Felix Salmon


Felix Salmon
Jul 7, 2010 03:46 UTC

The Time Mag paywall: it’s back, and higher than ever — Nieman Lab

Robert Sullivan’s fantastic story on bringing bus rapid transit to NYC. This can really happen, people! — NYMag

Record Low Yields for the 2-Year U.S. Treasury Note — Vix and more

Why admire RenTech?

Felix Salmon
Jul 6, 2010 21:31 UTC

Memo to John Ioannidis: you’re popular with some extremely rich and important people! Sebastian Mallaby reports on RenTech:

Simons’s faculty of quants does not think like the rest of the financial industry. It does not hire people from the rest of the financial industry, either, and has little in common with academic finance. For a while Simons’s scientists picked through finance journals, looking for ideas that could be traded profitably. But they soon concluded that none of the ideas worked. When I visited Simons’s Long Island campus, a star statistician had stuck an article to his office door. “Why Most Published Research Findings are False,” the title proclaimed, summing up the faculty’s disdain for the crowd’s wisdom.

The Ioannidis paper is worth reading, and not only because it’s presented, for free, in a beautiful HTML (rather than PDF) format. (If it’s all a bit wonky, here’s Alex Tabarrok’s attempt to translate it into English.) Among his headings:

  • It can be proven that most claimed research findings are false
  • The greater the flexibility in designs, definitions, outcomes, and analytical modes in a scientific field, the less likely the research findings are to be true
  • The greater the financial and other interests and prejudices in a scientific field, the less likely the research findings are to be true
  • The hotter a scientific field (with more scientific teams involved), the less likely the research findings are to be true
  • Claimed Research Findings May Often Be Simply Accurate Measures of the Prevailing Bias

All of these things, of course, apply in spades when it comes to finance. What’s not at all obvious is why anybody at RenTech thinks that they’re exempt from Ioannidis’s findings — especially given that RenTech’s very own Bob Mercer told Mallaby that “the signals that we have been trading without interruption for fifteen years make no sense.”

Mallaby is convinced that this band of science-hating scientists constitute the best possible group of risk managers, and that it’s unconscionable to interfere with what they do in any way:

Hedge funds have nurtured a paranoid and contrarian culture that makes them good custodians of risk—not perfect, but certainly superior…

If lawmakers understood the virtues of hedge funds, they would have written a bill that actively promoted them. Instead, their legislation will hamper Simons and his followers in myriad small ways, forcing them into pointless registration with the Securities and Exchange Commission. Tragically, a basic truth is being missed: Investment risk is not going away, and the best way to handle it is to entrust it to hedge funds.

I fail to see why it should hurt RenTech to register with the SEC; even Economics of Contempt concludes that although the registration requirements are a bit too fuzzy and capricious, “on net, in spite of the epically bad drafting, this could end up being a net positive for the financial system.” Certainly RenTech has more than enough money to be able to hire a couple of extra compliance officers if it has to. And registration with the SEC is not “pointless”: indeed, it’s the only way in which systemic-risk regulators can try to look directly at these key market players, with an eye to seeing whether unhealthy concentrations of risk are being built up across a group of large institutions. They might not succeed, but at least it’s worth at try.

Besides which, I’m not at all convinced that the best way to deal with investment risk is to start paying billionaires 2-and-20 to manage your money for you. For a good example, look at RenTech itself: the funds which are available to the public, RIEF and RIFF, have dropped to $6 billion of late, down from $30 billion in 2007; they might be closed down altogether. Clearly, RenTech’s management are better at enriching themselves than they are at building a long-term franchise for stewarding other people’s money.


“It can be proven that most claimed research findings are false” reminds me of a circular logical impossibility (e.g., “there is no such thing as absolute truth”).

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Entering the age of default

Felix Salmon
Jul 6, 2010 19:22 UTC

James Saft today quotes the “six ways to dig oneself out of a debt hole” of Jeffrey Gundlach. Boiled down, they are

  1. Growth
  2. Lower interest rates
  3. A money transfer from an outside benefactor
  4. Higher revenues (taxes) and/or lower spending
  5. Printing money
  6. Default.

