Felix Salmon

The limits of microfinance

Felix Salmon
Jan 15, 2010 20:21 UTC

Richard Rosenberg has a good new paper — short, clear, summarized here — saying that the jury is very much still out on whether or not microfinance helps improve the incomes of the poor. But even if it doesn’t help the poor out of poverty, it still does a great deal of good in terms of giving them tools to deal with poverty.

Although Rosenberg makes a strong case that this is a very valuable service, it does seem to me that it’s a service which both can and should be provided and funded locally, by the likes of Grameen. Right now there’s an enormous amount of time, money, and skilled labor being put into microfinance across a large number of non-profit and for-profit philanthropies in the developed world, and I’m not at all convinced that all those resources couldn’t be put to better use elsewhere.

Microfinance appeals to the kind of rich westerners who used to believe in the power of financial innovation to make the world a better place. Now that we’ve learned that financial innovation is prone to backfiring dramatically, I think it makes sense to approach microfinance more cautiously. Microfinance institutions tend to lend out money at very high interest rates, and it’s easy to show lots of success with that kind of business model when you’re growing fast and making it very easy for your clients to refinance.

Eventually, however, the growth in microfinance is going to slow, and the borrowers are going to find themselves saddled with large debts. If, as Rosenberg says, there’s a good chance that those borrowers will still be in poverty at the time, the consequences might be pretty messy.

Do financial journalists routinely break the law?

Felix Salmon
Jan 15, 2010 18:21 UTC

Ben Sheffner makes the case today that it’s illegal for journalists to convince or induce sources to leak information, if those sources are obliged not to do so. He pegs his article off the Gawker case, but notes that the WSJ, too, might be guilty of the same tort. He concludes:

Mainstream journalists may not be comfortable putting it this way, but they routinely ask their sources to break the law or violate some legal duty by coughing up information some contract or statute obliges them to keep secret. Gawker calls it a “scavenger hunt”; others call it “reporting.” Perhaps what’s most surprising is that it doesn’t lead to more lawsuits.

Of course when Sheffner talks about “some contract or statute”, he’s referring to much more than just nondisclosure agreements. Specifically, whatever’s true of NDAs is also true of SEC regulations, like the “quiet period” surrounding earnings statements, securities issues, and the like. Nearly all financial journalists have run into people saying “I can’t talk about that, we’re in the quiet period” — and most of them will have continued to push their source for the information anyway, on an off-the-record basis. Often, they end up getting the information they want — but even if they don’t get it, simply asking their source to violate the SEC regulation is, if Sheffner is to be believed, an illegal act in and of itself.

Now it’s pretty hard to imagine who would ever sue a journalist for inducing such a statutory violation — so it’s hardly surprising that there isn’t a lot of jurisprudence surrounding the issue. But it’s still a little sobering to wonder whether virtually all journalists have broken the law at some point, just by asking a source for information.


Yeah, the lawyer’s letter is pretty clear that the cash reward part is what prompted action. Although it seems that the law doesn’t distinguish between monetary inducement and other kinds.

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Will Dodd kill the CFPA?

Felix Salmon
Jan 15, 2010 17:58 UTC

Bloomberg has confirmed the WSJ report that Chris Dodd is seriously considering dropping the Consumer Financial Protection Agency from the Senate’s financial-reform bill. This is hugely depressing news, since it’s predicated on a complete fallacy:

“The most effective solution to strengthen consumer protection is to keep the regulation of the bank and the products it sells within the same regulator,” said Scott Talbott, senior vice president of government affairs at the Financial Services Roundtable, a Washington-based industry trade group.

Er, no. As anybody with a bank account knows, there are many, many cases in which the interests of the bank and the interests of its customers are opposed to each other. A bank regulator exists to keep the banking industry safe and sound, and the more money a bank can squeeze out of your customers — to their personal detriment — the better the financial position of the bank in question.

What’s more, Dodd wants to reduce the powers of the Fed, not expand them. But if he demotes the consumer protection function to a division within the Fed, that will only serve to give the Fed even more in the way of disparate goals. And what existing agency but the Fed could really do this?

It’s hard not to be cynical here and see this as a ploy by Dodd to ensure a high-paying financial-sector sinecure upon his imminent retirement from the Senate. Certainly if Dodd does kill the CFPA, that will be worth many billions of dollars to America’s largest banks. I’m sure they’ll find some suitable way to reward him for his work.


Felix — Thank you for fighting this fight on behalf of working class Americans who are too busy to focus much time on financial details. Unfortunately financial complexity acts like a steeply regressive tax.

These same working class people are also to busy to speak out on an issue that will affect their lives tremendously. I guess I should be happy. As someone who is financially literate, my banking costs will continue to be subsidized by others less financially literate.

