Felix Salmon

Be careful what you wish for, Vikram

Felix Salmon
Dec 18, 2009 15:22 UTC

The WSJ adds color to the story of Citigroup’s flop of a stock offering on Wednesday. Citi, it seems, is deciding to blame the government, which allowed Wells Fargo to do its own TARP-exit stock offering at the same time. Treasury, of course, is having none of it:

Treasury officials said Thursday that… it was Citigroup’s idea to stage the ambitious stock offering, despite the government’s misgivings…

Earlier this fall, at the urging of the Treasury, the Fed and FDIC laid out the terms for Citigroup to leave TARP: It would need to raise roughly $20 billion in new capital.

Citigroup executives said that was an unnecessarily large amount, because the bank already had ample capital. They also warned federal officials last week that such an ambitious offering could fall flat, embarrassing Citigroup and the government, according to people familiar with the matter.

Despite such worries, Citigroup executives pushed ahead, fearful of becoming the last major bank still under TARP.

It seems here that Citi, at its highest levels, was pushing Treasury hard to allow it to exit TARP. Eventually, Treasury agreed, and Citi then pushed its equity capital markets team to get a monster stock issue out the door no matter what. The predictable result was that both Treasury and the equity capital markets team ended up wondering if everybody wouldn’t have been better off had nothing happened at all. But Citi’s leadership — and I’m looking straight at Vikram Pandit here — knew what it wanted: an exit from TARP, no matter what the cost. And that’s what it got.


That anyone bought that garbage stock “C” at this juncture is amazing. Considering the losses suffered after previous stock offerings, I am surprised anyone bothered. They are either hoping for a monster rebound, or have too much money to play with.

Its interesting to note that Citi is basically the only bank whose stock has failed to recover as admirably as its competitors.Its also basically the only bank that still has significant writedowns in the pipeline, (BoA probably does too, but they appear to have the ability and resources to weather them.)

Instead of propping Citi up, Treasury should have forced them to divest their operations into independent units. They are a perfect example of a company that should be broken up. Otherwise, the sore will continue to fester, dragging down the sector and economy.

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Weakening derivatives’ super-priority

Felix Salmon
Dec 18, 2009 14:34 UTC

Thanks to Brad Miller for pointing me to Mark Roe’s excellent column on super-priority for derivatives in bankruptcy:

True, somebody has to win and somebody has to lose when there is not enough money to go around. But these super-priorities warp the financial industry’s incentives to avoid problems… If financial players set their deals up perspicaciously with enough collateral, they need not worry if a counterparty such as AIG or Lehman collapses, as they will be paid before regular creditors. Some players – Goldman Sachs and JPMorgan are those talked about – set up parts of their AIG and Lehman deals to take advantage of these super-priority provisions. Knowing now what can happen in a financial meltdown, other financial players will do the same in the future, making the financial system more fragile…

If the derivatives and repo transactions were not so favourably treated in bankruptcy, financial players would seek other ways to protect themselves. That effort would channel them into stabilising the financial system or at least into making sure they were dealing with stable counterparties…

Priority facilitates liquidity and risk-spreading, but others pay for part of those benefits because they lose in bankruptcy and the financial system is potentially rendered less stable…

Priority proponents say we should fear financial contagion: one institution defaults and then its counterparty cannot meet its own obligations. Priority, they say, helps to contain the contagion. This could be so, but the opposite can also be true. We saw last year that priority also spreads contagion: as AIG and Lehman weakened, financial counterparties made legitimate collateral calls that, without their super-priority, would not stick in bankruptcy. This meant more of the weakened institutions’ counterparties knew that they would have to make similar collateral calls to stay even. This run-like process further weakened AIG and Lehman, and their weaknesses spread outward.

I’m particularly impressed by the way in which Roe makes a clear distinction between liquidity and stability — two things which are too often conflated. Indeed, in extremis, liquidity can sometimes be a bad thing, insofar as excess liquidity in one area of the markets (most likely Treasuries) can act as a super-magnet, unhelpfully pulling risk capital from everywhere else.

And there’s another problem with derivatives super-priority, which Roe doesn’t delve into: it encourages financial institutions to recast ordinary trades as derivatives contracts, in a multi-trillion-dollar game of beggar-my-neighbor where everybody needs super-priority because everybody else has it. The losers, of course, are less sophisticated investors who are naive enough to play in cash markets and buy real securities.

Goldman Sachs has sworn up and down that it was always fully hedged in its dealings with AIG. But it can only credibly say that because of super-priority provisions. Without super-priority, Goldman would never have allowed itself to amass such an enormous exposure to AIG, and AIG as a result would have been less vulnerable to a run from derivatives counterparties with collateral demands.

