Felix Salmon

What was special about the Dead Presidents?

Felix Salmon
May 12, 2010 13:03 UTC

The Dead Presidents CDOs now reportedly being investigated by the Justice Department were not your garden-variety synthetics:

One feature of the Morgan Stanley deals was a structure that could increase the magnitude of the bullish investors’ exposures to the underlying mortgage bonds. This feature, which was disclosed in some offering documents, made it more likely that such investors could lose money if the underlying bonds performed poorly.

This bears a family resemblance to what the NYT reported back in December (h/t Alphaville):

Morgan Stanley established a series of CDOs named after United States presidents (Buchanan and Jackson) with an unusual feature: short-sellers could lock in very cheap bets against mortgages, even beyond the life of the mortgage bonds. It was akin to allowing someone paying a low insurance premium for coverage on one automobile to pay the same on another one even if premiums over all had increased because of high accident rates.

I’d love to know more about this feature. I’m not looking for a quick one-sentence summary which can be dropped into a newspaper article, but a detailed explanation of exactly what it was and how it worked. Does anybody have offering documents from Citi or UBS for these deals which might include such a thing?

I think this shows the limitations of print-based journalism, and the long way we have yet to go before newspapers fully embrace the web. Both the WSJ and the NYT give the impression that they have seen and understood the structures in question, and that they’re simply summarizing them in order to make their stories easier to read for a broad audience. That’s fine — but once you’ve done that, do please give the full details online to finance geeks who want to understand the deals on a finer-grained level.

There were lots of synthetic CDOs structured and sold at the end of the subprime boom, but the ones being singled out by regulators and prosecutors seem to be the unusual ones — first the Goldman deal which was created at the behest of John Paulson, and now the Morgan Stanley deal with this mysterious embedded structure. It would be a great service if the news media, rather than just trying to report the news, also published primary documents and full details of what they’re writing about, so the rest of us can come to our own conclusions.

Update: ProPublica has found a bunch of Jackson prospectuses, if somebody fancies reading them.


As I understand it the posters above are correct, the CDS did not extinguish in line with the amortisation of the pools. So effectively it was like having 100% of your CDS on the last mortgage to repay, rather than having it exposed equally to the entire pool of mortgages. People who wanted to short the pool wanted this to make sure that they didn’t effectively pay premium for the 1st year on 100% of the pool and then watch as the pool amortised by 40-50% over the first 12 months as early repayments occurred. So they created this structure that was effectively amortisation immune. I believe that it’s described relatively well in Michael Lewis’s The Big Short.

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Felix Salmon
May 12, 2010 04:36 UTC

John Powers is a genius. Watch the 6 min intro to his film here, or live — Star Wars Modern

Photo set from massive sinkhole near St Jude, Quebec. Power of nature in an awful story — Montreal Gazette

How have I not until now come across RockPaperScissorsLizardSpock? — Deviantart

Michelle Vaughan’s wonderful oyster prints are now on 20×200, buy the pair — Salty, Slurp

Poster Boy jailed for 11 months, 3 weeks before his book comes out — WSJ

Congratulations, You’re Paying the Least Amount Of Taxes In Sixty Years — TBI

“It is a catastrophic mistake to increase the scale of complex systems without examining the possible implications for failure” — Index Universe

Apple’s no-nipples policy means fashion mags are censoring their iPad editions — ShinyShiny

The hedonic treadmill over the course of 39 minutes, courtesy of Jacob Weisberg — Twitter, ibid  

Advanced search in Gmail — Google

Full disclosure: John Powers is a friend. And Michelle Vaughan is my wife.

Gold and the worry trade

Felix Salmon
May 11, 2010 20:13 UTC

Is it a coincidence that the price of gold hit an all-time high just as David Cameron was becoming the prime minister of Britain? Yes. But it’s also indicative of the enormous amount of uncertainty that continues to pervade the market. If you’re just looking at the stock market, you’re not looking at the most sensitive barometer of fears about the global economy in general and the eurozone in particular. As Paul Krugman notes, the euro/dollar exchange rate is probably a better place to look, and that’s now back down below 1.27, after trading at 1.50 as recently as December. For what it’s worth, here’s the price of gold in euros:


It’s entirely conceivable that we could see gold at €1,000 an ounce pretty soon. Which, just as much as recent stock market volatility, is a pretty clear indication that there’s still a lot of worry out there, trillion-dollar eurozone bailout plans notwithstanding.


Finance is as we know, much like a fortune tellers ball! To monitor the exchange of value between different types of commodities is a full time role. Hence stock brokers! Gold is, like much of the market, effected in both highs and lows.