He’s too polite to mention the seventh option, which is to lie about how much debt you have and hope the markets don’t notice.

It’s worth bearing this list in mind in light of what David Merkel has to say about sub-sovereign debt:

I have long said that the health of the states is a more valid measure of the health of the nation than looking at national statistics. Why?

  • The states can’t print money, or force ask allow the central bank to buy their debt.
  • In general, the states must run balanced budgets. (Would that we constrained the Federal government to do the same through amending the Constitution. Somebody bring that up after the crisis is over, please?)
  • State statistics are more reliable than Federal statistics, because they serve fewer political goals.

John Dizard seems to be thinking along similar lines, saying that Greece has already started restructuring its debt, on the grounds that the state hospital system is imposing haircuts on its creditors.

It’s only natural to look at sub-national defaults and near-defaults, from entities like Greek hospitals or the state of Illinois, as indicative of a broader fiscal malaise. If nothing else, it’s a sign that the sovereign is either unwilling or unable — or both — to bail out the troubled borrower in question. And as Merkel says, sub-sovereign defaults are “purer” than their sovereign counterparts, since a lot of the tricks available to the sovereign are inaccessible to anybody else.

I don’t think it’s fair to say that problems with Greek hospital debt mean that the sovereign has already defaulted, any more than non-payment from Illinois means that we’re in the middle of a US default. But I do think that default will become more common among sub-sovereign debtors, and as it does so, both creditors and debtors will start considering it seriously among the menu of options available. When nobody’s doing it, default is unthinkable. But once it starts popping up all over the place, it becomes a strategic option. That’s true of homeowners, who are more likely to default when their neighbors are doing it too, and it’s true of sovereigns as well.


..and what happens when the people stop recognizing the so called “sovereign” as sovereign ? the quaint old “by the consent of the people” thing ? it might suprise how much this is now taking place..thanks to Felix and Jim, and Reuters, for these excellent articles..

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Sovereign default datapoints of the day

Felix Salmon
Jul 6, 2010 17:56 UTC

CMA Datavision has released its sovereign risk report for the second quarter of 2010. It’s based on CDS prices, and it makes for fascinating reading. It was a bad quarter for sovereign credit: 93% of sovereigns widened, and they widened a lot — by 30%, on average. Spreads in France, Portugal, and Spain all more than doubled, while Greece soared from 346bp to 1,003bp, at one point becoming the riskiest sovereign in the world, trading slightly wider than Venezuela. Only one country saw its CDS spreads tighten in significantly over the second quarter: Iceland tightened in by 17% to 330bp, making it riskier than Ireland but safer than Portugal.

CMA turns all of its CDS data into a 5-year cumulative probability of default: both Venezuela and Greece are more likely than not to default at some point in the next five years, according to these numbers, while Argentina comes very close. Portugal, Latvia, Iceland, Ireland, Spain and Croatia are all in the 20%-25% range, along with Lebanon, which has long had a debt which would be unsustainable were it not for a rich, generous and patriotic diaspora.

One interesting thing is that CDS spreads don’t correspond directly with default probability: Croatia, for instance, has a 20.5% chance of default with CDS spreads at 322bp, while Spain has a higher default probability — 20.7% — while having significantly tighter CDS spread of 265bp.

The reason is that CMA is using at least two different recovery ratios. If Greece or Spain or Italy defaults (or if the US does, for that matter), then CMA assumes that creditors will get back 40% of their money. But the recovery value in countries like Croatia and El Salvador is assumed to be significantly lower, at 25%.

Both figures are low, but I don’t think that this discrepancy makes sense. It seems to me that recovery values should be inversely correlated with debt-to-GDP ratios: if you have relatively little debt, then a modest restructuring can get you back on a sustainable footing, while if you have a lot of debt — like Greece, for instance — then the haircut you’ll need to impose on your creditors is much greater. I see no good reason at all for assuming that recovery values in Croatia will be higher lower than in Greece, especially after accounting for the fact that Greece is likely to have a large number of preferred creditors in Europe who will insist on being paid back in full before private-sector creditors get anything.