So let’s hope that derivatives super-priority is ended as part of an eventual financial-reform bill. Along with giving regulators the ability to treat late collateral grabs as a voidable preference in bankruptcy.


In a forthcoming article in the Harvard Law Review, I like Roe argue that the bankruptcy priority for derivatives discourages monitoring and thus probably contributed to the 2008 financial crisis. I also show how these exemptions encouraged AIG to take on correlated risks, selling guarantees on mortgage-backed securities while at the same time buying up subprime MBS for its own investment portfolio. Contrary to standard accounts, this conduct probably was rational from the perspective of AIG’s shareholders. Here’s a link:

http://papers.ssrn.com/sol3/papers.cfm?a bstract_id=1394995

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The Fiscal Times

Felix Salmon
Dec 18, 2009 13:56 UTC

There’s the serious, and then there’s the frivolous. The epitome of serious grappling with complex issues is Pete Peterson, and his crusade against fiscal excess. Frivolous, meanwhile, would be someone like Jackie Leo, who made a career of simplification as editor-in-chief of Reader’s Digest, and whose new book is characterized by Amazon thusly:

Amazon.com Sales Rank: #14,221 in Books

#3 in Books > Religion & Spirituality > New Age > Divination > Numerology

So it’s a little bit of a surprise to see that Peterson has hired Leo to be the editor-in-chief of his ambitious new publication, The Fiscal Times. Still, the idea is a good one:

The news operation will begin publishing with a roster of experienced journalists and leading opinion contributors, whose reporting and insights will aim to drive the conversation surrounding our nation’s most pressing economic issues…

The Fiscal Times and the Washington Post have agreed to jointly produce content focusing on budget and fiscal issues that will be available to both publications. The content will complement the Post’s budget and finance coverage, and will include profiles of key government officials, explanations of important budget trends or proposals and investigative analysis of government spending programs.

With any luck, this will help move the press in general, and WaPo in particular, away from the normal emphasis on who’s winning the political game on Capitol Hill, and towards more substantive analysis of policy issues. And in principle I like the idea of hiring a populizer as editor-in-chief, to help move the debate outside the beltway. Still, I doubt that fiscal policy is ever going to really grab the public imagination. Not unless and until it’s too late, anyway.

(HT: Tim Coldwell)

Update: Alex Leo, Jackie’s daughter, writes in:

She was the editor of chief of Consumer Reports, the EIC of Reader’s Digest (which is no longer the condensed rag it used to be), and the president of ASME. She is a serious lady and I think it’s unfair to categorize her flippantly. Her book is not numerology, it’s really about the famous essay “The Magical Number 7 Plus or Minus 2″. Just because Amazon thinks it is doesn’t make it so!


This post is ironic, right Felix? That mission statement is ridiculously disingenuous. How many “investigative analyses of government spending programs” do you think will point to successful social welfare policies and promote their expansion? Zippo. It won’t be because those programs don’t exist. It will be because Hiatt and Peterson are ideological deficit scolds in the new Republican mold (i.e., yell and scream about the deficit unless it involves supporting Democrats who advocate a healthy mix of tax increases and spending restraint). Wake up please. Everybody.

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Felix Salmon
Dec 18, 2009 06:18 UTC

Hermitage’s short documentary video on the Magnitsky case — YouTube

The latest investor letter from Howard Marks — Oaktree (PDF)

What do the Copenhagen protestors want? And just how counterproductive are they being? — Foreign Policy, FT

NJ editor blames pedestrian-safety enforcement for increased pedestrian deaths — Press of AC

Waldman slaps down McArdle on walking away — Interfluidity


Re: the NJ highway mortality rates, it’s probably migrant workers and other illegals. They don’t have cars and walk along the sides of highways at night. The poor bastards get nailed all the time.

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California issuing

Felix Salmon
Dec 18, 2009 06:12 UTC

Who does Bloomberg think has the appetite to wade through 4,000 words on a single Californian bond deal in October? The answer is “probably no one” which means that most of the people reading Michael Marois’s article will read the first five paragraphs, conclude that California got royally ripped off by the troika of JP Morgan, Citigroup, and Goldman Sachs, and move on.

If you read the whole thing, however, it’s not nearly as simple as that: the bond deal in question was in many ways perfectly timed, from the point of view of a major issuer, coming right when interest rates were at their low point. And it was huge — $4.14 billion — which is far too big to do an auction deal where the issuer sells to the banks directly, rather than using them to underwrite an issue aimed at real-money investors. What’s more, California sold the vast majority of the bonds it wanted to sell, while other states, like Maryland and Minnesota, sold as little as 25% of their intended issuance.

