Felix Salmon

The US default-risk meme

Felix Salmon
Mar 25, 2010 00:41 UTC

There’s a constant drumbeat of stories about how the price of credit protection on the USA says little if anything about America’s creditworthiness: Dan Gross had one just last week. I’ve written much the same story myself, but at least I tried to explain what was actually going on in that market; what I’m still waiting for is a journalist who can find someone who’s actually buying or selling these things, so that we can find out from the horse’s mouth why they’re doing so.

What’s new is stories looking at yields on Treasury notes and extrapolating default probabilities from those. Bloomberg had a headline on Monday saying “Obama Pays More Than Buffett as U.S. Risks AAA Rating”, which led with this:

The bond market is saying that it’s safer to lend to Warren Buffett than Barack Obama.

I’m pretty sure it’s safe to say that sentence simply isn’t true. For one thing, it’s predicated on the idea that Berkshire Hathaway bonds were yielding 3.5bp less than equivalent-maturity Treasuries, “according to data compiled by Bloomberg”, but when you start looking at gaps that small, you have to be very careful with the reliability of your data, and I suspect that the people at Bloomberg weren’t. In the comments over at Marginal Revolution, Ricardo pulls up all the actual trades of the Berkshire bond in question on March 18, the day that Bloomberg says it yielded less than Treasuries; there are seven of them altogether, starting at 1.206% and finishing at 1.023%. All but one are above the 0.93% that Bloomberg says Treasuries were yielding, and it’s not clear how much Treasuries were yielding at exactly that point in the day.

But that doesn’t stop Bloomberg from taking one suspect datapoint and constructing a large edifice of rhetoric atop it, talking about “concerns whether the U.S. deserves its AAA credit rating” and so forth.

Today, it’s the 10-year swap spread, which has followed the 30-year swap spread into negative territory, and suddenly everybody’s talking about “the fiscal situation in the US” and how “increased sovereign risk” is the culprit.

Well, it might be (or it might not be: Bond Girl has good non-default-risk reasons why this might have happened) but I’m going to need a hell of a lot more evidence before I start thinking of the Treasury market as including a measurable or even extant premium for default risk. In theory, it might well be there, and indeed the existence of that CDS market on US debt is prima facie evidence that it exists. But if it’s there, there have got to be better ways of finding it than by pouncing on curious anomalies in the bond market.

Update: Mark Gongloff has a good roundup of the various different explanations for negative swap spreads; sovereign default risk doesn’t even make the cut.


Greycap, the swap settles off of 3m libor, so the payoff incorporates 3m bank credit risk, independently of any counterparty risk in the swap. Besides, interest rate swaps between dealers are margined and have very little counterparty risk.
And if you add the funding angle (you can borrow against treasuries at below libor rates) the effective spread between the treasury rate and the swap rate is even greater than the quoted one.

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Iowa cracks down on Ben Stein’s sleazy paymasters

Felix Salmon
Mar 24, 2010 17:08 UTC

Ben Stein has a bit of free time on his hands these days, now that his odorous association with FreeScore.com and its sleazy owners Vertrue means that he’s no longer writing a column for the NYT. So he might be interested in reading the blistering 62-page ruling that Judge Robert Hutchison has just handed down in Iowa, which goes into great detail about how Vertrue has violated all manner of laws in that state with its unfair and deceptive practices.

Here’s the bit about Ben Stein’s arm of the company:

Vertrue maintains its own website FreeScore.com, where the consumers can purchase a service involving credit scores. However, Vertrue bundles another distinct product, Privacy Plus, with the purchase of the initial service, for an additional monthly fee of $1.00. Thus, to purchase the initial service, a consumer must purchase Privacy Plus, although this fact is obscured as much as possible. In such instances, although the record is unclear as to whether a consumer receives one welcome e-mail for both services or two separate e-mails for the two distinct services, there is no ambiguity that to cancel both services, a member must call two separate 800 numbers, even though the consumer had no choice but to purchase both services together. Most consumers will likely be unaware of the purchase of the second service (much like the post-transaction solicitations discussed above), and that when the consumer calls an 800 number to cancel the primary service, he or she will continue to be billed for the (unknown) add-on service. Moreover, even for the wary consumer that understands that two services are being purchased with only one click of the mouse, such a consumer may not understand that calling one number to cancel does not cancel both services, despite the “one-click” nature of the initial purchase.

