Felix Salmon


Felix Salmon
May 24, 2010 04:44 UTC

Crowded Rush-Hour Roads in Utrecht — How We Drive

For Mosel wines, “a 1°C increase in temperature would yield an increase in farmer revenue of about 30%” (pdf) — Wine Economics

Graydon Carter’s virtuoso review of Martin Amis — NYT

“My ‘option’ to return to the firm has devolved into a discussion on which way I would most like to get fired” — Above the Law

Ugly Lower East Side apartment asking over $5 million — Curbed

The Street Pianos are Coming! NYC’s Latest Public Art Experiment — Village Voice

PaidContent Founder Ali To Depart Pioneering Digital News Site — All Things D

“This is the best use of the Internet that I, personally, have ever seen” — Metafilter

The hoops David Pogue needs to jump through to approve blog comments — NYT


The “best use of the internet I have ever seen” is a lot of people being happy after two women refuse a request to become hookers. The two women didn’t even consult the internet in making their decision.

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Does a European fire break exist?

Felix Salmon
May 24, 2010 04:38 UTC

Mohamed El-Erian had one of his most explicitly bearish op-eds yet in the WSJ this weekend, saying that “the unwind of unstable investor positions is still in its early stages”. But he also talked a little about the necessary policy responses which have yet to be seen in Europe:

Are appropriate circuit breakers being put in place to limit the collateral damage for European growth and the global economy more broadly? …

The emphasis on circuit breakers is there, but badly targeted. Rather than focus on a defensible and sustainable fire break, too much effort and money are being deployed to defend the indefensible, like Greek over-indebtedness.

I’m skeptical that “a defensible and sustainable fire break” exists even in theory, let alone that it can be implemented in practice. Fire breaks work by isolating problem areas and preventing them from infecting the broader neighborhood. But the global financial system is far too complex and interconnected for any problem area to be isolated: as Rick Bookstaber has shown, correlations can and will appear from nowhere the minute a crisis erupts.

A fire break would, realistically, take one of two forms. Either it would be a bit like a real-world fire break, where you let Greece go down in flames but put lots of resources towards stopping the flames from spreading. I suppose the example here is Lehman Brothers: its collapse was so disastrous that it rapidly became obvious that the government would let no other large financial institution fail in Lehman’s wake. But that was hardly the message that Hank Paulson and the rest of the government wanted to send; they had hoped that letting Lehman fail would be the death of moral hazard and too-big-to-fail, rather than its rebirth. Certainly it’s hard to envisage a scenario where Greece’s collapse reduces the perception of the degree of risk in the rest of Europe.

So then there’s the other kind of fire break, where you burn down a bunch of Greek debt, causing short-term pain for Greece’s creditors, in order to make the sovereign finances more sustainable over the long term. The technical word for that is “default” — which is a lot more drastic than one might normally consider “appropriate circuit breakers” to be. And it, too, is prone to spreading uncontrollably.

This is why Europe is defending the indefensible: because failure to do so means a very high chance of chaos. Maybe once markets have sold off further, that kind of chaos might be more priced in. But for the time being, the indefensible is being defended just because the markets still seem to have faith in it and governments are hopeful they’ll be able to avoid a replay of the period between September 2008 and March 2009. The problem, of course, is that they don’t have a real plan for achieving that.


Now that Germany has agreed to quit whining and fall in line with the ECB’s plan, the debt can has been kicked WAY down the road and that’s a good thing for the euro.


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The Shorebank rescue

Felix Salmon
May 21, 2010 21:48 UTC

There’s a lot of conspiracy-theorizing going on around the high-level rescue of Chicago’s ShoreBank by Goldman Sachs, Citigroup, JP Morgan, Bank of America, and General Electric. The founder of the bank is BFF with BHO, and Chicago politics being what it is, everybody is assuming that the banks involved are expecting some kind of political quid pro quo down the road, for rescuing one of Chicago’s most-loved financial institutions.

I daresay they are. But on the other hand, it’s not nearly as implausible as everybody seems to think that America’s largest banks would step in to rescue ShoreBank. And to see why, it’s worth looking at what one of ShoreBank’s biggest critics, Tom Brown, has written on the subject.

