Opinion

Felix Salmon

Chart of the day: The big banks get bigger

Felix Salmon
Dec 9, 2009 21:58 UTC

marketshare.tiff

This chart comes from the Congressional Oversight Panel’s latest report, and it’s pretty self-explanatory. Here’s the COP’s gloss:

Bank consolidation has worrisome implications for moral hazard, as long as there continues to be a perception in the market of an implicit guarantee. As a small number of banks acquire a larger share of the market and competition decreases, the systemic risk they pose rises.

There will be more bank failures, and many of them will end up with the failed bank getting taken over by one of the big four. Treasury has as far as I can tell no plan at all for reversing the trend in this graph, even though a good 35% of the US banking system is now undeniably too big to fail and drenched in moral hazard.

Remember too that most of the deposits in this graph don’t only have an implicit guarantee from the federal government, they also have an explicit guarantee from the FDIC, which simply doesn’t have the ability to insure sums of this magnitude. But with too-big-to-fail banks valuing that status as being worth billions of dollars, you can be sure that they’ll fight hard to prevent any attempt to shrink them. Chances are, they’ll succeed. These banks will continue to be far too big for the foreseeable future.

COMMENT

“Primary contributers INCLUDING the vast majority of Americans,” I should have said. The rest of the world’s have nots are of course contributors as well.

Posted by 100yearoldman | Report as abusive

America’s broken colleges

Felix Salmon
Dec 9, 2009 19:39 UTC

Kevin Carey has a must-read and very sobering article on US higher education in the latest issue of Democracy. Basically, it isn’t working, for the vast majority of people who consume it, especially if they’re poor.

Throwing money at the problem won’t help and will probably hurt. Already the Pell grant program has ballooned from $2 billion to $20 billion since 1980, yet the proportion of the typical college’s tuition costs that it covers has dropped from 70% to 33%, thanks to a 500% rise in tuition rates. On top of that, most of the poor kids who go to college don’t graduate, and a very large proportion of the ones who do graduate are neither literate nor numerate to anything approaching what most of us would consider college-graduate (or even college-entry) standards.

Insofar as college exists to educate, then, it’s failing. Writes Carey:

After decades of inaction, some recent efforts have been undertaken to collect that information: It now exists, but colleges and their powerful (and virtually unknown) lobbies will not permit the public to see it. As a result, colleges are far less focused on student learning than they should be, and consumers haven’t a clue what to do and have come to believe, mistakenly, that the most expensive colleges are also the best.

I’ve said many times that education is the most expensive thing that people regularly buy without asking whether they’re getting value for money — but the problem, as Carey pinpoints, is that colleges make it impossible for anybody to make that determination. Instead, they trade on their reputation, and that is not helpful:

The influence of reputation is exacerbated by the fact that most colleges are non-profit. For-profit institutions succeed by maximizing the difference between revenues and expenditures. While they have strong incentives to get more money, they also have strong incentives to spend less money, by operating in the most efficient manner possible. Non-profit colleges aren’t profit-maximizing; they are reputation-maximizing. And reputations are expensive to buy.

The economist Howard Bowen wrote the classic treatise on how reputation-seeking influences university behavior. He called it the “revenue-to-cost” phenomenon. Essentially, colleges don’t figure out how much money they need to spend and then go get it. Instead, they get as much money as they can and then spend it.

At the same time, colleges have lots of incentives to raise costs, and precious few to lower them:

The information deficit rewards and sustains these inclinations. In the absence of independent information about quality, consumers assume that price and quality are the same thing…

Colleges all want to become more important, and they all know how to get there–spend and charge more.

Indeed, they have little choice. Ten percent of the U.S. News rankings are based on spending per student, with additional points for high faculty salaries and other costly items. If an innovative college found a way to become more efficient and charge less while maintaining academic quality, its U.S. News ranking would actually go down.