And the rest of Vertrue is even worse: Hutchison goes into great detail about how it preys on the elderly, almost never provides any benefits to the users of its products, and goes to great lengths to create bogus “surveys” and the like, the results of which are always discarded unread, to make people think that they’re being rewarded for doing something. He writes:

Unlike Vertrue‘s memberships, most consumer goods are tangible. Thus, for example, if a membership arrangement involves the periodic review of books or CDs on a negative option basis, the receipt of the items themselves serves as unequivocal notice to the consumer of the fact of membership and its attendant obligations.

By contrast, a membership that provides “access” to benefits may be all but invisible and may have little concrete presence in a consumer‘s life, especially in instances where the consumer is not even aware of purchasing the “access” in the first instance. Here Vertrue fosters invisibility by utilizing a marketing structure that obscures effective notice to the consumer of the membership enrollment and places numerous burdens on the consumer: the burden to cancel in order to avoid the onset of charges; the burden to differentiate a membership notice from the junk mail or spam that it resembles; and the burden to detect an ambiguous charge on one‘s account statement and act on it. Vertrue‘s own records show that 84% of the more than 860,000 Iowa memberships involved no discernible use whatsoever of any membership benefits by the consumers who were subject to membership charges. Thus, the Defendants‘ overall marketing scheme has netted more than $35 million in membership charges from Iowans, and has provided remarkably little in return. Indeed, Vertrue‘s own benefit usage data for memberships that began after 1989 and were active as of May of 2009 shows that 91.5% of memberships involved no benefit usage whatsoever.

I look forward to Vertrue being slapped with a massive fine in Iowa, and to the authorities in 49 other states following suit. Sadly I doubt Ben Stein can be held personally liable for any of this, but he’s certainly morally culpable. And next time he cashes a check from Vertrue, he should think about the story of Charles Pope:

Charles Pope, a 63-year-old military veteran from Marshalltown, testified at trial regarding his experience with a check mailer. Mr. Pope‘s experience appears to be representative, and well illustrates the objectionable features of Vertrue‘s method of marketing in the direct mail channel.

Mr. Pope received a mailing in the form of a “snap-pack,” a check-sized envelope that is to be opened by tearing off a perforated stub at the end. The outside of the snap- pack bore the name and the logo of the consumer‘s credit card issuer (“Union Plus” in Mr. Pope‘s case), and also bore the words “CHECK ENCLOSED” above Pope‘s name and address. The envelope contained a $10 check made out to Mr. Pope. The envelope also contained a check-sized slip of paper, which explained in small print that by cashing or depositing the check the consumer would be enrolling in a trial membership, which would lead to charges on the consumer‘s bank (or credit) account unless the consumer affirmatively canceled…

Vertrue‘s billing records showed that Mr. Pope‘s Union Plus credit card was charged $12.95 a month beginning in October of 2004, and the monthly charges continued through September of 2008, by which time the charge had risen to $14.95. Mr. Pope testified that he was not aware that he was a member of any Vertrue program until he was contacted by the Attorney General‘s office in about September of 2008, at which time he canceled the membership. He recalled receiving the check in the mail, but had assumed that he was being reimbursed for overpaying his credit card account. Mr. Pope testified that he never intentionally enrolled, and never made any use of whatever benefits the membership involved. Mr. Pope testified that he had seen the charges on his statement, but mistakenly believed that they related to insurance. By the time he canceled after four years, Mr. Pope had unwittingly paid $695.60 in membership fees. Upon cancellation, he was refunded only one payment of $14.95.

I wonder whether Stein feels like paying Mr Pope the other $680.65 out of his own pocket.


Not apologizing for Ben, whom I happen to like as a person if not as “an economist”… If however you find literally “loathsome” having, in his time, glossed over the (to me, evident) troubles of Wall Street, one could name several apparently paid contributors even unto this very news service whom you must then consider evil incarnate for no less energetically clutching to the self-same shaky premise, louder and for longer.

Just saying, when it comes to economic misguidedness, Ben Stein has no monopoly. Not by a long shot.

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Howie Hubler’s second act

Felix Salmon
Mar 24, 2010 15:56 UTC

Loan Value Group has one of the best ideas I’ve seen in the housing crisis so far. It involves no legislation or government cash, it keeps homeowners in their home, it prevents distressed foreclosure sales, and it benefits both borrowers and lenders. In a world where the pervasive problem of negative equity is signally failing to turn up in significant principal reductions, LVG has come up with a clever way of doing something substantially similar, without lenders having to take the hits to their balance sheet which are necessary when they do an immediate principal write-down.