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The problem with banning floors on credit-card rates

Felix Salmon
Jan 15, 2010 16:37 UTC

On Tuesday, the Federal Reserve released its final rule governing credit card issuers. The whole thing can be downloaded here; it’s a mere 1,155 pages long. And credit card consultant Timothy Kolk has found something rather worrying buried within it.

Here’s the language from page 317:

Consumer groups and a member of Congress raised concerns about two industry practices that, in their view, exercise control over the variable rate in a manner that is inconsistent with revised TILA Section 171(b)(2). First, they noted that many card issuers set minimum rates or “floors” below which a variable rate cannot fall even if a decrease would be consistent with a change in the applicable index. For example, assume that a card issuer offers a variable rate of 17%, which is calculated by adding a margin of 12 percentage points to an index with a current value of 5%. However, the terms of the account provide that the variable rate will not decrease below 17%. As a result, the variable rate can only increase, and the consumer will not benefit if the value of the index falls below 5%. The Board agrees that this practice is inconsistent with § 226.55(b)(2). Accordingly, the Board has revised comment 55(b)(2)-2 to clarify that a card issuer exercises control over the operation of the index if the variable rate based on that index is subject to a fixed minimum rate or similar requirement that does not permit the variable rate to decrease consistent with reductions in the index.

In English, what this says is that credit card companies can’t put a floor on their credit-card interest rates. If you’re paying 12 percentage points above Libor, you pay 12 percentage points above Libor, no matter how low Libor goes. On page 516, the Fed gives an example: even if the terms of a credit-card contract include a floor below which an interest rate cannot fall, that floor can no longer be enforced after February 22.

Sounds great, right? Surely if there’s no minimum interest rate, that’s got to be good for consumers? Actually, no: there’s a problem here, due to the fact that interest rates are very low right now.

Let’s say that I’m a customer-owned credit union, and I want to issue my customers a card carrying a low interest rate of 9.9%. I also want to protect myself in case rates rise a lot, so I put in language saying that the interest rate always has to be at least 3.9 percentage points over the Prime rate. Prime is currently just 3.25%, but if Ben Bernanke were to raise the Fed funds rate past 3%, then the rate on the credit card would begin to rise.

As of February 22, that kind of product will be illegal. The variable-interest bit (Prime + 3.9%) is fine. But if you have a variable-interest credit card, you can’t set a floor any more. Which means that since Prime is just 3.25% right now, the interest rate today would be set at an uneconomical 7.15%.

As a result, if I want to charge a 9.9% interest rate today, I need to peg the card’s interest rate at Prime + 6.65%, and the rate on the card will start rising as soon as Bernanke raises rates by so much as a quarter-point.

Clearly a Prime + 3.9% card with a floor of 9.9% is a better deal for consumers than a Prime + 6.65% card. But the Fed is banning the former product, and forcing issuers into the latter.

The point here is that banks need to charge at least 10% or so on their credit cards, no matter how low prevailing rates are, just because of charge-offs and expenses. That doesn’t mean they always need to charge at least 10 percentage points more than the Fed funds rate, however.

I do think that floors on credit-card interest rates are a bad thing if they’re set so that consumers can’t benefit from falling rates. But right now, when rates are at zero, that’s really not an issue — and banning floors can sometimes make products worse rather than better. I wonder whether the Fed understood this when it put its rules together.



I’m not sure the situation is as dire as you presented. The restrictions on floor rates means that any card issuer that has a floor rate on a variable-rate account will not be able to utilized the “variable-rate exception” in 12 CFR 226.55(b)(2). In other words, the issuer loses the ability to follow any changes in the underlying index. But, this does not mean the issuer will have to remove the floor and lower the APR. In fact, it creates an awkward situation where a card issuer has disclosed a variable-rate to the consumer but, according to the Fed, can not increase the APR even if the index changes. According to the Federal Reserve, this is for the consumer’s protection. But, as Felix pointed out there will be situations where consumers will not benefit and, in fact, might be harmed (not to mention consumer confusion).

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Big earners in banking

Felix Salmon
Jan 15, 2010 15:06 UTC

Let’s be clear about this: JP Morgan’s earnings today were very strong indeed. So why are the shares down? Simply because this is one of those instances where the interests of the bank and the interests of its shareholders are not perfectly aligned. Investor disappointment with the earnings is a function of the bank’s loan loss reserves, which are now a whopping $32.5 billion, or 5.5% of total assets. It’s entirely proper that JP Morgan should be treading cautiously when it comes to loan losses these days: the real economy is still very shaky. Shareholders would doubtless be much happier if the bank took a large chunk of those loan loss reserves and reclassified them as profit, but that’s not the responsible course of action.

JP Morgan’s earnings make this morning’s WSJ report — that financial-sector bonuses are going to hit an all-time high in 2009 — a little more plausible. But if you look at the accompanying interactive graphic, something very weird emerges. The WSJ helpfully breaks out each year’s numbers by constituent firms — but looking at the makeup of the 2006 and 2007 pools, the likes of Bear Stearns, Merrill Lynch, and Lehman Brothers are nowhere to be seen.