I do think that in future reports CMA should make its recovery-value assumptions explicit. The CDS data is important and interesting, but the default probabilities are less so, based as they are on recovery rates which seem dubious indeed.


OK, suppose God comes down from heaven and informs you that your recovery rate assumption is correct and that you have correctly modeled the joint stochastic evolution of hazard rates and FX. Now you can confidently imply a default probability, but what is the point of the exercise?

What you have is a risk-neutral probability, i.e. the probability that gives you the right price in your chosen units. If your goal is to make inferences about “real” probabilities, this is every bit as circular as it sounds, because it embeds the price of risk. One expects (hopes?) this price is positive, in which case the implied probability must be higher than the “real” one. But if DanHess is right, then the price of risk might be negative, giving you probabilities that are too low – maybe even negative themselves. A negative probability would be a clear indication that some of your assumptions are wrong, but in general you can’t decide whether your probability is too high or too low without knowing the “real” probability in the first place.

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Towards a Google Bank

Felix Salmon
Jul 6, 2010 15:24 UTC

Adam Ozimek has a bright idea:

Allow any company to become a bank with a very minimal regulatory barrier if they do 100% reserves on deposits. This means people will know their money is there whenever they want it, which will make the “bank” safe from runs, which will eliminate the need for FDIC insurance or heavy handed regulation.

In principle, I like the idea of non-banks like Google and Wal-Mart being able to conduct banking-style services. It works fine in other countries, like the UK and Mexico, and in principle anything which increases competition in the banking sector should be good for consumers.

On the other hand, I don’t see any reason why these new banks should be less regulated than existing institutions. Indeed, in the first instance — the first two or three years of operation, say, while the model is still untested — I’d want much more regulation, even unto a complete ban on lending. And I’d certainly want these institutions to voluntarily submit to the oversight of the Consumer Financial Protection Bureau, even while they were under $10 billion in size.

It’s also worth asking exactly what Ozimek means by “100% reserves on deposits.” What counts as “reserves”? Would uninsured deposits at banks count? How about money market funds? Would they all need to be available on demand at par? And would the reserves count as the cash reserves of the parent company for accounting purposes? If so, could these banks ramp up against their current cash reserves without having to make any extra reserving actions at all, happily lending out everything they take in as deposits?

Even with strict controls, there are some interesting things which Google might be able to do in the payments space, including building payments functionality right into its Chrome browser and Android OS. Indeed, Google’s already moving in that direction without a banking license.

The reason that Ozimek wants loose regulation when it comes to these new entrants, of course, is that it’s much harder to do any kind of payments innovation when you’re part of a regulated institution. Which is why companies like Visa and Mastercard, even when they were owned by banks, weren’t actually banks themselves. But the problem is that if you want to encourage innovation, you also have to encourage failure. So the question I have for Ozimek is this: do you want to see a payments system fail? And how do you build a system which can cope with such a failure, if you’re not keeping a close regulatory eye on it?


Central banks were created due to various single bank failures. Before central banking many institutions acted as banks and printed their own currency. A pharmacy in new york for instance produced US dollars. These thousands of banks across the US had currencies units (dollars) that traded at discounts or premiums to each other relative to the perceived safety of the underwriting bank.

Gold and silver backed currencies were thus considered “safe”. The initiation of central banking and a monopoly on currency note issuance to the Federal reserve central bank was created to mitigate risk. I am not advocating pro or con on the article, just providing historical context.

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Truth and lies in oil-skimming statistics

Felix Salmon
Jul 6, 2010 14:13 UTC

Kimberly Kindy has an excellent and very sobering report on the monstrous discrepancies between the various numbers being bandied around when it comes to the amount of oil that BP is able to skim off the Gulf of Mexico every day.

