Felix Salmon

How the AIG bailout scuttles chances for a second stimulus

Felix Salmon
Nov 18, 2009 16:08 UTC

Paul Krugman is right to be worried about the unintended consequences of the AIG bailout:

We’ve greatly increased the chance of a Japanese-style lost decade, with I would now give roughly even odds of happening. Why? Because bank-friendly policies have squandered public trust in all government action: try talking to the general public about stimulus, and it’s all confounded in their minds with the deeply unpopular bailouts.

I do fear that the Obama administration has done a bad job of separating the financial-sector bailouts, on the one hand, from the stimulus bill, on the other. And if the general public starts conflating the two, there’s no chance of any more stimulus, no matter how needed it might be.

Part of the problem is that Tim Geithner was so vocal about the urgent necessity for both of them, dating back to his tenure at the Fed during the Bush administration. If he comes out and says that a second stimulus is needed, the obvious rejoinder will be “well you said that about the AIG bailout too”. And there’s no good answer to that.


Mr. Krugman appears to hold the belief one of these government economic activites was better than the other and should; therefore, not generate a lack of trust. In my opinion, there’s no confusion, or confoundedness. Wrong is wrong and there can be nothing wronger about this. A third wrong won’t make this right.

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Ben Stein’s sleazy paymasters, cont.

Felix Salmon
Nov 18, 2009 14:36 UTC

Flâneur points me to the 35-page staff report for Jay Rockefeller on “Aggressive Sales Tactics on the Internet”. It concentrates on three extremely sleazy companies, all based in Norwalk, Connecticut: Affinion, Webloyalty, and our old friends Vertrue, the employers of Ben Stein. Here’s a typical datapoint:

In discussing methods for reducing the cost associated with the call centers, Vertrue employees estimated that it received “7 million customer calls per year” and that “cancellation calls represent approximately 98% of call volume”.

In general, the customers of these companies have no idea that they’re customers until they discover mysterious charges on their credit-card bills. When they investigate further, they find that during the checkout process at reputable websites like priceline.com or 1800flowers.com, they inadvertently clicked on a link which automatically gave their credit card details to these rip-off merchants.

Why would otherwise-admirable websites get into bed with these creatures? Here’s a hint:


No, those aren’t misprints: we’re genuinely talking here about CPMs in the thousands of dollars. (A typical internet banner ad pays CPMs in the single digits; at a high-prestige website appealing to rich individuals, it might get into the $30-$40 range. But never anything remotely like this.)

The money being made in these scams is enormous:

Financial information provided to the Committee by the companies shows that Affinion, Vertrue, and Webloyalty and their e-commerce partners have generated over $1.4 billion in revenue from Internet consumers who have been charged for membership programs. Of the   $1.4 billion in total revenue, $792 million went to the e-commerce companies that partnered with Affinion, Vertrue, and Webloyalty.

The websites and e-retailers that have partnered with Affinion, Vertrue, and Webloyalty include some of the most well-known and high-traffic e-commerce websites on the Internet. They include travel sites, airline sites, electronics sites, movie ticket sites, and the websites for popular “brick and mortar” companies. Eighty-eight e-retailers have made more than $1 million through partnering with Affinion, Vertrue, and Webloyalty and, of the 88, 19 companies have made more than $10 million. Classmates.com, which has been partnered with each company at different times and has earned more than any other partner, generated approximately $70 million in revenue.

And where’s the money going? Primarily, it turns out, to private equity:

In 2001, Cendant rebranded its membership club unit as “Trilegiant” and, in 2005, sold it to Apollo Management, a New York-based private-equity group, which in turn renamed the company Affinion…

Webloyalty is owned by the Greenwich, Connecticut private-equity group, General Atlantic, LLC…

In 2004, MemberWorks changed its name to Vertrue. Three years later, in 2007, Vertrue was de-listed and sold for approximately $800 million to a group of private equity investors led by One Equity Partners, the private equity arm of J.P. Morgan.

These are big, reputable private-equity shops: what are they doing in this ultra-sleazy world of making money off unsuspecting dupes by exploiting loopholes online? In the real world, vendors can’t take your credit-card information and “data pass” it to someone else with minimal disclosure, but that’s still legal on the internet. As the report notes,

Affinion, Vertrue and Webloyalty use aggressive sales tactics intentionally designed to mislead online shoppers… While Congress and the Federal Trade Commission have taken steps to curb similar abusive practices in telemarketing, there has not yet been any action to protect consumers while they are shopping online.