Through the course of the article, I kept waiting for the other shoe to drop — to read some piece of information which indicated that California could have done better than it did. But it never quite got there. It’s undeniable that the banks made fat fees on the deal: the three banks between them made $12.4 million, and total fees amounted to $25.8 million, or 62.3bp. That seems expensive to me for no more than a couple of weeks’ work and no real risk. But here’s the bottom line: California got 30-year bonds away at 7.23%, even after paying a steep 325bp spread over Treasuries. When the state came back to the market in November, the spread had come down to 300bp, but the yield was still slightly higher.

Clearly this deal isn’t going to win any awards — it had to be shrunk from $4.5 billion to $4.14 billion; it priced significantly higher than the banks had led California to expect; and it soured the entire national market for municipal bonds. You can see how bond investors are unhappy with it. And you can also see how an open auction of $4.5 billion in bonds would have been an utter disaster, since there simply wasn’t that kind of demand in the market.

The article jumps around a lot, and it’s hard to follow the various threads, but I get the impression that the main criticism of the deal is that the banks persuaded California treasurer Bill Lockyer to sign on to a monster bond issue on the grounds that they could build a lot of buzz around a super-jumbo deal and that it would be a blowout success. The implication is that Lockyer — and the muni market as a whole — would have been much better off just saying no.

There might be something to that — but at the same time the bond market had to turn at some point: interest rates never fall forever. And the less that California issued at those low rates, the more of a backlog it would have, and the more it would end up having to issue at higher rates.

I do wonder, though, whether the tremors from this inelegant deal foreshadowed the minor panic that surrounded the Dubai default the following month. California is too big to fail, and there’s an easy carry-trade/moral-hazard play there for anybody who wants it: buy California munis at 325bp over Treasuries, safe in the knowledge that if push comes to shove the federal government will ultimately bail the state, and its bondholders, out. Except the market obviously doesn’t put that much stock in the moral-hazard play, since 325bp is an impossibly wide spread for an entity with a de facto sovereign guarantee. So when Dubai’s sub-sovereign issuers started defaulting, you can see how various pent-up fears might have been let loose.

And therein the biggest lesson of the California deal, I think — one which Marois doesn’t explore at all. What’s California’s credit really like? What are the chances that it will get bailed out by the federal government? And what does that mean for sub-sovereign issuers across the nation and the world? Maybe we’re beginning to see some real differentiation between different levels of credit, depending on whether the issuers are sovereign nations, or states, or state-owned companies, or para-statal organizations, or whatever. And maybe that, in turn, is happening because the sovereigns themselves are running out of money to bail out their subsidiaries.


Perhaps CA’s huge spread reflects the market’s assessment of its sovereign guarantor.

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Media relations emails of the day, Interoil edition

Felix Salmon
Dec 17, 2009 19:12 UTC

On Monday, Barry Minkow put out a press release accusing a NYSE-listed company, InterOil, of being “nothing more than hype”. InterOil has had a large short interest for some time, and it seems that Minkow touched a nerve, because InterOil’s senior manager for media relations, Susuve Laumaea, went borderline insane via email in response:

you are a gutless coward of the highest order, a jealous and envious SOB… You are a loser, a non-achiever and a sour-grape. Piss off you good for nothing… Do not be afraid on account of me being a descendant of cannibals … no, no, believe me, I will not cannibalise you or feed you to the swamp crocodiles…

you are known crook, conman, convicted felon, a psychopath and a pathological liar who is jealously envious… You have no sense of common decency. You are neither here nor there among the cream of decent God- fearing humanity. You are a scum of the earth, a creepy-crawlie who should have been locked away and the key thrown away too so that you rot away like the dung heap you are. You are a coward of the highest order… I can’t use you as crocodile feed because you are too poisonous … those alligators will die eating you, cooked or uncooked…

Who gave you the authority to investigate InterOil, you piece of shitty non-entity? You are nothing more than an internet pirate, a low-life manipulator who is out to profit by your dishonest, fraudulent, slanderous and cowardly methods. Up yours.

Well, the “convicted felon” bit is actually true, but in many ways that just makes Minkow more believable as an uncoverer of fraud. But somehow it’s not easy to trust a company which accuses its critics of being a “dung heap”, and tells them they are too poisonous to feed to crocodiles.


this is incredible. make me very suspicious of Interoil – without having done an ounce of work – what kind of real company responds like this? unreal

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Which blogs does Jim Bunning read?

Felix Salmon
Dec 17, 2009 18:02 UTC

The NYT quotes Jim Bunning quoting “a blogger”:

On Thursday, Mr. Bunning, who has one of the most conservative voting records in the Senate, remained a thorn in the chairman’s side. He quoted a blogger in delivering his criticism: If the Senate confirmed Mr. Bernanke, the senator said, it would be like rewarding the captain of the Titanic for piloting the ship into an iceberg, not for getting everyone off safely.

