Felix Salmon

Beware those S&P 500 benchmarks

Felix Salmon
Mar 26, 2010 18:41 UTC

Next time a fund manager brags of outperforming the S&P 500, remember this:

A favorite index for advisers has been the S&P 500, because its performance has been below every other major asset class over the past decade. Virtually any portfolio diversification away from large-cap U.S. stocks would have outperformed the predominantly large-cap S&P 500. All an investor needed was a small allocation to international stocks, small-cap stocks, REITs or bonds–or even cash–and his portfolio would have “beaten the market.”

I don’t actually have a problem with using the S&P 500 as a benchmark for a fund with a dynamic asset-allocation policy, so long as the benchmark is consistently used and was set ex ante. But if anybody starts telling you now how much they’ve beaten the S&P 500 by over the past 10 years, then before investing with them it’s definitely worth asking to see their marketing materials in the intervening years. It’s pretty important that they always used the S&P 500, and not just when it made them look good. Otherwise, Richard Ferri is right that the comparison is downright misleading, and not the kind of behavior one would expect from a fiduciary.

(Via Abnormal Returns)


I think it’s a fair comparison, because many people recommend investing S&P 500 based index funds as an alternative to other investments. Index funds just don’t offer enough diversification.

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The negative bag-check fee

Felix Salmon
Mar 26, 2010 18:18 UTC

Back in September, Joe Brancatelli made a compelling case that bag-check fees at major airlines were actually losing them money, rather than making money. And that was before Southwest airlines embarked on a major marketing campaign touting the fact that they check bags for free — a campaign that Eric Joiner calls “pure marketing genius”.

Eric has some very smart and well-informed analysis of the economics of checking bags: essentially, if, like Southwest, you only have one kind of aircraft, then checking bags saves you money because it speeds up the rate at which passengers get on and off the plane. And he knows that the economics of reducing the bag-check fee from $25 to $0 are essentially the same as the economics of reducing it from $0 to -$25. And so:

What if an air carrier said…rather than charge you a fee to check a bag, They would PAY you to do so?

I love this idea. A lot of people, of course, simply hate the idea of risking their bags being lost, and/or of milling around at a baggage carousel waiting for their bags to arrive. But many others would love the idea of getting paid, in dollars or in frequent-flyer miles, for checking their bags — especially if they had realtime information on exactly where their bags were at all times. (I think the current paper baggage tags would need to be replaced by tags with RFID chips, but that’s doable.)

The result? Passengers would get on and off planes more quickly, the airlines would make more money, and everybody would be happier. It’s a vast improvement from the status quo, where, according to Eric, airlines sometimes deliberately lose bags:

Consumers think the airlines lost the luggage. In fact many times the airline couldn’t accommodate it so they chose to pay a premium to deliver it to you later, often at the cost of your loyalty and future business.

So, Southwest (or JetBlue, or Virgin America, or one of you guys), whaddyathink? Who wants to be the first airline with a negative bag-check fee?

(HT: Ryan Schick)


What is ironic is that I have been yacking about the strategy of baggage handling since 2008. I wrote the article linked below which is really what I think about this subject. Its more valid today that it was then.

http://www.freightdawg.com/2008/02/heres -why-i-don.html

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Shia LeBoeuf vs the short-sellers

Felix Salmon
Mar 26, 2010 15:51 UTC

May I present to you Shia LeBoeuf, momentum trader:

After preparing for his turn as a hedge-fund trader by visiting trading floors of small brokerage houses, LaBeouf in the April issue of GQ talked up the stock of an oil and natural gas exploration company that has yet to produce any of either.

“IOC’s momentum is major, and it will surprise to the upside,” LaBeouf said in a text message to the GQ article’s author, Adam Sachs, using the trader lingo he apparently picked up while prepping for the film.

IOC has been a darling of the short-seller crowd for a long time now: in June 2009 I received but did not open a letter from one such short-seller puporting to contain a Markopolos-style lay-down proof that the company is a fraud. It’s a copy of a letter which was sent to the SEC, and the short-seller in question wanted third-party confirmation that he had sent the letter and knew what was going on at a certain date.