I wonder whether anybody at JP Morgan knows or cares that its private equity arm is paying large sums of money to predatory bait-and-switch merchant Ben Stein in an attempt to boost the amount of money misleadingly extracted from individuals who can least afford it. And I wonder too how and why all these companies have ended up in private-equity hands. Is it because private companies don’t need to answer to the public in the same way that public companies do?


I was victimized last year by one of these innocuous looking ‘click here’ subscription ads on the Orbitz website. I discovered four months of charges on my billing after the fact. After strenuously complaining to Orbitz the charges were refunded. I now refuse to visit the Orbitz site and am very watchful of all others.

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Felix Salmon
Nov 18, 2009 05:10 UTC

Hipsters discussing Cyclocross — Xtra Normal

Get an email per week from Maria Bartiromo for only $300! — Investor Place

Conversion Closing Rap — YouTube

Baumkuchen is my favorite cake ever! So it’s sad the article on it isn’t online. But the summary is great — TNY

NFL stadium sells for less than the cost of a Manhattan 1BR — Bloomberg

Brooklyn Chef Goes Ballistic, Throws Live Lobster on Patrons — Eater

Who sold credit protection on AIG to Goldman Sachs? They’re a huge and unknown beneficiary of the bailout — NYT

Is there anything Marc Faber won’t say to get more media attention? — JRE

How do senators place a hold on a nominee? By sending a press release to the NYT! — Newsweek

Qaddafi and the Italian models — NYT

Josh Tyrangiel to BusinessWeek: another sign that Bloomberg’s determined to go mainstream — BW

The Paul Wilmott magic show has disappeared! Or never appeared in the first place! — Wilmott


Adam Smith in Ten Minutes

http://www.gla.ac.uk/about/history/fame/ adamsmith/

Emphasizing the connections between “The Theory of moral Sentiments” and “The Wealth of Nations.”

The Moral Sentiments is a leading example of a particular approach to moral philosophy – one that regards it not as sets of rationally or Divine ordained prescriptions but as the interaction of human feelings, emotions or sentiments in the real settings of human life. In many ways it is a book of social and moral psychology. What we can call economic behaviour is necessarily situated in a moral context. But more than that the key theme of the book is an opposition to the view that all morality or virtue is reducible to self-interest. Indeed his opening sentence declares that everyday human experience proves that false, he writes: “How selfish soever a man may be supposed, there are evidently some principles in his nature which interest him in the fortune of others, and render their happiness necessary to him, though he derive nothing from it except the pleasure of seeing it”.

Via Mark Thoma (http://economistsview.typepad.com/econo mistsview/2009/11/the-very-best-short-su mmary-of-adam-smiths-life-and-work.html) and Gavin Kennedy (http://adamsmithslostlegacy.com/2009/11  /very-best-short-summary-of-adam-smiths .html).

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Goldman’s human face

Felix Salmon
Nov 17, 2009 21:49 UTC

Today the squid is showing its human face — you know, as opposed to wrapping itself around one. Goldman deserves to be applauded for two things today: first of all Lloyd Blankfein’s admission and apology that his bank “participated in things that were clearly wrong and have reason to regret”, and secondly its $500 million 10,000 Small Businesses Initiative, under which it will team up with community colleges, business organizations, and Community Development Financial Institutions (CDFIs) — all with the aim of removing barriers to growth in the small-business sector of the economy.

As a board member of a CDFI myself, I can attest that the kind of funding that Goldman is providing — some $300 million in loans and grants — can make a world of difference to our members. We’re happy to do a lot of work underwriting loans to small businesses, but by their nature these things are risky, and if someone like Goldman Sachs steps in to backstop losses on a portfolio of small business loans, there’s no shortage of borrowers we are eager to be able to help, often in conjunction with public organizations like NYC Business Solutions. All too often there’s lots of goodwill in such places but a serious shortage of lendable funds: initiatives like Goldman’s should help change that. And given that small businesses are a key driver of employment growth, there has never been a better time to do this.

I also asked Goldman which activities, exactly, Blankfein had in mind when he talked about doing “things that were clearly wrong”. They pointed me to his Handelsblatt speech:

The industry let the growth and complexity in new instruments outstrip their economic and social utility as well as the operational capacity to manage them. As a result, operational risk increased dramatically and this had a direct effect on the overall stability of the financial system.

So complex structured products would be one example of what Blankfein was talking about; another, I was told, would be cov-lite loans. Would that more bank executives went public in describing such things as “clearly wrong” in normative terms, rather than simply money-losing mistakes in hindsight.