As Jessica Pressler says, why no name for this blogger? My feeling is that it’s Kid Dynamite, although he didn’t say exactly what the NYT said that Bunning said that he said (yes, I know, this is getting confusing):

Bernanke cannot and should not be exalted for his response to the crisis which HE failed to prevent. The accolade from Foreign Policy is mind boggling to me. To bring back an old analogy: it’s like commending the captain of the Titanic for getting people out on lifeboats after he steered the ship into an iceberg.

Firstly, Kid Dynamite was talking about an award from Foreign Policy, not Senate confirmation; secondly, he said that lauding Bernanke would be akin to giving the captain a gong for getting people onto lifeboats, not that it wouldn’t be.

But maybe I’ve got the reference wrong? Did some other blogger say something closer to what Bunning said?


He definitely reads at least one financial blog, take a look at this post:

http://cunningrealist.blogspot.com/2009/ 12/bernanke-responds.html

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Flyglobespan, holdbacks, and E-Clear

Felix Salmon
Dec 17, 2009 15:45 UTC

What was the proximate cause for the overnight failure of Flyglobespan airlines, which has stranded thousands of passengers far from home as Christmas fast approaches? Douglas Fraser explains:

It was liquidity that did for Globespan – or to be precise, the cash that ought to flow from the company that carries out its credit card transactions with passengers.

This is a business that gets a lot of its payments up front, but these payments weren’t making their way into the Globespan coffers. Quite a lot of that money seems to have been withheld by a company called E-Clear, which specialises in credit card transactions for the low cost airline business.

What we’re talking about here is something called credit-card holdbacks, which brought down Frontier Airlines last year. It’s all quite legal, as I explained then: all airlines deal with something called an “acquiring bank”, which passes on their credit-card income while holding back a certain percentage so that they can refund travelers their money should the airline fail.

In Europe, E-Clear seems to have carved out a niche in the high-risk business of processing airline credit card transactions. As Flyglobespan teetered on the brink of insolvency, E-Clear had two choices: either buy the airline itself, or let it fail. It chose the latter.

So I’m not persuaded by the dark mutterings from Flyglobespan’s administrators:

Administrators said they planned to investigate why a “significant” amount of cash from credit card bookings did not reach Flyglobespan.

Bruce Cartwright, of PWC, said this was not to do with the credit card companies, but the way money reached the airline when online transactions were processed by a company called E-Clear.

He said: “That money goes into a booking site and is then passed to the airline.

“There does in this case seem to have been a significant build-up of cash that has not reached the company.”

I’m not sure what he’s talking about when he refers to “a booking site”, but my guess is that E-Clear is going to end up losing money on this whole deal, thanks to the number of people who booked travel on their credit cards and are now due a refund. Yes, E-Clear will have held back a large amount of Flyglobespan’s money, for precisely that eventuality. But I’m sure it had the contractual right to do so.

The only twist in this case, as opposed to the Frontier Airlines case, is that in Europe low-cost airlines force passengers to pay extra when buying tickets on their credit cards, precisely because that credit-card income gets held back. (If you buy a ticket on your debit card, that’s cheaper, but don’t expect your money back if the airline fails and your flight never takes off.) It seems that the canny Scots knew that buying on their credit cards was a good idea regardless — after all, Flyglobespan’s credit-card income seems to have made all the difference between flying and failing.

So if you do find yourself flying in Europe and wondering whether it’s worth paying extra to charge your credit card, remember the insurance which comes with it. It’s not always particularly valuable: if you buy a low-cost ticket you only get a refund back, which won’t cover the cost of a last-minute replacement flight should the airline fail. But it’s still better than nothing.

(Thanks to Joe Brancatelli for the heads-up)

Don’t invest in art funds

Felix Salmon
Dec 17, 2009 15:15 UTC

File this one under “you could see that one coming a mile off. The Art Trading Fund, which was doomed before it launched, doomed at launch, and even more doomed a year later, has finally failed: its liquidators are holding a creditors’ meeting in January.  

Art is simply not an asset class which lends itself to hedge-fund strategies. If you’re ever approached by a former financial-markets professional who has bright plans for some kind of an art fund, run, don’t walk, in the opposite direction. The art market will happily take full advantage of cocky newcomers like that: it chews such people up and spits them out for breakfast.

All the same, it’s really quite impressive that this fund managed to go from launch to liquidation in less than 18 months two and a half years. Even I didn’t think they were that incompetent.

(Thanks to Teri Buhl for the heads-up.)


bingo. yet ANOTHER sign of the massive bubble we were in…

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