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Real income datapoint of the day

Felix Salmon
May 11, 2010 16:09 UTC

Manhattan incomes rose by 35.5%, in real terms, between 2000 and 2008. Manhattan, Kansas, that is. Meanwhile, in much more educated and vibrant cities like Raleigh and Austin, real incomes fell substantially. What’s going on here? Mike Mandel looks at the numbers:

Brains and education did not seem to count too much in success in the last business cycle. Overall, the top ten cities, measured by growth in per capita income, had an average college graduate rate of 17.7% The bottom ten cities had a college graduate rate of 31.8%.

My feeling is that this is a historical anomaly, and largely a product of the beginning and end points that Mandel used: 2000 was the peak of the dot-com bubble, which artificially inflated tech salaries, while 2008 came at the end of a commodity boom which helped oil-rich states. The long-term trend is inescapable: the returns to education are large and growing, and if you’re not a college graduate and you don’t own your own company, it’s becoming increasingly difficult to maintain a middle-class lifestyle.

What’s more, Mandel’s outliers have to bee seen in the context of the bigger story about real wages, which he noted back in April: real wages in general have been falling, for the first time since the Great Depression. And with unemployment still at 10%, there’s not much hope that they’ll start rising again any time soon. If you want to see incomes go up in your city or region, your best hope is frankly just to get lucky, like Manhattan did. Because wages in the U.S. as a whole aren’t going anywhere.

(HT: Cowen)

Update: I had lunch today with Allison Schrager of the Economist, and she asked a good question: how did the percentage of college graduates in these cities change from 2000 to 2008? And what happened to the student population in Austin?

Update 2: Mark Beauchamp of EMSI makes some excellent points via email:

Mr. Mandel’s lead example of Metro Areas with the Biggest Real Per-Capita Income Gains was Houma-Bayou Cane- Thibodaux, LA — a metropolitan area that had 11% of the population of the San Jose MSA in 2002.

Between 2002 and 2009, its population grew 5.08% while its total employment grew 19%.  You have to have an income-per-capita increase in jobs like that.  An income-per-capita ratio favors regions that have explosive income growth (especially jobs that pay above the previous average), and population growth that lags behind the job growth. Conversely, the ratio will not favor areas that have a high amount of population growth with concurrent losses in total income.

The  biggest “loser” by this metric is the San Jose MSA, and during the same time period  its population grew by 86,269 people (5.16% growth) and lost 43,314 jobs (a 5% loss).  For purposes of scale, the San Jose MSA added the equivalent of half of the population of the Houma MSA and lost the equivalent of half Houma MSA’s workforce between 2002 and 2009.

Tying this in to education level is pretty silly — these are boom towns (oil and military), and likely with a high amount of young workers, early in their careers who didn’t bring spouses or children (extra, non-income-producing population, thus dampening the ratio).  This is like comparing the boom towns of the Western US with the established cities of the Eastern US during the Long Depression at the end of the 1800’s.

He also has some numbers for college graduates in Austin: they were 46% of the population in 2002, and 44% in 2009. So that doesn’t explain very much.


i am thinking we are seeing a decades long deflation of incomes. with a minor up tick in the mid 1990s. and a lot of the current deflation since 2000 is because jobs that required education were subject to being sent where they could hire much cheaper labor. and i like that idea of several Apollo like projects, the reason so many in physics and math went to wall street is really simple. not only do they pay well, but its where the jobs are. there are very few companies that do much in the way of research and development that need their skills and knowledge any more. most r&d in the private sector is only for projects that can show returns in a quarter or year at most. might have some impact on why we don’t have a lot more math and science grads

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Europe: It’s more than just government debt

Felix Salmon
May 11, 2010 13:50 UTC

02marsh-image-custom1.jpgRonan Lyons is unimpressed by the now-viral NYT graphic showing the web of debt within Europe. It’s particularly unfair to his native Ireland, he says:

Because they didn’t look behind their statistics, however, the graphic is about as informative as CNBC’s now infamous unveiling of Ireland as the world’s most indebted country, with debts worth 1300% of GDP! The point that both miss is that you can’t look at debt liabilities without looking at corresponding assets.

That is why the markets are worried not about all debt. They are worried particularly about government debt, because typically there is no corresponding asset.

PIIGS-debt.pngIt’s true that Spain and Ireland — particularly the latter — have much less of their debt at the government level than, say, Greece. And Lyons helpfully provides a little chart showing how much of each of the PIIGS’ external debt is government debt.

But we’re still a long way from the point at which markets are more worried about government debt than about corporate debt, at least if you’re measuring such things using credit spreads. Investors still believe in the concept of the “sovereign ceiling”, and it’s still extremely rare for any corporate, including a bank, to be able to borrow more cheaply than the government of the country it’s in.