IOC was trading in the 30s at the time; it has more than doubled since then, and at the beginning of this year, when I reckon LeBoeuf sent his text message, it was trading in the low 80s. That’s a really painful short squeeze.

Personally I have not spent much time looking into IOC. But the short side of the trade is represented by some very smart money indeed, while the long side seems to be represented by Shia LeBoeuf and other momentum traders making a lot of money squeezing those shorts. In finance, of course, nobody much cares if you’re right: they only care if you’re profitable. But I can only imagine what the shorts said when they found out yesterday that their investors’ money had been transferred into the pockets of a Hollywood pretty-boy.


„In finance, of course, nobody much cares if you’re right: they only care if you’re profitable“

André Kostolany used to say: „The most important thing is to be right than to make large profits….“

Best from Zurich!

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Student loans and fiscal policy

Felix Salmon
Mar 26, 2010 15:19 UTC

I don’t even pretend to understand the parliamentary mechanism by which the long-overdue overhaul of the student loan system was pushed through inside a health-care reconciliation fix. Certainly that says a lot about how dysfunctional Congress is.

But it gets worse. Simplified, the question was what to do with the $60 billion or so over 10 years that the government will save by no longer subsidizing private student lenders through guaranteeing their loans. The Republicans, who wanted to keep the status quo, evidently thought that Sallie Mae et al were a great place to send that money. The Democrats, by contrast, thought it would be better spent on “federal grants to needy students and help fund other federal education programs, such as support for community colleges and historically black schools”.

You probably won’t be surprised to hear that I’m with the Dems on this one. (And so, interestingly, are a majority of Republicans.) But note what happens when the government finds a large annual savings somewhere in the budget: the money immediately gets spent elsewhere. As far as I can tell, no one seriously proposed that the private loan guarantees be abolished with the savings simply going towards a lower annual deficit. Right now, that money is (weirdly, indirectly, inefficiently) being spent “on education”, and so we have a bipartisan consensus that it should therefore continue to be Spent On Education going forwards, even if the original expenditure was wasteful and nonsensical.

And not just spent on education in general — the money must be spent on tertiary education in particular. Heaven forfend that savings from one part of the education budget might be spent on, say, shoring up holes in the K-12 area. When it comes to federal budgets, money is most certainly not fungible.

Politicians are always good at lauding inputs rather than outputs: you can be sure that Democrats will talk proudly, in the next election, at least to certain constituencies, of how they increased funding for community colleges and historically black schools. And they’ll do that regardless of whether or not the quality of education at those colleges actually improves. Which is why reducing government spending, even when we’re running a trillion-dollar deficit, is such an incredibly difficult thing to do.

Update: OK, this makes a little more sense: Matt Yglesias says that “some of the saved money is going to finance Affordable Care Act activities in the early years” — which means that it’s not all going into tertiary education, and that including the bill in the health-care reform process has at least some justification.


najdor –

Where can one find those “student debt profiles”?

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Why mortgage principal reduction isn’t happening

Felix Salmon
Mar 25, 2010 22:10 UTC

BofA’s “earned principal forgiveness” program looks very similar to the Responsible Homeowner Reward plan of Loan Value Group that I wrote about yesterday. In both cases, homeowners staying current on their mortgage payments get a reward after a certain number of years — a principal write-down on their mortgage in the first case, and an old-fashioned cash payment in the second.

I think I prefer the cash payment to the principal write-down, assuming that the write-down would cost the bank just as much money as a cash payment would. While the effect on the homeowner’s balance sheet is the same, most people would prefer a pile of cash to a principal reduction — especially if the principal reduction is taxable, which it might well be, in five years’ time.

There are two problems with such programs catching on, however. The first, as detailed by Shahien Nasiripour, is that Treasury’s loan-mod program seems designed to use principal reductions only as a last resort. And the second is the fact that although such plans can benefit both borrowers and lenders, that doesn’t mean that everybody ends up happy. Tom Brown reprints with approval this letter:

Dear Mr. Moynihan,

I awoke this morning to read that Bank of America intends to begin forgiving mortgage principal for delinquent borrowers. I am writing to inform you that I will never bank with your firm ever again.