The $500 million though is really a drop in the bucket compared to the kinds of numbers this company throws around. Its almost insulting in a way, but at this point we are the dog underneath the table and are willing to take whatever scrapes these people want to toss our way.

So are we supposed to get excited about this? I wouldn’t exactly say that, but I wouldn’t completely scoff at it either. They didn’t have any reason or were mandated to do this in anyway. Of course its a blatant PR move, but its not a bad one. Its really in their best interest too for as the economy soars so do their profits. Its really just a win win situation for everyone involved. Some more money possibly in line with the kind of money they’ve been paying out in bonuses would have been nice, but who are we really to complain.

I don’t really blame Goldman Sachs for the financial crisis, they were simply going about their businesses. Looking back at it, things could have been done differently of course, but hindsight is always 20-20. Its refreshing to see someone step up to the plate and admit that they didn’t handle things as well as they could have. Is it sincere? Probably not, but at this point its all we’re going to get and its better than nothing.

Check out my blog on the Goldman Sach’s penance offering at…. http://www.thedebtgazette.com/2009/11/go ldman-500-million-penance/

How UBS chooses the names it will give the IRS

Felix Salmon
Nov 17, 2009 21:02 UTC

Lynnley Browning looks today at the 4,450 clients that UBS is going to give up to the IRS, going down the list of characteristics that UBS is going to look for when deciding which of its accounts to choose.

What’s interesting is that it looks as though more than 10,000 UBS clients have already approached the IRS voluntarily. Clearly if client focus is UBS’s number-one priority (as all banks always say that it is), UBS will have every incentive to try to pick a subset of that group when it hands over the 4,450 names. And given how close UBS private bankers are to their clients, I’m sure that UBS knows which of its clients have chosen the voluntary-disclosure route.

There’s no obvious way that the US government can force UBS to give up a certain number of names the IRS doesn’t already have. After all, it can hardly complain if UBS told some of its clients that they were probably going to be given up anyway, so they should probably hand themselves in voluntarily.

But it will still be interesting to see whether UBS ends up handing over to the US government any information that the IRS hasn’t already been given voluntarily. My guess is that of the 4,450 names, only a tiny fraction will be unknown to the IRS at this point.


Thank you for the insightful story. Although the press and the IRS are playing up on the story of rich and well-heeled tax dodgers, the majority of the offshore account holders are immigrants, who for obvious reasons, did not have tax-free 401k and IRA accounts to put their life savings into.

In the past, the IRS penalties for even reporting voluntarily were so harsh (i.e., no guaranty that the IRS still won’t bankrupt and throw you in jail), that many had no choice but to stay underground. With the recent voluntary disclosure, they had a way out, but only by coughing up a 40% penalty of their savings. In other countries, aside from paying back taxes and interest, the voluntary disclosure penalty is in Canada 0%, in Italy 5% and Great Britain 10%. But even with the U.S. government, where there is money involved, the morals and long term consequences get ignored.


1. http://www.lynamtax.co.uk/news/
2. http://www.tax-news.com/asp/story/Italy_ Launches_Tax_Amnesty_xxxx39110.html
3. http://www.cra-arc.gc.ca/gncy/nvstgtns/v dp-eng.html?=slnk
4. http://www.irs.gov/newsroom/article/0,,i d=104361,00.html

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What’s Berkshire Hathaway’s expected life?

Felix Salmon
Nov 17, 2009 18:14 UTC

Berkshire Hathaway has a lot of equity: its book value is about $125 billion. And since equity is forever, it makes sense for Berkshire to have a very long time horizon when it comes to buying assets. But still:

Berkshire Hathaway Inc.’s Warren Buffett, who agreed to buy Burlington Northern Santa Fe Corp. in his biggest takeover, said the railroad’s results in the next 100 years will justify a $26 billion bid that’s “not a bargain.”

“It’s a good asset for Berkshire to own over the next century,” Buffett said in an interview with Charlie Rose.

It’s refreshing to see the 79-year-old Buffett taking such a long view. But the fact is that Berkshire Hathaway is not going to exist in anything like its present form in 100 years’ time. It’ll probably last no more than 10 years after Buffett dies before it’s broken up into various component parts. And when he gives quotes like this to Charlie Rose, it seems as though he’s somewhat in denial about what his legacy is really going to be.

The minute that Buffett dies, Berkshire becomes a large conglomerate, and will trade, like all conglomerates, at a discount to its sum-of-the-parts valuation. Sooner or later, Berkshire’s CEO will be persuaded to monetize the difference, and the storied company will come to its natural end. That’s no bad thing: it’s intrinsic to the nature of capitalism, which Buffett loves. But it does mean that buying companies on a 100-year time horizon is somewhat unrealistic.