All of this can be fixed — all that’s really needed is a bit of sunlight on data which is already being collected, but largely kept secret. The problem is a higher-education lobby which is secretive, powerful, and which won’t let change happen. Here’s just one example:

In 2006, Mark Schneider, the commissioner of the Department of Education’s National Center for Education Statistics, proposed adding some new questions to the annual survey all colleges are required to fill out in exchange for federal funds. Colleges would be asked if they participated in surveys and tests like NSSE and the CLA. If the college answered “yes,” and had already chosen to make the data public, it would be asked to provide a link to the appropriate Web address. It would not be required to participate in any test or survey not of its choosing, or disclose any new information. It would just have to tell people where to find the information it had already, voluntarily, disclosed. One Dupont Circle rose up in anger and the proposal was summarily squashed. For his temerity, Schneider was nearly fired.

Individuals can’t do any kind of cost-benefit analysis on college educations, which means that the government must: this country simply cannot afford a system where hundreds of billions of dollars are spent and wasted on subpar higher education every year. Education is a very good thing, but only if it works — and many graduates, along with most of those who fail to graduate, would have been better off both individually and societally had they never gone to college at all. That’s got to change, and if the colleges won’t move in the right direction, the government’s job is to step in and force the issue.

COMMENT

I am a recovering college professor. My last year teaching, my administration announced a 10 percent increase in tuition. The stated reason (have to applaud their honestly at least) was to give the college more cachet among applicants and parents because it cost more.

Posted by Curmudgeon | Report as abusive

How investment banking is like a video game

Felix Salmon
Dec 9, 2009 18:38 UTC

Paul Kedrosky is nominally talking about a Swedish poker player, but really he could be talking about any number of i-bankers, hedge-funders, and private-equity types:

Isildur1 isn’t playing to make enough money to retire. He’s playing a video game, and trying to run up the highest score. That the score is denominated in dollars is only of nominal importance.

The question is whether and how, in a world populated by such men (and they’re always men), one can alter compensation to prevent untoward risk-taking. Isildur1 poses no systemic risk; the same cannot be said of Jimmy Cayne or Dick Fuld, or even Jon Meriwether, circa 1998. If they take their compensation in stock, and that stock rises quickly, that only serves to accelerate the rate at which their high score is rising, and to encourage them to take ever-greater risks.

The real problem here, I think, is that these men became so rich so early on in their careers that they’ve long since left the normal world of needing to make money so that they can spend it. Tying up compensation in long-vesting stock doesn’t change that: only a drastic cut in total compensation will solve this particular problem. And that’s one thing which is certainly not going to happen.

COMMENT

I find investment banking to be more like playing Black Jack in a casino.

Posted by eddieblack | Report as abusive

What happened to the W Union Square?

Felix Salmon
Dec 9, 2009 16:04 UTC

There are two reasons why it’s hard to report clearly on things like the foreclosure auction of the W Union Square. The first is that there is a very complicated capital structure, which journalists have difficulty explaining. And the second is that it’s really hard to resist ledes like this, in the WSJ:

Dubai World’s private-equity arm ponied up about $282 million in 2006 for the trendy W Hotel Union Square in Manhattan. At a foreclosure auction Tuesday, the winning bid was $2 million.

This is the kind of thing which is literally true, but in all other senses false. Dubai World has not lost $280 million on the hotel, the hotel is not worth $2 million, and indeed the two numbers refer to entirely different things: the first is the total value at the top of the market for the mortgage, mezzanine debt, and equity combined; the second is the amount of mezzanine debt that an investor is swapping into a new equity tranche.

The Real Deal, has less color and much more detail — detail which is great for debt-market professionals, but which just gets confusing for the rest of us. Bloomberg, meanwhile, spends a lot of time talking about Dubai, which tends to obscure the details of what’s happening with the hotel. But if you put them all together, you can work it all out.

Basically, Dubai World (or its investment arm, Istithmar) paid $282 million in total for the hotel, and took out a $115 million mortgage. Istithmar put down $50 million of its own money, and borrowed the rest in what’s known as a “mezzanine” transaction: $117 million of high-yielding debt which isn’t secured against the property.