The LVG trick doesn’t work for everyone: it’s really only for strategic defaulters, who have the ability but not the willingness to pay. And the idea is to give them a nudge to keep on paying, and to do what most people with mortgages want to do, which is to stay current on their loan. Up until now, homeowners have faced only the sticks of moral disapproval and reduced credit rating when pondering whether or not to walk away from their loans; now, LVG is offering them a substantial cash carrot as well.

If you just keep on doing what you’ve been doing all along, and make your mortgage payments on time, LVG will offer you a lump-sum payment under its Responsible Homeowner Reward plan, which is explained in some detail in this press release. The reward is paid by the lender, and is calibrated to your specific circumstances, including just how underwater you are on your mortgage. And it can be implemented in just a few days, bypassing entirely the infuriatingly incompetent customer service representatives at loan servicers, who seem to be able to do nothing but lose paperwork on a predictably regular basis.

One of the surprises about this crisis has been how few strategic defaulters there have been to date. But the number is rising, and it’s very much in the best interests of the financial system that it never approach the kind of critical mass at which strategic default tips over into being a perfectly normal and acceptable thing to do. Schemes like LVG’s are a very good way of minimizing strategic defaults, and they benefit not only the homeowner and the borrower, but also the solvency of the financial system as a whole. I hope they catch on among more than just a few hedge funds buying up mortgages in the secondary market.

Today, Max Abelson uncovers a very interesting nugget about LVG: one of the owners is none other than Howie Hubler, the former Morgan Stanley bond trader who contrived to lose $9 billion on mortgage-backed securities and who is one of the great chumps in Michael Lewis’s new book. Hubler saw clearly that subprime mortgages were going to go bad, but he believed for far too long in the models which banks and ratings agencies used to get triple-A ratings for a bunch of nuclear waste. And so he ended up selling Deutsche Bank’s Greg Lippmann, and others, enormous amounts of credit protection on triple-A MBS in order to fund his bearish bets on the weaker end of the market. When the crisis then hit and correlations went to 1, Hubler lost billions — but not before walking away from the bank with a ten-figure bonus.

I have no problem with Hubler’s second act: he’s received the single most expensive education in mortgages that anybody could ever have, and it’s silly for that expensive education to go to waste. If he can turn LVG into a force for good in the housing market, that might make up for some tiny part of the chaos he caused during the crisis. I wish him and LVG luck — especially if they don’t turn into patent trolls who try to aggressively prevent other people from implementing similar ideas.


Dear Mr. Salmon,

You write that Mr. Hubler “might make up for some tiny part of the chaos he caused during the crisis” through his current venture.

I would suggest that his role was hardly “tiny” as it was his $9.0 billion loss that put in motion the rapid descent of Morgan Stanley, ultimately leading to the Federal Reserve’s rescue. If one believes — and I think many do — that Goldman Sachs would have followed MS into the abyss had it not been for the Fed’s intervention, then I think Mr. Hubler’s part in this crisis is much greater than you suggest.

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Blogonomics: The Gothamist sale

Felix Salmon
Mar 24, 2010 02:59 UTC

Gawker and Gothamist were both started in 2003, and both grew to become big blogs; it’s interesting, now Gothamist is being sold to Rainbow Media, to see Gawker’s Nick Denton’s weird attempt to downplay the achievement of Jake Dobkin and Jen Chung.

Let’s say Jake and Jen end up with $1.5m each. That sounds like a lot; but they’ve been at the job seven years. And my understanding is that the contract would require them to stick around for another three, making a decade in total.

So that works out as about $150,000 per year — plus any compensation under the employment agreement they get from Cablevision.

Not bad — but still better to be even a junior analyst at Goldman Sachs or a fancy Moveable Type consultant. And you don’t have to work for the Dolans.

For one thing, I think that Jake and Jen are going to end up with more than $1.5m each, although the terms won’t be made public so we likely won’t ever know for sure. I don’t think either of them has been racking up debts along the way, so this is genuinely life-changing I’m-a-millionaire windfall money we’re talking about here, not a salary dribbled out over the course of a decade.

What’s more, it’s worth remembering how much Denton pays his bloggers. In 2003, when he launched Gawker, he paid editor Elizabeth Spiers $1,000 a month. Even today, now that he’s fully-fledged media mogul making millions of dollars himself, I still don’t think that any of his bloggers makes $150k a year.* And very few people can blog for Denton for more than a couple of years at a stretch. So Jen Chung, the editorial-side half of the Gothamist team, turns out to have made an extremely good decision indeed when she decided to stick with Gothamist equity rather than taking a better-paid editorial gig elsewhere — especially considering what’s happened to thousands of well-paid journalists in the past few years.