Principal forgiveness is an affront to every responsible, non-delinquent borrower in your book of assets… you are rewarding those who bit off more than they could chew, while those who did not take on excess leverage, or who kept their income-to-debt ratios manageable, see no benefit, even as their home equity values have declined. Even worse, you are denying savers who sit in the cash market the opportunity to purchase inventory from the delinquent.

Capitalism should migrate assets from the weak to the strong, not the contrary… allowing those who are delinquent to now benefit from their financial excesses is a despicable solution that ignores the integrity and responsibility of those who actually finance the lion’s share of your earnings: those who don’t default.

I’m not entirely clear how banks are supposed to give their savers the opportunity to buy distressed real estate, or why anybody thinks that’s a particularly good idea. But what’s abundantly clear, not only here but in the comments to my Loan Value Group blog entry, is that the anger behind the infamous Santelli tea party rant has not gone away, and that if people hated the idea of interest-rate reductions on mortgages back then, they’ll really hate the idea of principal write-downs now.

Bankers are always on the look-out for a good excuse not to engage in principal write-downs, and this is another arrow to add to their quiver of such excuses: doing so will enrage and inflame their customer base.

Remember too that it’s pretty much impossible to quantify the upside, to a bank, of a principal reduction, since doing so requires calculating exactly how much the probability of redefault has been reduced. Bankers, as we know, like to do things that make their bank money in quantifiable ways, so that they can then show their boss how much money they’ve made, and ask for a nice seven-figure bonus at the end of the year.

For all these reasons, I suspect that BofA’s move into the world of principal reduction will remain very small-scale, and that insofar as the practice takes off, it will do so only among hedge funds and others who have bought mortgages on the secondary market. At least unless and until Treasury modifies its modification principles.

Update: WaPo is now reporting that “For the first time, the government will offer financial incentives to lenders that cut the principal these homeowners owe on primary mortgages.” I’ll believe it when I see it, although this is undoubtedly encouraging.


If a bank is willing to sell a house via short sale, why not just reduce the owner’s principal? I have a neighbor who hasn’t paid his mortgage for two years, but is still living there. He lost his job, but is now working again (for much less). The bank is trying to sell the house for $100K less than his mortgage and no one is interested. Whay not just reduce his principal by, say, $70k and refinance him with a slightly higher interest rate? Everyone wins, sort-of.

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Goldman’s outperforming mortgage CDOs

Felix Salmon
Mar 25, 2010 16:28 UTC

I’m a bit late to this, but Stephen Gandel had an interesting post this weekend about the now-famous Harvard thesis upon which Michael Lewis based a lot of his latest book, and whether it partially exonerates Goldman Sachs from the charge of deliberately building CDOs which were designed to go bad, to the profit of Goldman Sachs.

Gandel gets comments from both Janet Tavakoli, who will never admit that Goldman is anything but pure evil, and from AK Barnett-Hart, the author of the thesis, who keeps a certain amount of scholarly caution while agreeing that Gandel basically read the thesis correctly.

Here’s what he found:

One thing Barnett-Hart examines is how the CDOs of different investment banks performed. Turns out Goldman wasn’t the worst CDO underwriter after all. Quite the opposite.  Barnett-Hart looked at CDO deals underwritten by investment banks from 2002 to 2007, and found that out of about 700, Goldman’s CDOs performed better than every other major underwriter of the investment product on the street. Through the end of 2008, just 10% of the bonds that Goldman packed into its CDOs had gone bad. J.P. Morgan’s rate of default was about four times that, making it the worst U.S. investment bank in the CDO game. But plenty of others had similarly bad numbers. Merrill and Bear came in at a default rate of about 35%, and Citigroup posted a similarly depressing 30%. Barnett-Hart goes on to praise Goldman’s CDO underwriting prowess.

Of course, the likes of Merrill, Bear, and Citigroup never went short mortgages, so they can’t possibly be accused of deliberately constructing highly-toxic CDOs in the knowledge that those CDOs would end up defaulting. It’s hard to be evil when you’re fundamentally incompetent. But as the Lewis book shows, it was really Deutsche, not Goldman, which was most cognisant of the coming subprime collapse. And Goldman’s decision to go short came really rather late in the game.