The mezzanine debt itself is broken into three tranches, which needn’t concern us right now. Suffice to say that what happened yesterday was a debt-for-equity swap. LEM had $20 million of mezzanine debt, and swapped $2 million of its that into 100% of the equity in the hotel, which was valued in the auction at $2 million. So Istithmar’s $50 million of equity has been wiped out, and LEM now owns the hotel, and is responsible for servicing the $115 million mortgage and also the $115 million $97 million of remaining mezzanine debt, $18 million of which it owns itself.

If you want to put a value on the hotel, it’s probably $115 million of mortgage plus $115 million $97 million of mezzanine debt plus $2 million of equity plus an unknown amount of past-due debt: call it somewhere in the $240 million $215 million range. That’s about a 15% 24% decline from the top of the market: a significant drop, but nothing particularly out of the ordinary. And most of the hotel’s lenders will be made whole, at least for the time being; the only exception is LEM, the new owner.

Lots of people are extremely worried about commercial real estate at the moment, saying that it’s the next shoe to drop. But a $240 million valuation still works out at almost $900,000 $800,000 per room, which is still a lot of money for a hotel which no one likes very much. The W Union Square is one of those creatures of the boom years: glossy and expensive, with no real soul. My guess is that its value has quite a bit further to fall yet.

Update: I’ve had second thoughts about how this deal works, and have updated the numbers accordingly. But the broad gist is unchanged.

COMMENT

I had to click through to find out, so I just note that LEM is a US-based PE firm.

Posted by raf_oh | Report as abusive

Information consumption charts of the day

Felix Salmon
Dec 9, 2009 14:50 UTC

I love these charts, from a new paper (37-page PDF here) on how much information Americans consume each day:

2.tiff 4.tiff 5.tiff

The last one is the most surprising to me — but it’s largely a function of the fact that a lot of technological prowess goes into compression and decompression of television signals, while that isn’t needed in computer games. As you can see from the hourly chart, we still spend more than five times as much time in front of the telly as we do gaming.

As someone who stares at a computer screen for most of the day, and doesn’t even have a television, I’m a bit surprised at the fact that people still seem to be spending far more time with the latter than with the former. Indeed, even radio still seems to outweigh computers in terms of total hours used — and over half of radio listening still takes place at home, as opposed to at work or in the car, according to the Arbitron data used for this report.

But look closely at the report, and things become blurrier. It’s not clear what they did with the radio figures, but it looks to me as though they included time spent in the car but excluded time spent at work. And the computer figures exclude time spent at work, although it’s unclear what they do with people who work from home.

In other words, this isn’t total information consumption: it’s just the information we consume at home and in our cars, rather than at work. Given the increasing erosion of the line between work and home, I do wonder why that decision was made. But in any case, even after excluding the workplace, Americans still consumed 3.6 zettabytes of information in 2008, and will surely consume more in 2009. And the information we get from computers (as opposed to computer games) is barely visible in that number.

(HT: Matlin)

COMMENT

If I listen to the radio while interneting, it that time counted double?

Posted by drewbie | Report as abusive

Well done, Darling

Felix Salmon
Dec 9, 2009 14:17 UTC

To nobody’s surprise, bankers are complaining about the UK’s 50% supertax on their bonuses this year:

The government hopes the move will encourage banks to use additional cash to shore up their capital bases, rather than pay high salaries. But banking groups have warned that penalizing high earners in the financial sector will lead to an exodus of talent overseas.

But of course this is the genius of a one-off, nationwide supertax: while any individual banker might be able to move overseas, they can’t all do that en masse. And in any case moving overseas doesn’t alter the tax status of this year’s bonus, while next year’s bonus will go back to normal taxation levels — most probably under a more plutocrat-friendly Conservative government, to boot.