And Denton’s math is off, too: while Jake and Jen might not have paid themselves much at the beginning, they did start drawing a salary eventually. And going forwards, I think it’s safe to say that Rainbow Media is going to pay them substantially more than $150k/year, and not just for the next three years, either. Rainbow is acquiring talent here, especially Jen’s, and it’s going to want to keep her and her family happy and well fed for the foreseeable future, well past three years, if it possibly can. Rainbow Media is not something the Dolans take any particular interest in, and Jen’s going to be able to work with a very large degree of autonomy, including working a lot from home. A high-intensity Gawker Media gig with zero job security this is not; instead, Jen will overnight become the highest-paid blogger on any media company’s payroll, anywhere in the world.

As for Jake, he’s surely at or near the very top of his NYU Stern business-school class right now when it comes to financial success — and he’s done it on his own terms, building a spectacular archive of photographs in his plentiful spare time, never once dealing with a boss. The idea that he would have been better off trying his luck at Goldman Sachs or becoming a fancy Moveable Type consultant is laughable. (Jake would last about 10 minutes at Goldman, as he’ll be the first to tell you.)

Jake and Jen worked hard building something they were rightly both very proud of. They never sold any equity to anybody, and they ended up selling their company at a time of their choosing: I don’t think it’s a coincidence that both have recently become parents for the first time. They both have long careers ahead of them at Rainbow if that’s what they want, or can leave after three years with a world of opportunities and bulging pockets. So when Nick tells his readers to “hold off on the envy”, he’s living on a completely different planet. Jen and Jake have achieved something great here: they’ve built a real blog business with seven-figure revenues from scratch, they’ve got rich doing so, and they did it their way, on their own terms, all before either of them turned 35. Many congratulations to them both.

*Update: And that’s pre-tax. As right points out in the comments, Denton’s math is post-tax. I don’t think anybody on the editorial side at Gothamist comes close to making $150k after tax — and even making that much money as a fancy Moveable Type consultant is not going to be easy. Believe it or not, there are even junior analysts at Goldman Sachs who don’t make $150k after tax.


I love talking about making millions from a blog on a blog

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Why I’m not worried about hyperinflation

Felix Salmon
Mar 23, 2010 21:41 UTC

The smartest reaction so far to the Kinsley-Krugman hyperinflation debate comes from Ryan Avent:

The pain of hyperinflation is every bit as bad as and worse than the pain of tax increases, or spending cuts, or default. No politician would risk it, and even if the politicians were willing to, America’s independent Fed wouldn’t let them.

The truth about hyperinflation is that it isn’t so much an economic phenomenon as a political one; it corresponds to the complete breakdown of a country’s political institutions…

To get from America’s current situation to one in which hyperinflation is a realistic possibility, one must pass through an intervening step in which America’s political institutions utterly collapse. And I submit that if Mr Kinsley has reason to believe that such a collapse is imminent, he should be writing columns warning about that rather than the economic messes which might follow.

It’s also worth expanding on what Ryan’s hinting at in his reference to “America’s independent Fed” — and that’s a neat little rhetorical sleight-of-hand on the part of Kinsley. Consider:

The Federal Reserve is independent, but Congress and the White House have ways to pressure the Fed. Actually, just spending all this money we don’t have is one good way.

Compared with raising taxes or cutting spending, just letting inflation do the dirty work sounds easy. It will be a terrible temptation, and Obama’s historic reputation (not to mention the welfare of the nation) will depend on whether he succumbs. Or so I fear.

Kinsley continues:

Hyperinflation is the result of explicit policy choices by public officials… There are reasons to worry that our political leaders may opt for inflation even if there is no economic evidence of it happening naturally.

The logic here is that simply running large fiscal deficits is an “explicit policy choice” by officials who “opt for inflation”. Just by spending money, the government is pressuring the Fed to, um, what, exactly? Keep interest rates too low? Print money?

It’s true that the Fed isn’t looking particularly independent these days, but that’s largely because inflation isn’t a problem, and therefore the Fed is rightly concentrating on the second part of its dual mandate, which is reducing unemployment through loose monetary policy. Fiscal policy and monetary policy should both be pulling in the same direction right now — which is the direction of trying to extricate the country from the deepest recession in living memory.

