Felix Salmon

Bikinis in Basel

Felix Salmon
Dec 29, 2009 15:35 UTC

Just how far is the WSJ moving towards UK-style journalism? Well, the editor of its European edition, Patience Wheatcroft, used to edit the Sunday Telegraph — a broadsheet gently ribbed in media circles for its ability to illustrate just about any story with a picture of a girl in a bikini.


Today, she gives us a case study in how that’s done, illustrating her column on the impossibly-dry subject of international capital adequacy regimes with the photo caption at left.

The quote is a great one — but the decision to illustrate it as literally as possible is pure Fleet Street. And of course if this bikini-photo is too small for those of us reading the column online, a bigger version is only a click away!

In any case, many thanks to the WSJ for using a Reuters picture. I think in this case a dot-portrait would have defeated the purpose somewhat.


There used to be a time when every single edition of the Hurleygraph was illustrated with the image of that delightful woman.

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Why credit-card interest rates won’t be capped

Felix Salmon
Dec 29, 2009 14:57 UTC

What happens if you cap credit-card interest rates at 16%? Yes, at the margin, the amount of credit extended on credit cards would fall. That’s a feature, not a bug. But would it fall dramatically? Pamela Yip quotes Odysseas Papadimitriou:

“If you cap the interest rate, it’s not like people are going to have lower interest rates than they do now,” said Odysseas Papadimitriou, chief executive and founder of Evolution Finance Inc., which operates CardHub.com. “Instead, everyone who has an interest rate below 16 percent will continue to have the same interest rate and everyone who has above 16 percent will not have access to credit any longer.”

Papadimitriou previously was senior marketing director at Capital One, so he has some insight into how card companies work.

This isn’t really true.

For one thing, credit-card companies make substantially all of their profits from people paying more than 16% interest on their cards. The rest of us generate a certain amount of cashflow in terms of interchange fees, but mainly we’re option value: so long as we have a credit card, there’s a chance that we’ll start running up large balances on it, miss a payments by a couple of days, and suddenly we’re a high-value customer.

Capping interest rates at 16% would force credit-card companies to move away from the current soak-the-poor sweatbox approach, and move instead towards a much more equitable system without bizarre cross-subsidies from the poor to the rich. Chances are that annual fees would rise and loyalty rewards would shrink — and as a result the people who pay off their cards in full every month — the people who use credit cards mainly for payments convenience, rather than because there’s a credit line attached — would start using credit cards less and debit cards more. Again, feature, not bug.

What’s not true is that anybody currently paying a rate of interest above 16% would suddenly find themselves with no credit at all. Mike Konczal, back in May, showed this mathematically: high credit-card interest rates are all about maximizing profit for the card issuer, rather than being remotely related to increased credit risk. If you’re currently paying 29.99% on your credit card, that’s not because it’s the minimum level at which you’re profitable for the bank: rather, it’s because it’s the level at which you’re maximally profitable for the bank. Big difference. There’s a very good chance the bank would make money charging you 16%, too — just not as much money.

That said, Yip is right that the cap on interest rates ain’t gonna happen. The banking lobby is too strong, and we’re up against serious reform fatigue in Congress. Instead, we’ll continue to live in a world where banks deliberately make it as hard as possible to borrow money the old-fashioned way, by taking out a loan, just because they make so much more money by offering you a credit card instead. And that’s depressing.


There is a flawed premise on credit card profitability baked into this thinking. It is not true that non-interest paying card holders are not profitable. For Visa and MasterCard low credit risk card holders with reasonable transaction volumes (i.e. over about $7500 per year) can be suitable profitable- with a pretax ROA of about 2% at that spending level. Folks like this who use cards for transactional purposes and those that use cards for credit use purposes are nearly 100% unrelated to each other (absent occasional transitions from one category to another) and there is no cross-subsidy (other than maybe some leveraging of fixed cost computer platform type functions). Depending on how the consumer uses the card, credit cards should be thought of as two different products when analyzing concepts like those in this post. The subsidy that IS happening is that consumers who do not use a reward-based card product for as many purchases as possible are subsidizing those that do through generally higher merchant transactional costs (which, as a ‘cost of goods sold’ ultimately is an expense input that is passed back to all consumers in more or less efficiently priced product categories). All credit card issuers are happy to have high volume low risk consumers (Amex in particular, with its higher interchange rates); the repricing that is going on is merely (i) a predictable reaction to the CARD Act and (ii) a too late recognition by the issuers that they had underpricing unsecured credit for a decade or more- despite what individual card holders feel about their own credit worthiness.