I am surprised so many people agrees with the post. Salmon has obviously not studied Berkshire in depth and therefore completely unaware of the synergy in Berkshire’s current structure which would be lost if the company is broken up.

Saying Berkshire will be just like any conglomorate after Buffett’s death and that ALL conglomorates trade at a discount is both untrue and exhibit faulty logic. He did not justify either of these statements. Could it be that he isn’t even aware that these statements bags major assumptions that may not be valid?

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Can options spikes be a coincidence?

Felix Salmon
Nov 17, 2009 17:58 UTC

Whenever there’s a surprise takeover bid at a significant premium to the (formerly) prevailing stock-market price, dozens of journalists and bloggers immediately pull up options-volume data. Much of the time, they discover a suspicious spike in options volume just before the deal was announced. The conclusion is obvious: insider trading!

So many thanks to Baruch for bringing a bit of context to bear on such exercises. His main points: is that options volumes are by their nature extremely lumpy. Just about any options contract, if you look at it, will have occasional extremely large spikes. As Baruch puts it, “the volume of a particular option resides in Extremistan”.

What’s more, the options markets are constantly awash in rumors, any one of which can easily cause on of these spikes. Baruch provides one example: last Friday, a rumor hit the market that Palm would be bought by Nokia. It wasn’t, but that didn’t stop 21,000 options being traded in one day on the $12.50 calls alone. That’s over five times the size of the option volume in 3Com before it was bought by HP.

And one other thing: if you did have inside information that 3Com was being bought by Nokia, you’d make more money simply buying the stock than you would buying the options. The only reason to buy the options is if you simply don’t have the cash to buy the stock.

None of which is to say that there wasn’t insider trading in 3Com, of course. It’s pretty hard to prove a negative. But statistically speaking, if you look at options volumes on every takeover bid which crosses the transom, eventually one of them is going to see this kind of spike, even if there’s no insider trading at all.


An off topic bike/hipster link you might enjoy http://www.xtranormal.com/watch/5684963

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Understanding the AIG decision

Felix Salmon
Nov 17, 2009 16:01 UTC

As Dean Baker notes, Neil Barofsky’s report on the 100% payments to AIG’s counterparties is the news of the day. It’s sexy stuff, revisiting the dramas of the week of Lehman’s collapse, and of course going into great detail about the way in which the crisis’s designated villain, Goldman Sachs, walked away with billions of dollars of taxpayer money despite saying they never asked for it nor particularly needed it.

I agree with Barofsky that, in hindsight, the payments should have been made at less than par; TED has a good explanation of how that could have happened, given sufficient aggression. After all, it’s not like Treasury wasn’t being run by a hard-charging former investment banker at the time.

But I’m maybe slightly more sympathetic to the Fed than most — or at least I understand how this happened. It shouldn’t have happened, that’s true: for the sake of putting a knife into the moral-hazard trade, some haircut — any haircut — should definitely have been imposed, even if it was only the 2% that UBS offered to accept.

But the government owned AIG, which created the situation that Germans call Anstaltslast: the fact that state-owned companies simply don’t default on their obligations. The government was also battling a major crisis using the only weapon at its disposal: enormous amounts of liquidity. When you’re putting out a fire, you don’t stop to worry that large amounts of liquidity are going to end up where you don’t particularly want them — the important thing is putting out the fire.

So yes, given a bit more aggression and foresight, the Fed could have tried to cram down a haircut onto AIG’s counterparties. But at the time, no one was particularly interested in being harsh to the global financial sector; instead, they were trying to rescue it. With hindsight, it now seems that companies like Goldman Sachs have turned out to be the biggest winners, paying out billions of dollars in bonuses even as the rest of the country struggles with an extremely nasty recession. But that wasn’t particularly foreseeable. And so although I agree with Barofsky that the Fed and Treasury should have been harsher on the counterparties, I do understand why they weren’t.


They have had no actual “legal authority” to force the haircut or maybe they did, it’s irrelevant.

They had plenty of leverage in any negotiations and they pissed it away. How hard would it have been to say “If you don’t want to take a haircut, you’re on your own and good luck with getting anything since you’ll have to wait in line with the rest”

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Understanding currency ETCs

Felix Salmon
Nov 17, 2009 15:33 UTC

I was confused yesterday about currency ETCs; after a detailed conversation with Nik Bienkowski of ETF Securities, I think I understand them a bit better.