It’s also hard to see the dynamics by which hyperinflation — or even plain old ordinary high inflation, for that matter — could emerge. If there’s a panicked run away from the dollar and dollar-denominated assets, that would hurt both the stock market and the bond market, hitting wealth hard. It would also send the cost of imports up. But the US doesn’t import so much that import-price inflation would pass through into domestic hyperinflation. And with the markets in turmoil, weak unions, and unemployment surely rising, I don’t think that workers would be in any position to ask for double-digit wage increases on an annual basis. In any case, to have any hyperinflation you need a maniac helming the printing press, and Ben Bernanke is not a maniac. Yes, he’s expanded the money supply significantly, but only when disinflation was the greatest risk facing the economy. It’s almost impossible to imagine the Fed continuing to print money once consumer prices start rising sharply on Main Street — and, frankly, it’s hard to imagine the Obama administration putting pressure on the Fed to do so.

As Krugman notes, it’s instructive to take a hard look at Japan, which ran enormous deficits for many years and which still has no sign of any inflation any time soon. Deficits, in and of themselves, do not cause inflation. And while Kinsley is right that there’s no obvious way out of America’s current fiscal problems, he’s wrong that politicians can simply choose inflation as an option. Just as the Treasury secretary does not control the value of the dollar, the president does not control the trajectory of consumer prices. So in order for his fears about hyperinflation to be remotely justified, Kinsley first has to explain how the Fed is going to transmogrify into the Reserve Bank of Zimbabwe. And he hasn’t come close to doing that.


If there is 12% inflation for a decade, the dollar loses 3/4 of its value. While we might not think of 12% as the wheels coming off the wagon, the dollar loses most of its value very quickly.

If we allow ourselves to acknowledge that such levels of inflation are a kind of hyperinflation (in the sense that most of the value of cash and long bonds disappears in just a few years) we realize that there have been hundreds of instances of this spanning almost every nation in the world. Deflations by contrast have been exceedingly rare and comparatively mild.

I think the odds of avoiding an inflationary bout sometime in the next decade or two are about the same as the odds of Cornell taking it all. Go Big Red! Those Wildcats have nothing on you!

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The FDIC: An IMterview with Heidi Moore

Felix Salmon
Mar 23, 2010 18:24 UTC

Heidi Moore has a good story today about the banks winning the FDIC lotto and being allowed to take over the assets and deposits of other, failing banks. But I was left wanting more, especially when it came to her conclusion, so I took to IM:

Felix Salmon: You write “The FDIC’s pool of buyers—large or small—is getting tapped out” and that “as many buyers as the FDIC can find, it is not likely to be anywhere as many as it needs”.

Can you tell me a bit more about that?

Heidi Moore: Yes, definitely.

Felix Salmon: Once someone like Stearns takes over a bank, does that make it harder to take over another?

Heidi Moore: First, there is the expectation by many that bank failures will be higher in ’10 than they were in ’09. So the sheer numbers will be more.

Felix Salmon: If the sheer numbers just stayed constant, and the number of failures in 2010 stayed at 2009′s high level, would there still be a problem?

Heidi Moore: Yes

Felix Salmon: Are 2009′s buyers tapped out, as it were?

Heidi Moore: “Tapped out” is extreme. but they’re closer.

The FDIC has a mail list of about 400-600 banks or so that it contacts whenever a bank is coming up for auction.

These banks are chosen due to their strongish capital ratios

Felix Salmon: And that list more or less sufficed during 2009

Heidi Moore: Yes, although there were a handful of banks that simply didn’t get sold

Felix Salmon: But sometimes the capital ratios take a ding when a failed bank is taken over?

Heidi Moore: Yes, exactly. Every time you buy a failed bank, even if the FDIC is guaranteeing the assets, there are still some bad loans that need to be covered by adequate capital. There are few banks that can maintain high capital ratios to cover their own losses as well as the losses of more acquisitions.

And the FDIC is always checking in on them. For instance, they can’t apply the profit from an acquisition toward the capital ratio.

Felix Salmon: So it’s rare-to-never that an acquiring bank comes out of one of these deals with a capital ratio as good or stronger than when it went in.

Heidi Moore: There are enough repeat buyers that it’s not impossible. But yes, a hit is inevitable.

Felix Salmon: Which means that there’s basically a finite pool of excess capital at those 400-600 banks, and the FDIC is slowly depleting that pool.

Heidi Moore: Not “depleting” because the FDIC doesn’t sell unless the bank has proof that its cap ratio will bounce back.

Stearns, for instance, has a tier one ratio of something like 17%, and it has made 5 acquisitions.

Felix Salmon: Has its capital been depleted at all by those acquisitions?

Heidi Moore: This is why the stock-warrants plan is so great; banks can buy FDIC banks without handing over cash that could hurt the capital ratio.

Felix Salmon: So this is why I’m confused. If Stearns can buy banks without hurting its capital ratio, then why can’t it continue to do that more or less indefinitely?