Lewis is a storyteller, not a historian, so when it comes to finding evil intent at investment banks, absence of evidence is not evidence of absence. But Lewis also clearly has no love for Goldman, and the Goldman press office, for one, is upset with the contents of the book. Given the book’s subject matter and Lewis’s sourcing, I’m sure he would have loved to include a Goldman plot to rip off its own buy-side clients. But in fact it seems that Goldman’s clients were better served than the clients of other sell-side players in the CDO market.


She’s on MSNBC today:

http://www.msnbc.msn.com/id/21134540/vp/ 36088862#36088862

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Felix Salmon
Mar 25, 2010 06:50 UTC

How climate change is affecting Latin America’s coffee crop — NPR

Tonchi moving from T to W: obviously V was passed over — NYT

Advice for PBS: “Instead of showing Andrea Bocelli, I’d telecast David Robertson and the St. Louis Symphony performing Samuel Barber’s ‘Prayers of Kierkegaard.’” — WSJ

E&Y tries to defend itself

Felix Salmon
Mar 25, 2010 06:44 UTC

Contrarian Pundit has a letter being sent out by Ernst & Young “to address certain media coverage and commentary on the Examiner’s Report that has at times been inaccurate, if not misleading”.

It’s pretty obvious why the letter isn’t being sent to the media outlets in question: it’s hilariously disingenuous, and anybody reading it side-by-side with, say, this piece at ZeroHedge will find it simply laughable. For instance:

Because effective control of the securities was surrendered to the counterparty in the Repo 105 arrangements, the accounting literature (SFAS 140) required Lehman to account for Repo 105 transactions as sales rather than financings.

For one thing, it’s jolly good that E&Y is so clear about this now, after the head of its Lehman team, Hillary Hansen, told the examiner that she had no idea what Repo 105 even was as late as June 2008. And more to the point, the examiner never says that the accounting treatment of the Repo 105 transactions was wrong; he says that the disclosure surrounding those arrangements was clearly inadequate. To which E&Y responds that “the 2007 audited financial statements were presented in accordance with US GAAP, and clearly presented Lehman as a leveraged entity operating in a risky and volatile industry”.

Well, yes. Which makes it all the more important that off-balance-sheet sources of leverage and risk should be clearly disclosed, no?

The letter continues in this vein for two pages, denying allegations which haven’t been made while stepping gently around the ones which have. Even if you haven’t seen things like the ZH report, the tone of the letter is decidedly weird. If you have seen things like the ZH report, the letter will only serve to make your opinion of E&Y even worse. If I was on the audit committee which received this letter, I would certainly be shopping my account right now. And if this is the best defense that E&Y can muster, they really are in for a world of Lehman-related pain.


Although the Examiner’s Report expressly declined to take a position on the issue, it seems quite unlikely that Lehman’s repo 105 program in fact met the standards required by FAS 140 for off-balance sheet treatment. In particular, LBIE (Lehman’s UK entity) apparently repo’d two different “buckets” of securities in the UK: (i) securities that were already owned LBIE, and (ii) securities transferred to LBIE from U.S. Lehman entities. With respect to the second category, the means of transfer was a repo between the U.S. Lehman entity and LBIE. That repo between the U.S. Lehman entity and LBIE, however, would not be characterized as a true sale for U.S. bankruptcy law purposes; indeed, the very impetus for the repo 105 structure was Lehman’s inability to obtain a true sale opinion from a U.S. law firm for repos transacted by U.S. Lehman entities. And there lies the problem: the transfer of securities from U.S. Lehman entities to LBIE, and the characterization of such transfer for U.S. bankruptcy law purposes, were not addressed in the Linklaters UK legal opinion upon which Lehman depended for FAS 140 purposes (and one might conjecture that Lehman probably never informed Linklaters of the specific providence of the securities). Instead, the Linklaters UK legal opinion simply included an express assumption that there were no provisions of foreign law that would have any effect on the opinion. Accordingly, it is hard to imagine that Linklaters would still have been able to provide its UK legal opinion if there had been an explicit statement of the fact that certain of the securities that were repo’d in the UK by LBIE were first acquired by LBIE from U.S. Lehman entities in repo transactions that did not constitute true sales for U.S. bankruptcy law purposes.