As commenter hsvkitty points out, BP only got the permits to start drilling at the Deepwater Horizon site in the first place because the Minerals Management Service believed their statement that they “could recover 197 percent of the daily discharge from an uncontrolled blowout of 250,000 barrels per day”: a March report from BP said that it had the capacity to skim and remove 491,721 barrels of oil per day.

Even after the explosion, BP was still insisting that it had “skimming capacity of more than 171,000 barrels per day, with more available if needed.”

So far, it has managed to skim less than 900 barrels per day. Add burn-offs, and you get to just over 300,000 barrels in total, over 77 days — that’s less than 4,000 barrels per day.

BP’s reaction to being massively wrong, by a factor of over 100, is to grab onto the biggest numbers it can find — to try, in other words, to deal with the optics, rather than the reality. Take the much-vaunted super-skimmer, for instance. Some reports say that it “can collect up to half a million barrels of oil a day”, but it’s much more accurate to say that it can theoretically collect that many barrels of contaminated water, which is only about 10% oil. And, as Kindy drily notes, “thus far, it has been unable to produce those results in the gulf.”

BP knew full well that a blow-out at the Deepwater Horizon site would involve oil bubbling up to the surface from miles below sea level, rather than being spilled directly onto the surface from a tanker. But it never seemed to stop to think that much of the oil would never surface. BP also said that much of its skimming capacity would come from outsourcing skimming operations to Marine Spill Response — but BP never asked MSR whether they could hit its marks, and neither did MMS, when BP submitted its insanely overoptimistic numbers.

All of which is a sign of the knee-jerk credulity that most of us exhibit when faced with a large and seemingly highly accurate number. 491,721, you say? Well, that must be true — or at least in the ballpark.

It would be interesting to compare that number with other oil companies’ projections of their oil-skimming capacity in the Gulf. Their rigs haven’t exploded, of course, but what did they say they could skim off in the event that the unthinkable were to happen? In hindsight, it seems that any number over a few thousand barrels per day would clearly have been a massive overestimate. But of course the bigger the number submitted, the easier it was to get the necessary approvals. You can see why BP exaggerated so much, and why there would have been enormous incentives for its rivals to do likewise.


Collection of the BP oil spill has never been a “skimming” operation. This “spill” is a gusher of oil being released from the seafloor, approximately one-mile below the sea surface. USCG is using conventional skimmers, boom and dispersants normally deployed for inland waterway surface oil spills.

BP and USCG will eventually use tankers to collect the oil that has been released into the Gulf of Mexico as a result of the Deepwater Horizon blowout of April 20, 2010. Unfortunately, this decision will be made after the devastation of many coastal communities.

The blowout of April 20, 2010 aboard the Deepwater Horizon was clearly preventable. The fact that the BP oil spill has been allowed to reach coastal areas is inexcusable.

For a clear understanding of the issues involved, visit:

http://renergie.wordpress.com/2010/05/25  /bp-is-not-the-only-responsible-party/


http://donovanlawgroup.wordpress.com/201 0/06/05/the-oil-pollution-act-provides-f or-the-federalization-of-the-bp-oil-spil l/


http://donovanlawgroup.wordpress.com/201 0/06/14/why-bp-does-not-want-an-accurate -measurement-of-the-gulf-oil-spill/

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Felix Salmon
Jul 6, 2010 07:20 UTC

Quiggin’s Zombie Economics is available for pre-order — Amazon

How Citi “structured their business so that no agency knew what they needed to effectively regulate the company” — American Banker

“As any competent designer knows, the Futura uppercase ‘N’ needs to be treated with care, as the pointy corners can be treacherous” — Brand New

Surowiecki on how the auto-dealer exemption came into the financial-reform bill — TNY

The WSJ covers Middle School 223, the Lab School of Finance and Technology — WSJ

You’re more than twice as likely to be Lady Gaga’s fan on Facebook as you are to follow her on Twitter — Reuters

Kinsley with a sensible deficit column — Atlantic Wire

WizardRSS will convert any partial rss feed into a full feed — Wizard RSS

The more you know, the better it tastes

Felix Salmon
Jul 6, 2010 05:06 UTC

Patrick LaForge was underwhelmed by his visit to McNulty’s Tea & Coffee:

I inquired about the roaster and was told with a shrug that the shop used an unnamed roaster in Long Island City, Queens. Presumably the beans had been roasted recently.