So there won’t be any exodus here. And I’m surprised too at the relatively low level at which the supertax kicks in: £25,000, or about $40,000. Banks in general caused much of the UK’s extremely harsh recession — GDP is going to contract by 4.75% this year — and also are responsible for a large part of the country’s massive budget deficits. They should pay a more in taxes this year than might be indicated by their share of total income.

One-off windfall taxes and supertaxes are dangerous things to play with: you don’t want to make a habit of them. But we’re living in extraordinary times: this is exactly the year to implement them. Good for Alistair Darling.

Counterparties

Felix Salmon
Dec 9, 2009 04:32 UTC

Bike racks in loading/parking areas, &/or bike rooms, are a great alternative to freight elevators, which stop running at 6pm — NYT

Lady Gaga playing a Louise Bourgeois piano?! — Daily Mail

Simon Johnson slaps down Gerry Corrigan — Baseline Scenario

I don’t like this definition of TBTF, since it implies that failed WaMu was TBTF. But it’s a cute idea all the same — TNR

Would cutting interchange fees help create retail-sector jobs? — UCCF

“Bandwidth hogs” and unicorns are equally mythical — Ars, SA, Fiberevolution

Latest marketing gimmick: the “zero cost” ETF. Which still isn’t a very good deal (the fees rise, & it buys other ETFs) — ETFDB

Glenn Beck’s gold endorsement deal goes too far for Fox News — Daily Finance

More Americans Believe in Angels than Global Warming. And it ain’t even close — Outside the Beltway

Barack Obama for Treasury Secretary! (Cont) — DeLong

Value Line fires its legendary investment brain — Crain’s NY

“Now I demand to be called either ‘Monster’ or ‘Mr. Munch.’” — UPI

Why homes aren’t investments, cont.

Felix Salmon
Dec 9, 2009 04:25 UTC

Do you ever get the feeling that you must be right about something just on the strength of how ludicrous people sound when they argue against you? Take this, in defense of housing-as-an-investment:

Say you live in a neighborhood that you believe is going to clean up, crime will go down, housing stock will improve, and rent is going to go from $500 a month now to $1,000 in three years and then grow at 8% a year perpetually…

And say that you’re right, and say that no one else is as perspicacious as you are, which means that houses in that neighborhood are still cheap. Then yay, you’ve just found a gold mine!

Except, beware confirmation bias. “Housing markets are extremely local; block by block even. It’s much easier to spot a trend that others haven’t, and have local knowledge that others don’t, when the relevant market is your neighborhood,” continues Adam Ozimek.

I’ve got many friends who bought houses in London or NYC, saw both rents and property prices saw, and ended up making mark-to-market profits often exceeding their total lifetime earnings. That’s a good sign of a bubble, but at the time it seems like a sign of farsighted and insightful investment prowess. The point is that either property prices in general go up, or else they go down. Real estate is pretty much never a good investment in a down market, no matter how granular and detailed your local knowledge is. Meanwhile, in an up market, it doesn’t matter much either. Yes, that gentrifying neighborhood is going up in value. But so’s the old-money neighborhood a mile away, and so’s everything else in a 20-mile radius.

Remember that it’s sometimes not a good idea to buy a house even if your total monthly payments are lower than what you would be paying in rent on the same place. If prices fall, rents can fall too: just ask any landlord in New York City. And while the renters next door are happily renegotiating their lease so they pay $300 a month less than they were paying last year, you’re stuck with the same fixed mortgage for the next 30 years. If only you’d held off buying, your monthlies would be lower while renting, and you could buy now, if you were so inclined, at a lower price. Price the option: if you’re renting, you always have the option to buy. If you already own, you don’t.

Ozimek has other arguments, too, including the novel one that house investments are inherently leveraged while other investments aren’t. Well, yes, exactly. What that means is that a house can make you bankrupt in the way that other investments can’t: you can lose more money than you invested. And then there’s the bit about the “covariance with the rest of your portfolio”. OK, I’ll grant you that one: if the value of your home (not your downpayment) is somewhere in the region of 5% to 10% of your net worth, then congratulations, you’re very rich, and you can go ahead and buy what you like. For 99% of us, buying a home means putting our overall portfolio massively overweight real estate. And the only real way to justify that is precisely because a home is not an investment.