Recession hasn’t been kind to ShoreBank. Inner-city lending is an iffy proposition even in good times. Once the credit crackup started, the company hit the wall hard: at the end of the first quarter, non-performers accounted for 13.1% of assets, while is Tier 1 risk-based capital ratio came to -0.1%. That’s right, negative. ShoreBank lost $106 million in 2009, and projects it will lose a total of $100 million in 2010 and 2011…

ShoreBank, we now know, has a business model that is fundamentally flawed…

ShoreBank lent so much money to people who didn’t pay it bank that the bank’s entire capital has now vaporized. The bank is broke! Its business model and its execution failed. If ShoreBank gets more capital, it will almost certainly make more bad loans and go broke again…

There are reasons most banks don’t do the kind of lending ShoreBank does. To see why, take another look at those capital ratios and NPA numbers. If you want to set up an entity to make provide high-risk, socially enlightened finance, fine. Set up a nonprofit and fund it with voluntary contributions. That’s why God gave us the Ford Foundation.

I don’t know where Brown is getting his figures, but I went to the FDIC’s website (it’s not easy to navigate, I’m warning you, but this link might be a good starting point), and got a bunch of numbers for ShoreBank for the 12 months ending March 31, 2010. Here’s the balance sheet, the performance and condition ratios, and the income statement; if you want the full 69-page call report, it’s here. The numbers are certainly bad. Noncurrent assets and REO accounts for 14.6% of total assets, but the Tier 1 capital ratio is at least positive, at 2.05%, with the bank having $26.2 million in Tier 1 capital remaining. And the total loss for the most recent fiscal year was $17 million, not $106 million.

Certainly, with hindsight, a lot of loans have gone bad. But it took them a while to go bad: it didn’t happen immediately “once the credit crackup started”, as Brown would have you think. Indeed, Dan Gross, in November 2008, held up Shorebank as a great example of a bank where the loans were not going bad — along with Lower East Side People’s, where I’m on the board, and where we’re doing fine without any kind of bailout at all. Not all community development financial institutions are financially dubious things which should only be funded by non-profits like the Ford Foundation, and America’s largest bankers agree that the underbanked deserve non-predatory financial services, rather than the check cashers, payday lenders, and similar institutions which lend only at usurious rates.

This, I think, is the real reason why the biggest banks in the US are stepping up to rescue ShoreBank. If someone pointed to LES People’s as an example of successfully serving the underbanked, that would carry only a certain amount of weight: our total assets are a fraction of what Lloyd Blankfein got paid in 2007 alone, and we’re in a unique situation, in Manhattan, which doesn’t apply to similar institutions nationwide.

ShoreBank, by contrast, is about 100 times larger than LESPFCU, and if the big banks can make it work, can stand as real-world proof that community lending really is a viable business model, and can scale successfully into becoming a profitable multi-billion-dollar institution. In the best-case scenario, the investors will help to turn ShoreBank around, will learn how to do what it does, and will then themselves become much friendlier towards their low-income customers, because they’ll know how to make money from them the good way — by helping them improve their finances and ultimately to become higher-income customers — rather than the bad way, which is to bleed them dry in a predatory manner.

All of the investors in ShoreBank will get a lot of CRA credit for their investment, which makes it very low-cost for them. By rescuing this storied institution they will help a lot of Chicagoans who need all the help they can get; they will learn how to improve their own products for lower-income customers; and they will help to transition the underbanked part of the US population into becoming banked, which is ultimately good for everybody. So while the cynical take on the deal is understandable, I’m not jumping to any conclusions quite yet.


Mega, yes, the demographics are very similar.

Posted by FelixSalmon | Report as abusive

Siwoti Friday: Kwak fisks Langeler

Felix Salmon
May 21, 2010 16:34 UTC

This is where the blogosphere comes into its own: Gerry Langeler, a venture capitalist, takes to Dealbook to try to defend the crazy way in which most of his income is taxed at the 15% capital gains rate. And then James Kwak reads his piece, comes down with an acute case of Siwoti, and delivers a textbook fisking of what passes for Langeler’s argument.

This might be the first point at which I’ve actually seen an MBA put to good use:

Langeler can’t tell the difference between a founder and an investor. To start off, what does it mean to say that founders are “leveraging our money”? The concept of leverage only applies to debt. VCs invest by buying convertible preferred shares, which are a form of equity, not debt.*** They are buying a share of the company, and they get all the upside on that share. That’s not leverage. Seen purely from the standpoint of the capital structure, VC investments dilute the founders. Granted, the company is getting something valuable — cash — in exchange for that dilution. But it’s giving up some of the upside. That’s the opposite of leverage.

There’s much, much more where that came from: go read the whole thing. It’s overwhelmingly probable that you agree with Kwak already: I have yet to find a non-VC who thinks that VC incomes should be taxed at 15%. But you’ll still learn a lot, both about the economics of financing startups, and about the art of putting together a great blog post.


when it comes to narcissistic self-regard, investments bankers, hedge fund managers, and VCs make the most cosseted, spoiled athletes look like boy and girl scouts.