The answer to my central question about whether you can try to play the carry trade with these things is quite clear: it’s yes. The mechanism is just as commenter Daniel described it: the funds essentially buy currency forwards expiring tomorrow, sell them just before expiry, and roll over into a new short-dated forward. These forwards are extremely liquid, and since that constant rolling one-day exposure in the forwards market does an excellent job of reflecting the differences in local interest rates.

As a result, says Bienkowski, if the Aussie dollar ETC had existed for the past five years, holding it would have returned 4.8% per annum, before fees, over and above whatever you would have got from holding Aussie dollars alone. Fees are 39bp per year, accrued daily, so you genuinely can get a bit of carry out of these things.

So what’s all this about T-bill interest rates? It all comes down to the nature of the derivatives market. If I’m buying a forward expiring tomorrow and then selling it just before it expires, I don’t actually pay cash for the forward in one transaction and receive cash in a separate transaction when I sell it. Instead, the transaction gets netted out. If the currency has moved in my favor, I get paid a small amount of money; if it has moved against me, I pay a small amount of money. If it hasn’t moved at all, I get a tiny amount of money, corresponding to one day’s interest in local currency. Annualize that tiny amount of money, and you’re looking at the carry.

The investors, meanwhile, have put up an amount of money corresponding to the full notional amount of the underlying currency. That money needs to be invested somewhere, so it gets invested in T-bills. Hence the added T-bill interest rate. The T-bill interest rate isn’t large, but it’s the only actual interest paid on these instruments. The local-currency interest, by contrast, is basically an arbitrage condition: the forwards markets always reflect local interest rates because if they didn’t there would be a no-brainer arbitrage there. (This kind of arbitrage can fall apart during something as chaotic as the Icelandic devaluation, which was accompanied by the default of all the local Icelandic banks, but the currency ETCs invest only in G10 currencies, where that kind of thing hasn’t ever happened. Yet.)

The ETCs are dollar-denominated, and they all include either a long-dollar or a short-dollar position. The two facts cancel each other out, so if you’re a UK or euro investor who buys say the long Aussie-dollar ETC, you’re essentially getting direct exposure to the Aussie dollar in pounds or euros or whatever the currency is that you’re using to buy and sell the ETCs.

The ETCs are guaranteed to underperform their index, thanks to those 39bp in fees. But they shouldn’t underperform more than that, since Morgan Stanley has promised to pay the index return. “If Morgan Stanley didn’t pay us the index, they would be in default,” says Bienkowski. On top of that, much of the added complexity of the instruments is essentially designed to hedge precisely that Morgan Stanley counterparty risk.

Bienkowski is a fan of the instruments. “If you want to get access to foreign currency, I think these products are pretty good,” he says. “They aren’t leveraged, they’re not a CFD or a warrant. They’re basically bringing institutional money-market interest rates and spreads to the average investor. “

Thatsaid, currency ETCs are complex, and not easy to understand. There’s language in the prospectus about not buying them without talking to an independent financial advisor, but the fact is that most independent financial advisors aren’t going to be able to understand this prospectus very easily either. (Izabella Kaminska and I are at least as good at understanding these things as most independent financial advisors are, and we got very confused by them.)

If you’re a fan of the UK Financial Services Authority, you might take some solace in the fact that it has signed off on these currency ETCs; they fulfill its listing requirements as debt securities. “We’re bringing the wholesale currency market to a regulated exchange,” says Bienkowski. But the fact is that there’s still a lot of complexity here. In general it’s a good idea not to buy things you don’t understand, and there’s a lot of stuff in the prospectus which is difficult to understand.

On the other hand, historically it has been almost impossible for retail investors to play the carry trade, invest in foreign exchange, or in general diversify into fx as an asset class. If you’re worried that your investment currency is going to implode (be it dollars or pounds or anything else), then buying a few of these ETCs will give you some kind of hedge against that, helping to preserve international purchasing power. The underlying mechanics of them are not particularly pretty, but if you’re going to rely on the continued liquidity of any financial market in the world, the fx market is probably the best one to rely on: it’s incredibly liquid and robust.

Currency ETCs are very new and untested things, and so a sensible investor will probably hold off for a little while longer to see how they do. It might also be interesting to see whether and when a similar product might list on a US exchange. But in principle I can see why these things were invented, and I can also see why a certain class of globally-focused retail investor might be interested in buying them.


Well, it took some courage to use that “almost impossible” link to your own 2007 posting. Shorting yen would have worked out real well (not!) for a retail investor (03/21/07: 117.59; today: 86.38), not to mention the absolutely priceless quote about “a much lower-risk investment like an AAA-rated tranche of a CDO”.

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