In the story, the WSJ writes:

The increase in both revenue and compensation is due partly to the industry’s consolidation during the financial crisis. J.P. Morgan, for example, acquired Washington Mutual Inc. and Bear Stearns Cos. Bank of America bought Merrill Lynch & Co. and Countrywide Financial Corp. Those deals inflated revenue and compensation because the acquirers’ financial results now include the purchased companies.

This too implies that 2007 bonuses at Bear Stearns and Merrill Lynch aren’t included in the WSJ’s 2007 bonus pool figures. If that’s the case, then that’s a serious weakness in the data.

I suspect that the exclusion of Bear, Merrill, and Lehman is in fact exactly what’s going on here, and that it’s a function of a problem with many data service providers. It’s quite easy to get public data for companies which still exist, but it’s much harder — for reasons I don’t fully understand — to get public data for companies which used to exist but don’t any more. (Good luck, for example, finding a share-price chart for Chrysler, from back when it was a public company.) Still, if the WSJ did indeed exclude a large chunk of Wall Street’s bonuses in 2006 and 2007, they should make that clear in the article.


Until this administration or the next, or the next after that, removes Goldman Sachs and its off-spring from its influence, nothing will change. I believe it was Bush who installed a non-believer, think his names was Snow. He tried to blow the whistle and how long did he last?

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Quantifying the moral hazard trade

Felix Salmon
Jan 15, 2010 14:29 UTC

I’ve been having an interesting email discussion with Jim Surowiecki of the New Yorker about quantifying the moral hazard trade. If big banks have lower borrowing costs than small banks, he asks, why do we automatically attribute that to moral hazard (the idea that they’re much more likely to get bailed out in extremis) rather than the simple fact that they’re less likely to default? He also makes Jamie Dimon’s point that since the debt of too-big-to-fail banks wasn’t trading at risk-free rates, there can’t have been a moral-hazard trade going on.

The second point doesn’t hold much water. Moral hazard isn’t a binary thing which either exists or doesn’t. So long as the probability of being bailed out by the government is greater than zero, a bank’s cost of funds will fall a little. And even if the probability of being bailed out was 100%, that doesn’t mean that banks could borrow at the same rate as Treasury. As David Merkel points out, even debt with explicit (rather than implicit) government guarantees sometimes trades at a significant spread over Treasuries.

As to the first point, Carrick Mollenkamp comes to the rescue today with the fascinating tale of COFI, an index off which many mortgages are priced. It suddenly spiked on New Year’s Eve, from 1.259% to 2.094%, resulting in an unexpected increase in monthly payments for people with adjustable-rate mortgages.

It turns out that most of the COFI index was based on the cost of funds at Golden West, a subsidiary of Wachovia. When Wachovia was taken over by Wells Fargo, it was no longer eligible to be a reporting member of COFI, and the COFI index went from being overwhelmingly based on Wachovia’s cost of funds to being much more reflective of what smaller banks are paying. And it turns out that smaller banks pay much more than Wachovia did for money.

This datapoint is telling, because Wachovia — largely because of the Golden West acquisition — was a very rocky bank indeed, and was sold as a highly-distressed asset to Wells Fargo. The fact that its cost of funds was so low clearly had nothing to do with its inherent safety, which means that we have to attribute it instead to the moral hazard trade. And indeed the government went to great lengths to rescue Wachovia’s bondholders by forcing a sale of the bank.

Note here that Wachovia’s shareholders were pretty much wiped out in the deal — but that was fine by anybody playing the moral-hazard trade, just so long as the bondholders remained whole. Surowiecki says that “In order to believe that the banks engaged in reckless behavior because they assumed that if they got into trouble, the government would bail them out, you have to believe that financial institutions thought it would be fine if their share prices were driven down to near-zero as long as they were rescued in the end.” Not at all: Wachovia’s executives were very unhappy about the forced sale, but they had no choice in the matter, precisely because the government bailout expected by the moral-hazard types overruled any internal management decisions. Wachovia was not really party to the negotiations surrounding its sale: those essentially happened entirely between the FDIC, Citigroup, and Wells Fargo.

The small banks which now make up the COFI index are safer institutions than Wachovia, but because they aren’t subject to the moral hazard trade, their cost of funds is higher. That’s why it’s no great hardship for Wells Fargo to be paying a 15bp bank tax: it saves much more than that on its cost of funds just by dint of being too big to fail. And there’s a good case that in fact the tax should be significantly higher.