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Good news Friday: Litton withdraws in Ohio

Felix Salmon
May 21, 2010 14:21 UTC

While we’re still celebrating the passage of the finance bill through the Senate, I hear this morning that Litton, the mortgage servicer owned by Goldman Sachs, will no longer auction off that house Ohio and try to kick the occupants out. Litton’s law firm, Lerner, Sampson & Rothfuss, confirmed to me that the sheriff’s sale is being withdrawn, and Jorge Newberry of AHP, who’s trying to buy the house and lease it back to its current owners, says that although Litton has yet to approve the short sale, at least the Monday deadline is no longer looming.

I’ll keep you posted on how this case plays out, but so far, so good. I have no idea whether this development came as a result of pressure on Litton from its owners in New York — but if it did, then good for Goldman. Not only are they doing the right thing, but they also make more money this way, and they help to sidestep some very unpleasant PR. Everybody wins.

Update: I just spoke to the homeowner, who seems happy and optimistic, after having gone through two nightmare years with three different loan servicers, one of whom declared bankruptcy, leaving a large pile of unpaid taxes which had been included in the mortgage payments.

My commenters are right that a strategy of “make sure that your loan servicer is owned by an embattled investment bank, and then get a financial blogger on your side” doesn’t really scale. But the AHP model does scale, and so long as servicers act in their own best interest, there’s some hope that it can work more generally.


I’m glad you did it and all, Felix, but if I ever hear anyone at Goldman going, hey we’re not all bad – at least we let that family wotstheirname in Ohio off the hook – the gag reflex is liable to be a violent one.

Posted by HBC | Report as abusive

The great news from the Senate

Felix Salmon
May 21, 2010 13:54 UTC

It’s almost enough to restore your faith in government. The details have yet to be worked out — and you can be sure that after letting the Senate deliver its own bill on its own terms, Treasury will be deeply involved in the reconciliation process, trying to marginalize any measures it doesn’t like. But the outlines of financial regulatory reform are now clear — the NYT has the best chart, I think — and I have to admit that it’s much, much better than anything I dared hope for even just a few weeks ago.

Amazingly, and wonderfully, the Volcker Rule has made it through the Senate, and will surely not be opposed by the House, which never got an opportunity to vote on it. While Treasury might weaken or abolish Blanche Lincoln’s amendment forcing banks to spin off their swap desks, it now seems very likely that there will be some kind of legislation attempting to reduce the amount of speculation and gambling that goes on at regulated, too-big-to-fail institutions. While that kind of activity didn’t cause the financial crisis, I like the idea of it taking place at hedge funds and other institutions which tend to be less leveraged than banks and more capable of failing without massive systemic side-effects.

Of course, there are always things we’d like to see and which won’t make it into the final bill: the greatly-lamented part of the consumer protection agency which would force banks to offer plain-vanilla financial products is one, and Treasury will ensure that any limits on size or capital or leverage come out of Basel rather than out of Washington. (Me, I’d like to see a couple of basic rules or principles be put into US legislation, which would serve to backstop Basel.)

But as David Herszenhorn says, with this financial regulation bill joining health-care reform in becoming law, the Obama administration has managed to bag a couple of truly enormous elephants in its first 18 months or so in power. Is there any hope, now, that some sort of climate-change legislation might be next?


Sounds good, but the question remains if this isn’t just a battle plan for the war that has already been fought, and whether it addresses the new big problems that the US financial system is facing now, and will be facing in the near future, problems that revolve around the extreme policies applied by the Administration and the Fed.

Posted by yr2009 | Report as abusive


Felix Salmon
May 21, 2010 05:33 UTC

Long PHYS short GLD is earning >25% annualized — Yahoo

Are you human? Try deciphering CAPTCHA graffiti — Vimeo

When RSS feeds commit libel — VF

A Smoking Gun in BP’s Deep Horizon Mess — Thom Hartmann; See also

Sen. Ben Nelson: ‘I’ve never used an ATM, so I don’t know what the fees are’ — World-Herald

This interview with Johannesburg’s mayor just gets better as it goes on. “Every October or so, we use public transport” — Imgur



PHYS vs GLD is apples and pears: PHYS is a closed-end fund and 100x smaller than GLD. So it looks as if all the paranoiacs about GLD are piling into PHYS instead – and overpaying for their gold via the huge premium to NAV.

Compare COMEX ETF and GLD ETF instead: http://tinyurl.com/32yjafm. Hard to tell them apart.