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Blodget fires Carney

Felix Salmon
Mar 25, 2010 02:08 UTC

Why did Henry Blodget fire John Carney? I suspect that Carney himself will tell us soon enough. But the broad narrative of Foster Kamer’s post today rings true: it’s the age-old tension between the popular and the high-quality.

Now it’s worth remembering here that John Carney, for all his highbrow bona fides and thousand-word essays on whether Lehman executives deserve criminal prosecution, is entirely comfortable with lowbrow and populist fare. He helped launch Dealbreaker, he has an intuitive understanding for what kind of things generate traffic and pageviews, and he’s great at writing provocative headlines just crying out to be clicked on. Martin Wolf he is not.

Yet, writes Foster:

Blodget wanted more sensational, pageview-grabbing posts and click-friendly features like galleries, while Carney wanted to put forth breaking news scoops that told a longer narrative. It was also speculated that Carney, one of the highest paid members on the Business Insider staff, wasn’t bringing the traffic numbers to sufficiently satisfy Henry Blodget.

Of course Carney wanted longer news scoops: that’s where the pro-blogging world is headed. Without them, it’s still possible to get traffic, especially if you have aggressive or deep-pocketed business-development people, but it becomes much harder to garner the kind of respect needed to be able to charge $20-$30 CPMs and start making some real money from ads. None of this should come as news to Blodget, so I wonder whether this is indicative of a conscious decision to move downmarket, or possibly of a cash crunch or pressure from The Business Insider’s investors to ramp up traffic and cashflow more aggressively. TBI is a venture-backed company, and its investors want a highly-profitable exit: that kind of business model has always been hard to square with building a strong franchise for the ages.

The mention of Carney’s salary is also indicative of a newfound focus on cashflow at TBI. There’s a finite number of name-brand financial bloggers out there, and when you hire one of those brands, you do so in large part for the respect that gives your franchise as a whole, rather than doing silly math about whether the ad revenue from his pageviews justifies his monthly paycheck. Blodget wants to be taken seriously as a financial news outlet: he wants to compete directly with the FT. And to be able to do that, he’s going to have to be able to hire talent. After today’s events, however, he’s going to find it extremely difficult to hire any respected financial journalist with a reasonably secure job.

Carney certainly has his idiosyncrasies, and he wouldn’t last a week at Bloomberg, but he’s perfectly open about them, and one of the great things about media companies in general and blog companies in particular is that they’re pretty good about letting the talent do what it needs to do, just so long as the stories keep coming. And Carney always kept the stories coming. What’s more, the beating heart of Clusterstock is the dynamic duo of Carney and Joe Weisenthal; now that he’s fired Carney, Blodget must know that he risks losing Weisenthal as well. If he loses them both, he’ll rapidly become something like 24/7 Wall Street or Minyanville: a site with lots of low-quality traffic and generally uninspiring editorial content. After all, left to his own devices, Blodget is prone to publishing silly and irrelevant stuff like this which is barely worth tweeting.

Kamer’s sources within TBI certainly don’t seem happy about this news, and on its face there’s a lot more downside than upside for Blodget in firing Carney. I don’t worry about John: he’s a huge talent who will certainly land on his feet. But if I was an investor in TBI, I’d be very worried about Blodget, and I’d be phoning him up right around now asking him what exactly he thinks he’s doing. Because this kind of thing is likely to lose him a lot of respect in the finance and media communities.

Update: It’s worth noting that Henry Blodget put a post up last week with the headline “The Internet Is Making Us Shallow and Vapid! (Or Maybe We Were Just Shallow And Vapid To Begin With)”. Clearly he’s come to peace with appealing to the shallow and vapid. And once he did that, I’m sure the decision to fire Carney was made easier.


I agree – I stopped reading it because of Carney and Weisenthal, not the reverse. They have a rather annoying tendency to exhibit knee-jerk political views which were more panic-driven than thoughtful. If I want that, I can go to FoxNews, not a blog that’s supposed to intelligently digest financial news.

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