Felix Salmon
Jan 15, 2010 07:06 UTC

The hip-hop/contemporary art nexus — Slate

Even the Red Cross is talking about “looting”? Shame on them. And the NYT — The Awl

Excellent piece by artist Austin Kleon — 20×200

When a personal finance columnist gets hit with a 703.80% APR — Moneywatch

“Bit.ly is actually a Libyan domain. Probably not the best idea for the U.S. government to use” — NYT

Chinese netizens get around censorship by typing in “May 35″ instead of “June 4″ — NYT

When banks refuse to modify mortgages

Felix Salmon
Jan 14, 2010 22:23 UTC

Paul Kiel has an important story today on something I was not aware of at all: banks converting trial loan modifications into… trial loan modifications. This violates the government’s guidelines, but it seems that the likes of Chase and Wells Fargo are doing anything they can to avoid doing what is clearly envisaged in the government plan: transforming all trial modifications to permanent modifications if the trial-mod payments are made in full and on time for three months.

This screams “bad faith” to me. Up until now I’ve reckoned that a lot of the incompetence at mortgage servicers was due to incompetence rather than outright malice, and that they were simply overwhelmed by the volume of distressed mortgages they have to deal with. But there’s no reason at all for them to be asking for updated paperwork from people who have already completed their trial modifications — unless they’re desperately searching for excuses, legal or not, to avoid converting those modifications to permanent status. Shame on them — and I hope that somewhere a regulator with teeth is reading this story and preparing some serious penalties. Otherwise, this obnoxious behavior is only going to continue unabated.


I am so tired of all you better-than-the-rest-of-us people saying that foresclosures are the result of people being irresponsible or buying too much home. KISS MY ASS! I’ve been laid off 3 times since I bought my house, the 2nd time was 2 months after I re-financed. There was no hint at all of this 2nd layoff-we had zero notice and 2 months pay. We had refinanced because we got so far behind after the first time I was laid off and we wanted to catch up on all of our bills. We have 2 children who were quite young at that time. I had no severance at all when I lost my job. Took almost 2 years to find another full time job (contract) and yes I worked odd jobs as could be found in the interim. Then after 4 years of working under contract with promises of being made a “permanent” employee I was let go with 2 weeks warning. To try and keep our heads somewhat above water I took the first halfway decent job that came my way. Well I’m making less money now than I was 15 years ago, but at least I have a job. I finally got settled into my new job and my husband got laid off. We’ve never had extravagant things or fancy vehicles. I’ve never even been able to buy new furniture. Spending my money irresponsibly, really?

The investor bank has been dicking us around for months on end as we apply for and then are refused a modification because they “don’t do modifications”. But then we are required to try again and go thru the same charade. Before I got behind on my payments we had lived in our house for almost 10 years and not had problems. We’ve now lived there for 17 years and have been hanging on by a thread for many of those last 7 because the bank doesn’t want to work with us. So no, don’t accuse me of being irresponsible, or using my home as an ATM machine. HOW DARE YOU!!!! Try being in my shoes and see how it feels.

And how nice that you know how the majority of the country feels about modificaitons. Bull. I bet if anyone did a real survey of regular working class people you’d find that there are a lot of people in favor, and who could use the help.

So all of you that share this viewpoint, sit back and relax in your comfy little world and hope that reality doesn’t come knocking and try to boot you out.

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The bank tax is just an increase in cost of funds

Felix Salmon
Jan 14, 2010 21:28 UTC

Here’s one more way to look at the new bank tax, courtesy of the equity analysts at Oppenheimer & Co: it basically has the same effect on the banks hit by it as would a 15bp rise in the Fed funds rate. And much like an increase in Fed funds, it’ll simply end up getting passed through to customers in the form of higher loan rates. Which doesn’t mean that lending will fall — in fact, the Oppenheimer analysts reckon that any decrease in lending will be “barely measurable”, and will come about mainly in the form of lower demand for loans rather than less supply of credit from the banks.

Meanwhile, an anonymous “senior industry leader” from the murky depths of the financial-services industry emerges to inform Politico that lending could be hit to the tune of $1 trillion as a result of this fee. Don’t believe it. The reason that the source is anonymous is that he would never say something that bald-facedly ridiculous on the record. Banks already have excess cash on their balance sheets, and they won’t reduce lending by $1 trillion for every 15bp that their cost of funds increases. If that were true, then a 200bp rise in interest rates would reduce lending by roughly 100% of GDP.

It’s right and proper that too-big-to-fail banks should have a higher cost of funds than smaller community banks, given the extra systemic risk that they pose. Even after this tax, they probably won’t, thanks to the moral hazard play. But at least it’s a step in the right direction.

(HT: Weisenthal, Choksi)


“Meanwhile, an anonymous “senior industry leader” from the murky depths of the financial-services industry emerges to inform Politico that lending could be hit to the tune of $1 trillion as a result of this fee. ”

If I was going to say something as ridiculous as this, I wouldn’t want my name associated with it, either.

But murky depths of the industry is right. Like the sewer.

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