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Felix Salmon
Dec 29, 2009 05:17 UTC

Is there a simple physical limit to how many wireless broadband customers you can have in a small area? — Phorgy

Chinese Harmony train sets speed record — FT

Altucher on why you should rent rather than buy — NYPost

How Goldman Sachs is the guy who can make the Jack of Spades jump out of the deck and squirt cider in your ear — Kid Dynamite

“One of the oddest things to happen in the past year has been the fight between John Taylor and his Taylor Rule” — DeLong

Fox vs Time Warner Cable: Yet another reason to move to a-la-carte pricing — NYT

Should America be manufacturing its own luggage? — Economist

AT&T Resumes Online iPhone Sales — WSJ

“We’re on a sugar high,’’ El-Erian says. “It feels good for a while but is unsustainable.” — Globe

A very clear and useful primer on why the expanding monetary base isn’t intrinsically inflationary — Mankiw

The map of remoteness — New Scientist

Car routes in Boston — Cartogrammar

Depressing: No cap-and-trade attempt in 2010? — Politico

“Congress is effectively making private insurers unnecessary, yet continuing to insist that we can’t do without them” — New Yorker

TMZ’s 2009 ad revenue is $15M vs. $28M in 2008. (Blame the economy and AOL’s ad sales division woes.) — NYT

Spurious academic study of the day, Tiger Woods edition

Felix Salmon
Dec 28, 2009 20:42 UTC

You knew it had to happen at some point: a couple of economics professors at UC Davis have done an “event study” of the Tiger Woods news cycle, and concluded that

In the days beginning with Tiger Woods’ recent car accident and ending with his announced “indefinite leave” from golf, shareholders of companies that Mr. Woods endorses lost $5-14 billion in wealth.

This is silly stuff, of course: not only are the error bars larger than the estimated losses, but a huge proportion of those multi-billions comes from the decline of the share price of enormous companies like P&G, which had just one exposure to Tiger Woods through its Gillette subsidiary. Drawing a causal relationship between the Tiger Woods scandal and fluctuations in P&G’s share price is simply impossible.

What’s more interesting to me is that the numbers got weirdly changed when the UC Davis PR department got its hands on them and led not with the $5 billion to $14 billion range, nor with the $14 billion maximum figure, but rather with this:

Tiger Woods Scandal Cost Shareholders up to $12 Billion

I have no idea where the $12 billion number came from, as distinct from the $14 billion number in the study. But that’s the number that the WSJ’s Stephen Grocer decided to go with as well.

And how do the authors explain away the inconvenient fact that Tiger’s highest-profile sponsor, Accenture, saw no losses at all? You’re going to love this one:

Economic theory predicts that Mr. Woods should be able to capture nearly all of the excess profit generated by his endorsement of a firm like Accenture. For Tiger Woods, having Accenture as a sponsor probably does not increase the overall value of ‘the Tiger brand’ all that much. Mr. Woods should therefore have a lot of bargaining power when negotiating that deal, and may be able to extract a payment very close to Accenture’s incremental profit from the relationship. And if Accenture is paying Mr. Woods something very close to its extra profit from his endorsement, it is not much worse off without him than with him. Indeed, our estimates show no ill effect at all for Accenture after the accident.

This is completely bonkers. For one thing, the authors — Christopher Knittel and Victor Stango — have already pegged the value of the Accenture contract at $20 million a year — the same amount as the Gatorade contract, and less than the Nike contract. They then go on to say that the harm to Accenture of losing Tiger is unlikely to be much more than the $20 million that Accenture was paying him. Which might make some sense, if it wasn’t for the fact that they’re pegging the harm to everybody else of losing Tiger at $12 billion. (Or $5 billion, or $14 billion, or, well, just pull a number out of thin air, really.)

Accenture is clearly the biggest loser from the whole Tiger affair: it has to scrap its entire global marketing strategy and start from scratch. What’s more, Accenture’s total Tiger-related marketing spend is vastly greater than the $20 million a year it’s paying Tiger personally. The company has run into a large unexpected tail event, in a way that Nike and Gatorade haven’t. Those companies sponsor lots of athletes: one more or less has an affect at the margin, but that’s about it. If the Tiger scandal had no visible effect on the Accenture share price, you can be sure it had no effect elsewhere.

Update: Mike Konczal finds the real reason why P&G stock fell after Tiger Woods scandal erupted. Nothing to do with Tiger, and everything to do with revised earnings estimates.


Your blog makes exellent points, missed by so many media outlets who ran the release virtually word for word. My marketing students have learned much from the Tiger Woods case study in PR mgt., and the lessons will continue next semester with the UC Davis release and your blog (with the word use error corrected of course).