Ozimek finishes his argument with this rather bizarre rhetorical flourish:

A housing investment is more like buying a small business than it is like a security investment. In fact, it is buying a small business; the business is being your own landlord. Being a landlord is more likely to be a profitable venture if you have reliable renters who you can trust. As a landlord, you’re the best renter you could ever want, which makes being your own landlord less risky than being someone elses landlord. This is because being your own landlord solves the principal agent problem inherent in the rental relationship; the owner/renter interests are exactly aligned.

Huh? Living in your own home is like renting that home to yourself? Well, you are making rent-like payments to someone else — they’re called mortgage interest payments, and they’re going to the bank. Only in this case, if you find yourself in a situation where you can’t continue to make those payments, you can’t just move somewhere cheaper: instead you’re liable to end up losing all your money and your credit rating.

In any case, as a landlord, the best renter you could ever want is a renter who reliably pays more than your mortgage, and whose rent payments go up every year — maybe even by 8%! But there’s a problem here: even if the rental value of your property does go up a lot, you don’t reap the benefit of that unless and until you sell the house or move out and rent it to a second-best renter while looking for somewhere else to live yourself.

When unemployment is high, there’s a premium on mobility and the ability to go where the jobs are. Houses, by contrast, tend to tie people to one spot. And what happens if your neighborhood goes in the opposite direction to the one you’d hoped for, with crime increasing and all those overextended boutiques and coffee shops moving out? Try asking anybody who owns a home in Detroit whether houses are a good investment.

In my experience, most people who buy a home do so primarily for psychological reasons. They’re not bad reasons, necessarily, they just don’t make a lot of financial sense. People who insist that their home is an investment tend to be people who would have bought anyway, but who are just casting around for good-sounding reasons to justify their actions. They should just be happy that they have what they want.

Update: Ozimek replies.

COMMENT

Felix –

Homeownership is a terrific pseudoinvestment. The best pseudoinvestment most people will ever make. If done properly, it will chain people into a forced-savings regimen that will leave them much better off financially than they would otherwise be. It will also chain them into the kind of routine existence that is good for their financial health.

There is a reason homeownership is the foundation for much of the wealth in this country.

Posted by DanHess | Report as abusive

Did executive pay help cause the crisis?

Felix Salmon
Dec 8, 2009 23:59 UTC

Lucian Bebchuk, Alma Cohen, and Holger Spamann explain how executive pay at investment banks helped precipitate the crisis:

Our analysis undermines the claims that executives’ losses on shares during the collapses establish that they did not have incentives to take excessive risks. The fact that the executives did not sell all the shares they could prior to the meltdown does indicate that they did not anticipate collapse in the near future. But repeatedly cashing in large amounts of performance-based compensation based on short-term results did provide perverse incentives – incentives to improve short-term results even at the cost of an excessive rise in the risk of large losses at some (uncertain) point in the future.

Jeffrey Friedman, and those like Tyler Cowen who agree with him, are still welcome to believe that pay wasn’t a factor in the crisis. But I think they have to admit at this point that there is a coherent argument to push back against, rather than simply asserting, as Friedman does, that there’s no argument there at all. (Of course no one is saying that executive pay was the biggest factor. But I think there’s a colorable case that it played an important-if-not-decisive role.)

COMMENT

Uncle_Billy

” The vast majority of the population lives from month to month” because there is little concept of savings.

There is no concept of saying no to a $299/month car lease payment when a $3,000 used car (or bus) will do, and not everyone in the family need cell phones with a text/3G video data plan. Since when did $119/month cable TV become a must-have utility for 90% of households?

Everyone can save $500/month if they can say no to just these three things above. Instead, they’re contractually locked into two to three year commitments and complain they can’t save money.

Uncle_Billy – looks like you do live in a different world from some of us.

Posted by TElton | Report as abusive
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