Writes Lyons:

For Portugal and Spain, it’s only one fifth of all debt. In the case of Ireland, just five percent of all its debt is general government debt.

The reason is hardly a secret: Ireland is a major international financial services centre. The international financial services sector plays such a large role in the Irish economy that it even gets its own set of statistics from the Central Statistics Office. At the end of 2008, the sector had debts of almost €1,650bn. Don’t worry though – it also had assets worth about €1,660bn.

Don’t worry? Of course we should worry. We’ve all seen what can happen to bank “assets” in extremis: Lehman Brothers and Washington Mutual both had assets greater than their debts before they collapsed, and then suddenly they didn’t. And in case Lyons has forgotten, the Irish government is still providing an unlimited guarantee on $600 billion of deposits and interbank debts at Ireland’s banks.

Or, to boil it all down into one word: Iceland. Government debt was never much of a problem in Iceland: the problem was bank debt. But bank debt has a habit of becoming government debt when there’s a crisis. And I’ve never seen a sovereign default where the banks of the country in question all happily continue to pay all their debts. When a country defaults, its banks default too.

So I’ll side with the NYT over the FT here: the original graphic is just as informative as it is striking, and it’s important to look not only at direct government debt, if you’re examining a country’s finances, but also the total external indebtedness of the country in question. Which actually helps Greece, a country where a huge swathe of the population owns their home outright, and where credit-card debt and other personal indebtedness never had the kind of bubble seen in places like the UK.


Man Ireland has a lot of debt… :( no wonder i lost so much money on my Irish National Bank stock, here is a funny joke I saw about outstanding debts,
http://ponderingstuff.com/2010/07/05/ent ering-the-witness-protection-program-to- get-rid-of-bad-debts/

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Felix Salmon
May 11, 2010 07:40 UTC

The winner’s curse implies that Labour and the Lib Dems should allow a Tory minority government making huge spending cuts — Guardian

Cool Lilly Allen video — Field

“The euro stood at $1.2744, returning to levels seen before the rescue scheme was announced” — Reuters

I’m no great fan of Siegel. But this is an extremely lucid case for stocks — Kiplinger

Kinsley’s new column — Atlantic Wire

Cokie Roberts : Laura Bush :: ACA : John Paulson — Washington Examiner


I can see why you are not a Siegel, he is comparing apples to oranges, assuming inflation (as oppossed to deflation) is the only risk, and ignoring risk adjusted returns.

the yield on a 10 year corp portfolio (and i have not done this in too much depth just blended 50% ig with 25% of hvol and hy) is very approx 5.8-6%, as opposed to govt yields at 3.7%

with high unemployment, declining house prices, taxes soon to rise, excess capacity, and at some point a withdrawal of transfer payments there is a considerable risk of deflation, please don’t give me the “we’re printing money, look out for Wiemar inflation” argument. inflation just transfers wealth for debtor to creditor

given the still potentially huge risks to the financial system, shocks and volatility can not be ruled out. possibly the higher place in the capital structure is compensation for the slight drop in yield.

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Nassim Taleb didn’t cause the crash

Felix Salmon
May 11, 2010 07:11 UTC

Of all the silly theories about the cause of Thursday’s stock-market plunge, I’m not entirely sure why the WSJ has decided to give particular credence to the idea that it can all be traced back to a single $7.5 million trade for 50,000 options contracts. Lots of options trades of that size take place every day, and just because this one happened just before the market fell doesn’t mean it was the cause of the crash.

It’s becoming increasingly clear that the crash was fundamentally the fault of weak market structures, especially in the smaller electronic exchanges. It wasn’t a fat finger, it wasn’t cyberterrorism, it wasn’t the sale of 16 billion e-mini S&P contracts rather than 16 million — and it wasn’t an options trade by Universa, either.

When your hard drive fails, you don’t ask for the proximate cause of the failure: even if such a thing existed, which it doesn’t in any meaningful sense, knowing what it was really wouldn’t help. The important thing is that your hard drive is prone to fail and therefore it’s a good idea to have redundant systems and make sure that when it fails, no great harm is done.

So let’s not start pointing fingers at Universa, Nassim Taleb, or anybody else. The thing to look at here is the way the entire market is designed, not the identity of any given trader.


I was wondering when they were going to get around to blaming this problem on the options market, when they ran out of other people to blame.
If anything, I was trying to trade index options when the thing started to crash and, I’m assuring the index options market protectively self-shut-down as I couldn’t get a quote, a trade, anything for 15 minutes.
So go find someone else to blame.

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Why Greece might not default any time soon

Felix Salmon
May 11, 2010 04:59 UTC

Anna Gelpern has the smartest take on why Greece won’t default, which kicks off with this powerful truth:

As a descriptive matter, the global political commitment behind the no-restructuring option is without precedent. And sovereign debt is nothing but political commitment.