Heidi Moore: The expectation of the FDIC is that the capital ratios will take a hit. That’s the risk inherent in the acquisition. So FDIC tries to mitigate it by offering loss-sharing, warrants, etc. There’s only so many times they can go back to that well, though, which is why they’re opening the door to private equity now.

I actually saw a FDIC document where they said “we’re running out of buyers”.

Once the IMterview was over, Heidi got a statement from the FDIC saying that “We are still seeing first-time buyers, and in the few cases when we can’t find a buyer for a failing bank, it is usually due to the make up of the failed bank’s deposits.” So it’s a bit unclear whether or not the FDIC is actually running out of buyers or not. But it’s certainly something that the FDIC should be worried about: it makes intuitive sense that if the FDIC only has a few hundred qualified buyers, and the number of bank failures is continuing to rise, then eventually it might run out of buyers. But whether that means that private-equity shops will finally be given the opening they’re looking for remains to be seen.



You and Ms. Moore fail to mention the operational and management side of the equation. Regardless of balance sheet strength, there’s the question of management time for integration of everything from IT systems to credit practices. It also takes time to conduct due diligence on a target.

Particularly for acquirers who are smaller, which was the focus of Ms. Moore’s article, the people who evalute and integrate acquisitions are more than likely the same managers who are the top management of their own institution or run functional areas (credit, IT, legal, etc.) on a day-to-day basis. These institutions don’t have the management depth of an institution like JP Morgan Chase or Wells Fargo, which have the resources to maintain full-time business development/M&A and integration teams if they so choose.

Finally, I find it quite odd that the FDIC feels that a relatively small bank in Minnesota, with no prior knowledge of nor experience in the Florida or Georgia markets, makes a logical acquiror of a failed institutions in those markets. (My understanding is that Stearns, profiled in Ms. Moore’s article, operated only in Minnesota and Arizona prior to purchasing failed institutions in FL and GA during 2009.) It shocks me that the FDIC would choose such an institution over a management team with knowledge of local markets backed by private equity, but I understand that to be the FDIC’s current position.

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A FAB idea?

Felix Salmon
Mar 23, 2010 17:55 UTC

Matthew Bishop has a short piece on a new campaign called FAB, for Financial Access at Birth: the idea is explained in more detail here.

We propose that starting November 11, 2011 (11/11/11), every child born in this world will start life with a Financial Access at Birth (FAB) bank account. The opening of these “FAB” bank accounts would be integrated with the official birth registration process and perhaps with electronic banking. Governments, with the help of institutional/individual donors will make a deposit of US$100 in each FAB account.

On its face, the idea is a great one. It helps bring financial services to everybody: both newborns and their parents can benefit from having access to that bank account, and even if the initial $100 is untouchable until the child reaches the age of 16, the account can still be used in the interim by making deposits and withdrawals. And if there’s $100 in it for anybody who registers their child at birth, the world’s poorest children are much more likely to be known to their governments and whatever instruments of the social safety net exist. What’s more, once the bank accounts are set up, philanthropists both large and small can easily transfer money directly into them, bypassing financial intermediaries altogether.

The campaign was founded by Bhagwan Chowdhry, a finance professor at UCLA, whom I met on Sunday evening. He told me that former Mexican finance minister Francisco Gil-Diaz was on his board, and that got me reasonably excited, since Mexico is the obvious first place to try this scheme out. For one thing, Gil-Diaz is smart, well-intentioned, and powerful: a very potent combination indeed. Secondly, Mexico has a relatively low birth rate, which means that the cost of the scheme would be pretty modest there: with about 2.1 million births per year, the total deposits would only be about $200 million annually. The Mexican government could cover that sum easily. Thirdly, Mexico has large amounts of internal inequality, and a relatively weak federal government: this would be a good way of effectively transferring wealth from the richest parts of the country to the poorest. And finally, Mexico suffers from having a very small tax base and a very large informal economy; this would help to formalize a large part of the population over the course of the next couple of decades when Mexico’s oil revenues are going to continue to dwindle.

But I see problems with the FAB idea too.

Firstly, it’s not at all obvious whether any depositary institutions are both willing and able to open and manage bank accounts for millions of newborns. The poor are unbanked largely because banks don’t want to bank the poor: it’s not profitable for them. And governments tend to have severe restrictions on which institutions are allowed to take deposits: that’s one reason why microlenders often don’t do that. (And, of course, it’s a reason why unregulated mortgage lenders were a large part of the financial crisis, but that’s another story.)