Many coffee sellers now offer tasting notes as florid and adjective-rich as wine descriptions, but there was none of that at McNulty’s. The country of origin was listed and in some cases beans were described as organic or free trade. No details were offered about the specific growers. I didn’t realize how hooked I have become on knowing this information, even though I am not an expert who can make useful judgments based on it.

This is in some respects just a difference in marketing. A place like McNulty’s relies on the mystery and mystique of foreign lands. A roaster like Intelligentsia and shops Stumptown and Cafe Grumpy appeal to a different type of consumer.

This type of customer is obsessed — perhaps too much so — with authenticity. For these consumers, coffee is no longer an exotic product arriving by ship from third-world places with unusual names. Knowing the details of origin improves the taste.

LaForge has hit on something important here, which is clearly making its way into the world of coffee from the world of wine, where it has been going strong for decades. The more you know about your beverage, the better it tastes. That’s why so many wineries put so much effort into wine tours and that’s why you’re much more likely to enjoy your bottle of pinot noir if it has been preceded by a short explanation from the sommelier of who the winemaker is, where they’re from and what exactly they’re doing. There’s really no way of telling how or whether any particular part of the story affects the taste, but the simple telling of the story makes an enormous difference.

And so when you go to the Intelligentsia website, you’ll find them featuring specific coffees like the one from Edelweiss Finagro Estate, in Tanzania. You’ll learn what to look for when you taste it: “Toasted marshmallow and sandalwood greet you in the nose while saturated notes of pomelo and red wine appear immediately on the palate.” You don’t have to have any clue what a “saturated note of pomelo” is in order to get the message.

But that’s just the beginning of what Intelligentsia serves you with your pound of joe. They’ll also tell you who’s growing the coffee (Neel and Kavita Vohora), exactly where the farm is, what varietals are grown (Bourbon, Kent, SL-28, Tacri), what altitude they’re grown at (1700 – 1800 m) and what months they’re harvested (July – November). They’ll then add some color:

These are the only farms I’ve been to in the world where the biggest source of worry is not fungus or insect damage but invasion during the night by marauding herds of elephants, buffalo and even lions! They pass through from time to time looking for water and elephants will actually locate underground pipes and dig them up with their tusks. When they walk through the farm they trample everything in their path, leaving a big swath of razed land.

People like LaForge don’t want altitude information on their coffee because they prefer 1700m coffee to 1400m coffee. Instead, Intelligentsia is supplying something much more important and valuable: a unique narrative. It’s the same thing that’s going on in the wine world:

Unlike Bordeaux, where many of the best-known chateaus are run by corporations or wealthy absentee owners, Burgundy is full of estates, including many of the leading ones, that are essentially small businesses. Dealing with Bordeaux often requires working with middle management and marketing specialists. It’s much easier to visit a Burgundian estate and find the one person who has dirt on the boots, wine on the hands and a name on the bottle.

“For people of my generation, 30 to 50, I don’t think we’ve had the same magical Bordeaux moments, not in the same way we’ve connected to Burgundy or even the Rhone,” said Laura Maniec, who runs the wine programs for more than 15 restaurants in the B. R. Guest group.

She still buys a lot of Bordeaux for restaurants like Primehouse, a Manhattan steakhouse, and Blue Water Grill, a Manhattan seafood restaurant that hosts plenty of corporate parties where Bordeaux is nearly obligatory. “But there’s a passion and a spark and a personal connection that are missing,” she said.

What you get in Burgundy is a story and that personal connection, which is impossible to find in Bordeaux. And you’re increasingly finding the same thing in the new school of coffee roasters and importers. It’ll be interesting to see where it turns up next: tea? Truffles? Tofu?