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There’s no tradeoff between dynamism and safety

Felix Salmon
Dec 28, 2009 18:09 UTC

Raghuram Rajan tells the WSJ’s Mark Whitehouse that when it comes to capitalism, there’s a natural tradeoff between security, on the one hand, and dynamism, on the other. Justin Fox adds some necessary skepticism:

The greatest run of economic growth this nation has ever experienced took place from the 1940s through the 1960s, a period during which the welfare state grew and grew. And the financial innovation and dynamism of the past few decades has brought only modest rewards for most American families (measured by median household incomes).

I’m not saying there’s no tradeoff at all. Just that it’s complicated, and that there are probably some methods of providing economic security (a well-run universal health care or pension system, say) that could lead to increased economic dynamism because they encourage people to make riskier job choices.

I’d actually go further than that, and say that the dynamism of capitalism is largely a function of safety nets, dispersed risk, and limited downside. The limited-liability joint-stock company run by professional managers is a both a driver of dynamism and an exercise in maximizing the safety of as many principals as possible.

What’s more, a large reason for the excesses of the financial-services industry over the past decade is the insane level of bankers’ pay — the men in charge were so rich that they ran no real quality-of-life risk when taking enormous gambles with other people’s money. Even the biggest losers — the likes of Dick Fuld and Jimmy Cayne — are extremely wealthy men to this day.

If we want to increase the dynamism of the real economy — technology, manufacturing, services, all that kind of non-FIRE stuff — then making the finance industry smaller and less volatile is quite likely to help. After all, making it larger and more volatile did no visible good at all.


“And the financial innovation and dynamism of the past few decades has brought only modest rewards for most American families (measured by median household incomes).”

One major problem – median household income DOES NOT MEASURE the rewards for most American families. It is a point statistic that is a characteristic of a distribution, and does not describe actual economic reality for any person or group.

Would anyone willingly teleport back to 1999? 1989? 1979? We are fantastically better off than we were at each of those times, and it is entirely because of economic dynamism and not at all due to your silly “safety nets”.

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Where does John Mackey get his power?

Felix Salmon
Dec 28, 2009 15:15 UTC

Nick Paumgarten’s 9,000-word profile of John Mackey, the CEO of Whole Foods, obviously went to press too late to incorporate the news that he’s finally stepping down as chairman of the company.

The move comes a good two-and-a-half years after the sockpuppet scandal which should have cost Mackey both of his jobs but which instead ended in nothing but a narrow and pathetic amendment to the company code of conduct.

Mackey has built Whole Foods up largely by acquisition, which means that his personal stake in the company is tiny — less than 1%, and less than the average daily volume in the stock. All the same, Paumgarten describes Mackey as “not always an accidental accumulator or practitioner of power”, and it’s pretty clear that if there’s any threat to his complete control over the company, it’s going to come from his newest investors, rather than from any other executive. When Mackey buys a rival grocer, its executives often take on a senior role in Whole Foods — but after that, they rarely last long.

Still, Mackey stands out among founders of multi-billion-dollar companies for the relative modesty of his wealth and income. His 1.1 million shares are worth $31 million today, and have provided him with zero dividend income since August 2008. And yet he’s much more powerful, charismatic, and important than most other corporate founders and leaders — and has survived multiple episodes which would have cost virtually any other CEO their job. Could it be that somehow Mackey has swapped money for power, and that better-paid CEOs get held to a higher standard?


“The move comes a good two-and-a-half years after the sockpuppet scandal which should have cost Mackey both of his jobs but which instead ended in nothing but a narrow and pathetic amendment to the company code of conduct.”

Wow, you’re a bitter, defeated partisan, aren’t you? The guy is obviously a good operator and obviously has good ideas about how to bring down the cost of health care. I wish Mackey would have kept talking. You can’t treat your customers like they are all stupid, just because some are.

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Felix Salmon
Dec 28, 2009 06:41 UTC

AT&T stops selling iPhones in NYC because their network here is so craptastic — Consumerist, AllThingsD

“March 2009 is a reductio ad absurdum of the notion that CAPM alpha can be used as a metric of investment performance” — Dsquared

The inverse relationship between CEO pay and shareholder returns — WSJ

Real earnings of the S&P 500 ended the decade 80% lower than they began — Econbrowser

The WSJ’s Tastings column, RIP. Its common-sense attitude to wine will be sorely missed — WSJ

Bloomberg Quietly Scraps General News Department — Gawker

NominaStultorum explains why “New York, concrete jungle where dreams are made of” is grammatical — Awl

It’s impossible to price a CDO

Felix Salmon
Dec 28, 2009 06:37 UTC

The discussion about Goldman’s synthetic CDOs just happens to coincide with a separate thread about a working paper by four researchers at Princeton, who seem to have a solid mathematical demonstration that CDOs simply can’t be priced: the amount of computing power necessary to do so just doesn’t exist.

