedge funds and others who use leverage to finance short-term trading positions. It’s a source of extra income for those holding virtually risk-free securities since they can squeeze out extra return by lending them out.
Such financing makes for a deeper and more liquid market that gives investors confidence that if they buy a Treasury note, for example, they can quickly sell it if they want to.
The problem is that we don’t want to encourage the use of leverage to finance short-term trading positions. Indeed, from a public-policy point of view, we’d ideally want to discourage it.
Would a less liquid repo market mean, in turn, a less liquid Treasury market? I daresay it would. But that’s no bad thing: the more liquid the Treasury market, the more that investors flock to it in times of crisis, exacerbating the systemic downside of the flight-to-quality trade, and reducing the amount of liquidity elsewhere in the markets, especially among credit instruments.
There are serious systemic consequences to living in a world where a Treasury bond — or any asset, for that matter — is considered a safe haven from all possible harm. Investing shouldn’t be about safety: it should be about calculated risk. Excess demand for triple-A-rated risk-free assets, as we’ve seen over the past couple of years, can be much more systemically damaging than excess demand for risky assets like dot-com stocks. So yes, let’s throw some sand into the wheels of the repo market, either through a Tobin tax or through the Miller-Moore amendment or both. Because liquidity is not ever and always a good thing.
The Economist has a good short overview of the situation in Dubai, which includes this interesting take:
Investors had half-expected Dubai World to seek forbearance from its bankers, asking them to extend their loans. But they felt sure the emirate would make good on publicly traded instruments, and in particular Nakheel’s sukuk, rather than suffer further damage to its financial reputation.
I remember the days when investors felt that in the world of emerging markets, publicly-traded bonds were implicitly senior to bank loans. But those days came to an end in the late 1990s with bond defaults in Pakistan, Ukraine, and Ecuador — and they’ve never returned. And it’s not even obvious at this point that restructuring loans is easier than restructuring bonds.
Certainly any entity like Dubai World carrying a large amount of bank debt would be very wary about needlessly infuriating its bankers by defaulting to them while remaining current on its payments to bondholders. If Dubai World’s bondholders really took solace in the fact that they held bonds rather than loans, they thoroughly deserve a large hit in the wallet. And as Willem Buiter says, it’s a good thing too:
Property developers tend to be highly geared and very procyclical in their revenue flows and access to the capital markets. During construction slumps they drop like flies. Because the property sector is risky (ask Donald Trump), its creditors tend to get better interest rates than the sovereign rate. Dubai is no exception to this rule. If you earn a risk premium during good times, you should not moan when the borrower defaults from time to time when the going gets tough…
Property companies don’t fall into the systemically important category. Their collapse is painful for their shareholders, creditors and, if the local labour markets are weak, their employees. They are not, however, systemically important. Their collapse will not threaten the delicate fabric of financial intermediation. They are fit to fail. Creditors beware.
It’s almost quaint that there are still people out there who believe that all market participants are always rational actors making decisions in their own economic best interest. Take Daniel Indiviglio, who even stands up for IndyMac and its “inequitable, unconscionable, vexatious and opprobrious” regional manager, Karen Dickinson:
I’m a little confused about how Salmon proposes that the bank here wasn’t acting in its own best interest. If he means that its actions led to a judge awarding the home to the borrower, and that screws the bank, well that’s true. But I seriously doubt that the bank believed that its actions would lead to that outcome…
Had the mortgage contract been upheld, then Indymac would have repossessed the home, as planned. Clearly, that’s the outcome it expected its actions to bring. If Salmon means to speculate that the bank would have been better off if it had accepted one of Ms. Yaho-Horoski’s modification alternatives than force her to foreclose, then I’m not sure I can agree…
For whatever reason, it didn’t like the modification options Ms. Yaho-Horoski presented. Maybe it believed that they all had far more risk than just foreclosing and settling for whatever price it could obtain in the battered housing market. So the bank deemed foreclosure its best option.
On the one hand, this is trivially false, since IndyMac rejected a bid at full market price from Yaho-Horoski’s daughter: it’s inconceivable that after going through the expense of foreclosing on and selling the house, IndyMac would net more money than that. After reading judge Jeffrey Spinner’s decision, it’s pretty clear that Dickinson was a malicious liar who was acting not in the best interests of IndyMac but much more simply in the worst interests of the Yaho-Horoskis. If they suggested anything at all — even a desperate offer of simply giving IndyMac the deed to the house, in lieu of foreclosure — Dickinson was predisposed to reject it.
It’s also inconceivable that IndyMac thought it could get a significant amount of money out of Yaho-Horoski over and above the proceeds from a foreclosure sale. Yes, New York is a recourse state. But we’re not talking here about the only kind of situation in which lenders ever go after borrowers after they’ve foreclosed — a case where the borrower is wealthy, clearly has the money to repay the debt, and is simply refusing to do so because the value of the house has fallen. The borrower in this case was Diana Yano-Horoski individually, and all of the proposals she made involved using the combined income of herself, her husband, and her daughter. But Dickinson evinced no interest in maximizing the amount of money being put towards repaying the mortgage: she even “summarily rejected” the offer from Yano-Horoski’s husband and daughter to be added to the loan as obligors.
More generally, it seems that Indiviglio’s fundamentalist beliefs about what banks do are utterly unfalsifiable. This case isn’t a cut-and-dried example of a bank acting against its own best interest, yet he still refuses to accept that’s what was happening. It’s almost as if he doesn’t understand that banks are run by humans, and that humans are fallible, especially in emotionally-fraught circumstances: they get caught up in an us-versus-them mindset which confuses the best outcome for themselves with the worst outcome for their opponents, or they just panic and do something stupid, like lying to a judge or pulling an emergency brake cord on a subway train.
I’m not saying that “Indymac is just pure evil” — the straw man that Indiviglio sets up as the onlypossible alternative to his sunny world where everybody always acts in their own best interest. I’m saying that certain corporate officers, in certain situations, make mistakes — and often make very large mistakes. In the case of the housing market in general, and foreclosure proceedings in particular, those mistakes happen quite often, if not always as egregiously as in this case. Loan servicers are simply overwhelmed by the sheer quantity of mortgages in default, and frequently rush to foreclosure even when there are much better options available.
It’s both in the national interest and in the best interest of the loan servicers collectively to put a brake on such actions: if everybody’s rushing to foreclose at the same time, that just creates a glut of distressed property sales which in turn drives down property prices further and perpetuates the vicious cycle. On the other hand, if everybody else is slowing down, then immoral banks like IndyMac can try to act as free riders and grab all the collateral they can, free-riding on rest of the banking community. Such actions should be opposed by all three branches of government, including the judicial branch. Which is one reason why Jeffrey Spinner is such a hero.