Oops, I have a feeling that was your point.

Posted by RichardSmith | Report as abusive

How financiers are like illegal construction workers

Felix Salmon
May 20, 2010 20:32 UTC

Mark Beauchamp, following up from yesterday, provides some eye-popping numbers:

In the U.S. finance and insurance sector, we estimate that in 2008, 34% of the workers are not covered by unemployment insurance…

Sub-sectors like Central Banks, Commercial Banks, Savings Institutions all had low, single-digit percentages of non-covered workers. However, when we get into sub-sectors like Securities, Commodity contracts and Investments, the majority of workers in the field (66%) are not covered by unemployment insurance.

The further we push into more esoteric forms of finance, the higher the percentage of non-covered workers: Miscellaneous Intermediation (84%); Portfolio Management (80%); Trust, Fiduciary, and Custody activities (81%), and so on. We’ve included the full breakout in .xls here.

So our theory runs like this — in the finance and insurance industry, there was likely a widespread use of the 1099 status, evidenced by the high rate of non-covered employees in the sector nationally. When the financial crisis hit, independent contractors were “laid off” from companies, but because they weren’t employees of the firms, they would not show up as a decline in the Quarterly Census of Employment and Wages.

This is a bit like the way in which construction-sector employment didn’t fall nearly as much as everybody thought it would when the housing bubble burst: because a large proportion of the people working in that sector were undocumented all along, they weren’t counted when they lost their jobs.

The financiers aren’t necessarily illegal, of course, although paying people on a freelance/1099 basis is of dubious legality when they’re working for you full time. But this does help to explain a large chunk of Mike Mandel’s chart, I think.


You guys spent way too much time in formal schools. Most of the labor trades and crafts guys I know that are 1099 enjoy serious tax breaks. Pay ‘em in cash, get a minimum of 25% off, and since they are only reporting maybe 50% of what they make, it still nets out well.

It could be hysterically funny, not that any Democratic politician would sign on for it, to require documentation of taxes paid on earnings as part of any amnesty program.

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Revisiting the equity premium

Felix Salmon
May 20, 2010 19:53 UTC

Allison Schrager takes up the question of the equity premium today:

The return equities generate in excess of the risk-free rate (which is normally short-term Treasuries), is often assumed to be between 5% to 8%. In my experience risk managers go silent when asked where exactly this number comes from.

Schrager herself isn’t much more exact, concluding that “for now it remains a difficult question”. But I think even so she’s a bit too optimistic about the outlook for equities:

A zero long-term equity premium assumes firms in most industries will not be very productive or profitable for decades.

I don’t think this is true at all. For one thing, stock prices tend to have some kind of productivity and/or profitability gains priced in to them: especially in the technology sector, it’s perfectly commonplace for a company to see rising profits which still disappoint the market so much that the stock price falls. Rising profitability or productivity do not by any means mean rising stock prices.

More to the point, improvements in productivity can end up either as returns to labor or as returns to capital; and returns to capital can end up either with bondholders or with stockholders. If productivity improvements end up flowing overwhelmingly to employees and to creditors, then there might well be very little left for shareholders, even if the company is becoming much more efficient over time.

Schrager then continues her argument with this:

Equities are inherently riskier than Treasuries. Equity prices must ultimately reflect and compensate investors for that risk or no one would hold them in their portfolio.

I’m not sure where that “must” comes from: maybe it’s some kind of corollary of the efficient markets hypothesis. Investors certainly hope that returns on equities will be commensurate with the risk that they’re taking. But there’s no rule saying that any given asset class will “ultimately reflect and compensate” those hopes. After all, if there were such a rule, then really there wouldn’t be any risk at all!

When I see people like David Merkel and Eric Falkenstein do the math and come to the conclusion that the equity premium is somewhere between 0% and 2%, I generally come away much more convinced than I am by the vague arguments of those who put it at 5% or higher — arguments which often boil down to “the future will be like the past, if you ignore the really bad bits of the past”. In any case, it’s pretty clear that the number of people with large stock-market investments is much greater than the number of people who really understand the full range of possible outcomes and are comfortable with how much they could lose in the markets if things go badly.

But I’m thinking that maybe the current bout of volatility is helping to bring that home, at least a little.


If you assume that companies would not be profitable for decades, would you then buy equities at a lower expected return to treasuries? Of course not.

Schrager also seems to confuse ex-ante and ex-post in her attempt at an article and to have a definition of “equity premium” that changes while she’s writing. No wonder her conclusion is so weak.

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