Robert Oak has a good English-language explanation of the implications of the article: it boils down to the idea that if Goldman was loading up its synthetic CDOs with nuclear waste, there’s a good chance that its clients couldn’t have worked that out. Not because they were insufficiently sophisticated, but just because there aren’t enough computers in the world to do so.

It’s possible to overstate the connection between the paper and the events that happened at the height of the credit bubble. There’s a hidden implication in the paper that maybe with better models or faster computers we might have avoided some of this mess — but the solution to model risk isn’t more complex models, its less reliance on models altogether. And anybody who applied a simple smell test to the mortgages underlying the CDOs in question — rather than deciding instead to trust various quants both in-house and at the ratings agencies — would have come to the right conclusion without any computing power at all.

That said, there’s a case to be made that Goldman — along with much of the rest of Wall Street — was indeed arbitraging the models that investors and ratings agencies were using to price CDOs in general and synthetic CDOs in particular. The latter were particularly toxic, because synthetic CDOs are zero-sum, meaning that Goldman stood to gain in precise proportion to the degree to which the buyers of the paper were underestimating the risk involved.

The result was that Goldman had every incentive to structure CDOs which would blow up spectacularly, leaving investors with massive losses and Goldman with equal and opposite gains. The investors, meanwhile, might not have trusted Goldman (after all, they understood the zero-sum nature of these instruments), but did trust — far too much — mathematical models which turned out to be deeply flawed. And which, now, seem to be far too complex to get a grip on in any case, given the limitations of today’s computers.

In the final analysis, much of the problem here was a function of banks waving the magic letters “AAA” in front of the eyes of lazy institutional investors who thought they were getting free money by buying risk-free debt at hefty spreads over Treasuries. Some banks, like Merrill Lynch, did that and still contrived to lose billions; Goldman, by contrast, did that and managed to make a profit on the deals.

The whole sorry episode I think was fairly summed up by Goldman CEO Lloyd Blankfein when he said that “we participated in things that were clearly wrong and have reason to regret”. At the same time, however, Goldman wasn’t particularly evil or cunning here. It was simply acting like everybody else in the finance world, trying to take as much advantage of the credit boom as it possibly could. The main difference was that it had a bit more control over its own balance sheet than most of its rivals.


Felix, perhaps what you should say is that CDOs can’t be priced accurately. But what asset can be priced accurately? We don’t know the future. All CDOs got priced in an environment where people would make offers given the deal and pricing terms. Many offered to buy too much and lost. Systemic errors do happen. MOre people are buying aggressively at the peak of the market than the valley.

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The return of GDP bonds

Felix Salmon
Dec 28, 2009 03:29 UTC

GDP bonds are the instrument that refuses to die: Robert Shiller has resuscitated them in the NYT this weekend, this time with equity-like characteristics.

Each trill would represent one-trillionth of the country’s G.D.P. And each would pay in perpetuity, and in domestic currency, a quarterly dividend equal to a trillionth of the nation’s quarterly nominal G.D.P.

There are lots and lots of reasons why this is a bad idea, not least the fact that measuring the rate of increase of GDP is vastly easier than measuring GDP itself. Bonds like the ones pushed by Jonathan Ford are at least linked to the GDP growth rate; Shiller’s bonds, by contrast, are linked to actual nominal GDP, and that’s a much harder number to pin down.

But much more seriously, Shiller’s “trills” would be incredibly — and unhelpfully — volatile, as David Merkel explains. That fact becomes immediately obvious the minute you realize that if expected long-term nominal GDP growth ever rose above the yield on a sovereign perpetual bond, the value of a “trill” would be infinite.

Right now, the spread between the two numbers is relatively small, at 100bp. (Shiller seems to be using an expectation for long-term GDP growth of 3.4%; Merkel puts the yield on a hypothetical US perpetual bond at 4.4%.) If that spread fell further, the price of a trill would start rising exponentially. Similarly, if that spread were to widen much, the value of a trill would plunge. As a result, there would be a huge amount of market risk involved in buying trills: you could easily lose half or more of your investment if real long-term rates started to rise a lot.

And if trills are bad for the buyers, they’re equally bad for the seller. The whole concept of debt finance is predicated on the idea of investing in future growth: the country borrows money from investors for the present and future benefit of the nation as a whole. Shiller’s trills turn that concept on its head: the more successful the country becomes, the more it owes its creditors.

The underlying problem here is that sovereigns and individuals can’t sell equity in themselves. (That’s the main reason why the jock exchange never took off.) The S&P 500 might not be a perfect proxy for investing in the US as a whole, but it’s not a bad one either. If people want to buy a volatile investment which goes up, over the long term, in line with national GDP, the stock market is still the best place to look.


“the more successful the country becomes, the more it owes its creditors”

This is, of course, more or less the point; conversely, the less successful the country, the less it owes its creditors.

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