She adds a number of other good points, including that default wouldn’t actually do Greece all that much good:

A debt restructuring now is unlikely to bring needed debt relief for Greece. Among other things, Greek banks are massively exposed and would need to be recapitalized by the defaulting government or the foreign public sector. True, Argentina did it before, but it got the benefit of stiffing a bunch of foreigners for free in the bargain, which is not a foregone conclusion here. And Argentine officials could afford to stick it to local pension funds for internal political reasons. Don’t think Greece compares.

A debt restructuring now does not spare Greece the pain of adjustment – perhaps it does not even make much of a difference for the quantum of suffering. Paul Krugman says Greece is set to suffer in the extreme even if it defaults completely. And it will not default completely.

And on top of all that, the dominoes which would start falling in the event of a Greek default are Greece’s biggest export markets.

None of this changes the fiscal mathematics, of course. But Greece has an enormous amount of low-hanging fruit in the form of uncollected taxes on undeclared income, and although it will take time to start collecting that extra money, time is exactly what the EU has just provided, and is likely to continue to provide. After all, I don’t think anybody really believes that a Greek failure to follow to the letter every last IMF condition will mean that the country is immediately cut off and left to its own devices.

Greece will be a significant credit risk for the foreseeable future, if only because it needs external support to be able to service its debts. But Europe has now shown that Greece has that external support. Which means that default has moved from a real near-term possibility to something further off.

All of this is reasonably compelling — if Europe is serious about yesterday’s trillion-dollar package and it comes together as announced. Which brings us back to the question of political commitment. It’s clearly not there from the UK, which has loudly opted out from the whole shebang. Is it there from the rest of Europe?


What you call a powerful truth is a bit silly. It’s like Fred tried to stop drinking in the past and it didn’t work but now he’s going to do it because he’s really serious and committed. What kind of an argument is that?

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Waiting for details on the trillion-dollar rescue

Felix Salmon
May 10, 2010 19:50 UTC

It’s not all that easy to tell, but it looks very much as though most of today’s market rally is a function of the ECB deciding that it can start buying bonds in the secondary market after all. The trillion-dollar announcement from the EU looks big and grand, but ultimately is so vague that few market participants would place much stock in it.

If you have 16 central banks all announcing that they will buy both government and private debt, that’s going to provide a one-day boost to markets, which are going to price in all that future demand. But if all that yesterday’s announcements achieved was a one-day rise in stocks and bonds, that counts as failure. What’s important is that markets are so impressed by the trillion-dollar fund side of things that they don’t even bother selling the debt of countries like Spain and Portugal, since they know that a solid safety net exists.

That’s not going to happen. Just like Hank Paulson’s TARP bazooka had to be pulled out and used, the markets are going to push the Eurozone periphery to a point at which the new bailout mechanism needs to be activated. And right now, nobody knows how or whether that mechanism is going to work. Does it need to be ratified by every individual country which is providing a guarantee? How cheaply will the SPV be able to borrow? Will it just borrow at floating rates overnight while lending at three-year terms, thereby essentially becoming a bank? How much faith will the markets place in the fragmented set of guarantees which is meant to reassure lenders to the SPV that they will be paid back in full? If one country fails to make its pro-rated payment, what happens then? Does the SPV have seniority over private-sector bondholders and even bilateral lenders in the way that the IMF does? Can any of this work in the absence of a formal international treaty setting it up? There are simply too many questions and too many uncertainties for anybody to be reassured at this point that the eurozone’s fiscal problems have found even an intermediate-term solution.

Well done to the ECB, then, for saving the day — at the cost of its own independence. Let’s hope that it saves at least the rest of the year as well. Otherwise the cost was surely too much of a price to pay.


You all strike me as intelligent fellows, but I think you’re missing the point with respect to this EU bailout. Essentially, this represents an acknowledgement that the crisis, nearly out of hand, must be gotten under control, at any price. So this $1 trillion is a statement of resolve among the member states of the EU that the price of the crisis will be shared among the member states and amortized into the future, rather than paid in a series of lump sums by the profilgate PIIGS.

In practical terms, Felix is right, the resolve alone is a one-day wonder. It will take a series of further steps to assure the market that words will lead to deeds, just as it took Congressional ratification of TARP, followed by repeated assurances of low interest rates from the Fed, coupled with an ongoing program of debt repurchase agreements, starting with $300 billion in long-dated treasuries, and continuing with $300 billion in mortgage debt purchases added to the Fed balance sheet, on top of the Congressional blank-check written to Fannie Mae and Freddie Mac.

In short, this move by the European Union should be taken as just what it is: a good start, but only one step down the road toward a complete solution.

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