I wonder if it turns up in tea, will this whole practice include knowing where the particular silver tea set we are drinking from is made etc. I feel that such things take the fun out of enjoying a drink because you will often find yourself unimpressed and unable to enjoy drinking it just because it is not of a particular origin. But if you actually opened your mind, you would find that sometimes what others think is not good might just be your cup of tea, no pun intended!
http://www.acsilver.co.uk/shop/pc/Four-P iece-Tea-Coffee-Sets-Services-c97.htm

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The ethics of owning BP stock

Felix Salmon
Jul 6, 2010 03:27 UTC

Value investor Whitney Tilson is long BP, and answered my ethics question in a Q&A sent to his investors:

Q: Regardless of how cheap BP’s stock is, is it immoral to try to profit from owning it, in light of the company’s bad behavior?

A: As noted earlier, BP appears to have an atrocious safety record. In owning the stock, we are not endorsing its behavior, either before or after the Deepwater Horizon accident. But as value investors, we sometimes have to hold our noses when we invest because the cheapest stocks are often the ones of companies that have behaved badly or are otherwise tainted. Example include McDonald’s, which many believe bears responsibility for the obesity epidemic in this country (see Fast Food Nation and Super Size Me), and Goldman Sachs, which many blame for the global financial crisis (see The Great American Bubble Machine).

That said, we would have a problem owning stock in a company if we believed that its core business harmed people – most subprime lenders at the peak of the housing bubble, certain multi-level marketing firms and tobacco companies come to mind. BP certainly doesn’t fall into this category.

As for BP’s safety record, we don’t defend it, but we don’t think BP is deliberately blowing up its own rigs and refineries and killing its employees. If an email emerged that the CEO or board of BP were warned that the Deepwater Horizon rig was likely to explode and failed to act, we would certainly rethink the morality of holding the stock.

I don’t find this answer compelling at all. First is the language in which Tilson talks about his comparables, McDonald’s and Goldman Sachs. He writes about what “many believe” and what “many blame”, and cites the most shrill and stringent critics in both cases. Being a contrarian value investor is all about making your own mind up, and what’s germane here is what (and whether) the investor thinks about the ethics of the investment, rather than what someone like Morgan Spurlock or Matt Taibbi thinks.

Tilson then says there are companies he’d have a problem investing in, if they make harmful products. That seems to imply that it’s worth taking a serious look at the ethics of owning stock in BP. But his conclusion is trite, setting up a straw man of BP deliberately killing its employees, and saying that he’d only have a serious ethical problem with BP if it knew the explosion was likely.

Note the definite article here: Tilson is saying that he’d only have qualms if BP knew this particular explosion was likely. But the ethical case against BP is that it acted with reckless indifference towards safety standards in general, that it cut corners knowing that doing so increased the likelihood of disaster, and that it should have known that an explosion was likely, at some point, and that the chances of this explosion happening at a BP rig were significantly higher than the equivalent probability at other big oil companies.

This has important implications for the stock, of course. BP has thousands of oil rigs; the chances of one of them exploding are not much smaller today than they were a few months ago. The clean-up and other costs associated with the Deepwater Horizon are one thing, but how much will BP be forced to spend on upgrading the safety systems at all of its other rigs, now? We’ve learned our lesson, and surely all want to ensure that this kind of thing doesn’t happen again. But we’ve barely started to think about what that kind of root-and-branch revamp of BP’s physical and managerial safety systems might cost, both in terms of cash and in terms of opportunity cost. I’d be interested in what Paul O’Neill thinks — before he was Treasury secretary, he did amazing things for Alcoa’s safety record. If Tony Hayward’s successor wants to do something similar, it won’t be easy, and it won’t be cheap.


Would it be unethical for Exxon-Mobil to take over BP and put all of its substantial corporate resources behind the cleanup? Would it be ethical for indignant investors to destroy BP financially, making it impossible for them to meet their cleanup obligations?

It would be unethical for an investor to condone or encourage cost-cutting practices that compromise safety, but I see nothing evil in buying shares to sustain BP’s viability as an ongoing concern. Dragging BP down benefits nobody at this point (except for whatever vultures take over its assets in the fire sale).

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