The technology for banking the poor is improving fast, and often includes cellphones; in many cases, the cellphone providers themselves are the obvious providers of banking services. But in most countries that isn’t allowed. Meanwhile, the big international banks who might have interest partnering with FAB are very unlikely to actually want to manage millions of tiny bank accounts themselves.

Secondly, it’s still hard and expensive to transfer money internationally. Here’s Chowdhry:

Imagine further that your teenage daughter Emily decides to contribute $10 a month for Krupa for her college education. Krupa’s initial $100 deposit plus a $10 a month contribution from Emily accumulates interest until Krupa turns sixteen. At a (real) interest of 4% a year, Krupa would have accumulated nearly $3000 or Rupees 150,000 that can pay for her college education in India.

We are still a very long way from a world where a $10 deposit can wing its way from a US bank account to an individual’s account in India without being wiped out by transaction and currency-conversion fees along the way. And we’re equally far from a world in which a bank account with just $100 in it can predictably pay a 4% real rate of return — especially not in dollar terms. I’m pretty sure that’s never going to happen, and that it never has happened, either. Bank accounts simply aren’t things which pay positive real rates of interest, especially not positive real rates as large as 4%. If you can find a bank account paying just 0% in real terms that’s quite an achievement, most of the time.

And the IT infrastructure needed to put this scheme together is very likely to cost much more than the $100 per newborn that actually gets deposited into the accounts. Chowdhry was talking with great optimism about a plan in India which might cost as little as $5 per person, but I’ll believe it when I see it: enormous nationwide technology projects always cost insane amounts of money, and almost never come in on time and on budget.

Thirdly, Chowdhry is a bit confused, I think, about the whole question of which currency these accounts are going to be in. He talks about them being seeded with “US$100″, but if they’re dollar-denominated, that essentially means that the deposits have to leave the country and travel, ultimately, to the US. (It also means there’s no chance in hell of them earning a 4% real rate of interest.) Worse, it makes it very hard for the owners of the accounts to make deposits and withdrawals, which is a large part of the reason for setting up the accounts in the first place.

So it makes more sense, and it’s certainly more intuitive, for the accounts to be denominated in local currency instead. The problem then, of course, is that they’re utterly exposed to the risk that the local currency will be eroded away by inflation and/or devaluation to the point at which the initial deposit becomes worthless long before the child’s 16th birthday. Currency crises are, sadly, quite common things in poor countries: even Mexico has had two big ones over the course of Gil-Diaz’s career. And during a currency crisis, small locally-denominated bank deposits tend to be hit very hard indeed. Many of the world’s poorest would be much better off with 10% of a cow than they would with the local equivalent of $100 in the bank: real property can’t devalue like money can.

More generally, the FAB campaign seems to be operating in something of a vacuum: rather than trying to coordinate closely with international development institutions like the World Bank or the Inter-American Development Bank, it’s barging ahead on its own, largely oblivious to whether or not the campaign is actually being helpful in the broader development context. Access to financial services is indeed a key part of any development agenda, but it should ideally be deeply integrated into that broader agenda, I think, rather than being freelanced by US finance professors with a bright idea. Chowdhry and the rest of FAB’s board are undoubtedly well-intentioned, but that alone gets you precisely nowhere in the world of development, as we’ve seen many, many times in the past.

My feeling is that this whole scheme has been dreamed up by a group of rich men who live in a world where people can just walk into a bank and open an account and put money in it and have that money be safe there. Their dream is of a massive top-down project which gets implemented on a country-by-country basis. But that’s not the world that most people live in. And when it comes to successful development projects in the realm of financial services, it’s the schemes at the other end of the spectrum which often work the best: the ones targeted at women, which are built from the ground up, and which get rolled out slowly on a village-by-village basis. Those schemes aren’t as ambitious, but at least if they break they don’t end up costing billions of dollars.


Felix, my point was because the government is worried about protecting savings, they have usually balked at microlenders from taking deposits. Yes, savings will need to be protected using deposit insurance and other mechanisms. My op-ed piece from many years ago http://www.financialexpress.com/old/prin t.php?content_id=69055

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Regulatory reform goes to the full Senate

Felix Salmon
Mar 23, 2010 15:33 UTC

Back on March 11, when Chris Dodd put financial reform on a forced short timetable, I said that “financial reform is not dead yet: we’ll have a much better idea at the end of next week what its real chances are”. Well, that date has been and gone, and now a bill with no Republican support has been pushed through the Senate banking committee in a move that Bob Corker called “pretty unbelievable”. And yet, reform is still not dead: Dick Shelby, for one, sounds reasonably constructive when he says that “we’re not going to the floor polarized; we’re going to the floor right now in the spirit of trying to work a consensus bill, a meaningful, substantive bill that I’ve said all along that we need.”

Daniel Indiviglio thinks that means we’re in for “a wild battle”, even as Tim Geithner tries his hardest to make the conservative case for reform. And here’s his analysis of the political calculus:

Dodd can’t pass this bill without at least one Republican. He might believe he has a better chance at luring non-Banking Committee Republicans to vote for the bill with fewer changes than would have been necessary to get Republicans on the committee to go along. And he could be right. But I’m not at all convinced that he’ll necessarily have all 59 Democrats with him, so he may very well need several Republicans to come to his side. After all, even in the more liberal House, financial reform only passed by five votes, despite that chamber’s much stronger Democrat majority.

I suspect this is right. It’s not that there’s any chance of a bill passing with multiple Republicans supporting it even as a handful of Democrats vote nay. Rather, it’s that a handful of Democrats are only going to vote aye if there’s non-trivial Republican support for the bill. Or to put it another way, don’t expect this bill to pass with 60 or 61 yes votes. If it passes at all, it’s going to have more than that. And the route to getting the support of a decent minority of Republicans is still via Dick Shelby: the whole interlude of flirtation with Corker now seems, with hindsight, like it was a complete waste of time.


Unless they claw back at the record Wall Street bonuses, this bill will be lame

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Inside a not-bailed-out bank

Felix Salmon
Mar 22, 2010 15:19 UTC

People have many legitimate reasons to have a grievance against their bank. In fact, it’s rare to find someone who hasn’t been extremely angry at their bank at some point. But rarely is there a case as clear-cut as this one, from Aaron Elstein:

Last November, Martin Cadillac, a prominent New York area car dealer, sued Mr. Antonucci and Park Avenue Bank, claiming the bank made “extortionate demands” and engaged in “predatory lending.”

Martin Cadillac alleges that Mr. Antonucci threatened to terminate its credit line, which would have put the dealer out of business, unless it agreed to provide cars to the bank and members of Mr. Antonucci’s family. The dealer gave Mr. Antonucci’s son a $33,000 Land Rover for no charge, two Cadillac SRXs worth around $50,000 each to his wife, and a $75,000 Cadillac Escalade to the bank, according to court documents…

The feds say they began investigating Mr. Antonucci last October, and he resigned as CEO the same month. Earlier this month, regulators seized Park Avenue Bank and transferred its accounts to Valley National Bank.

A banker has a huge amount of power over his borrowers: he can end their credit line and their banking relationship at any time, and since it takes a long time to build up that kind of trust and relationship, such an action can mean the business is forced to fail. If these allegations have any truth to them, Antonucci deserves to go away for a very long time indeed.

Antonucci stands out for another reason, too: he’s one of the very few bankers who was so far beyond the pale that Treasury wouldn’t even give him the $11.3 million of TARP funds that he asked for. It seems that the bailout machine wasn’t completely a rubber stamp, after all.


I am not sure that the majority of banks who formally applied for TARP received TARP. But even if that were true, banks were advised privately whether or not to apply. All TARP applications were pre-screened by the bank’s primary regulator; that regulator actively and systematically advised banks whether or not their applications would be successful. One obvious “don’t bother” whisper was to banks on the FDIC’s problem bank list. And there were other “don’t bother” categories including banks in certain market areas with significant real estate price declines–Arizona, Nevada, Florida. I am not placing a value judgment here. The regulators were trying to be stewards of taxpayer funds and didn’t want to give TARP to bank that might fail.

What is clear here is that the criteria for a small bank to receive TARP was “absence of regulatory blowback risk,” i.e. the regulators picked only the banks that really didn’t need the capital now or in the foreseeable future. This was not a bailout. In contrast, the large bank qualifications for TARP were based on an almost diametrically opposed concept–the pressing need for capital now in order to be bailed out from receivership.

So to my earlier comment: If only the best small banks got TARP, how could it be that ANY of those “best of the best” small banks can’t now pay their TARP dividend? I think that there are several possible answers here: (i)misrepresentation of books and records during the TARP process (like Park Avenue Bank and UCBH); (ii)relatively lenient bank examiners, or(iii)some significant post-TARP event like unexpected CRE/SFR declines, unnoticed internal control failures or the like.

So…not getting TARP was a common occurrence (90% of the banks didn’t get TARP). However, the bank that now can’t pay its TARP dividends is flying a blazing red flag of something terribly wrong.

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