Felix Salmon

Institutions exit the muni market

Felix Salmon
Jul 8, 2010 18:11 UTC

Jenn Ablan takes a look at the muni market today, and although inflows have been strong this year, the smart money seems to be moving out of the market, positioning itself for a gruesome second half of the year.

The muni market is a curious beast. Most of it is highly illiquid, with small issuers, buy-and-hold retail investors, and tax-exemption rules which make enormous differences to the value of securities depending on where you live and what your tax rate is. At the same time, some big institutional players like to rotate in and out of the market on a speculative basis, with short time horizons, and when they do, they’re big enough to act as marginal price setters. If they’re moving on to the next thing, then prices are likely to fall a little — which is actually no big deal, for anybody but institutional investors who mark to market. Municipalities will pay a little more to borrow, but rates are still extremely low, and their investors, who are also their voters, will get slightly more attractive rates on their money.

The big danger in most markets when institutional investors leave it for dead is that it closes up entirely, and that borrowers have no market access at any price. That’s less of a worry when it comes to munis because they’re mainly reliant on individuals. At some point, if there’s lots of talk of default, then retail investors might stop buying municipal bonds, but that’s a little bit down the road. First you get the price decline (and CDS spreads widening out further still), then you get the default talk, and only then do you get the retail well drying up.

For institutions who mark to market, then, it makes sense to avoid munis for the time being: they have more downside than upside. But for buy-and-hold individuals, there’s no real reason to panic: you’re going to hold your bonds to maturity anyway, so it doesn’t really matter what happens to their value in the interim. And the chances are that they’re not going to default; what’s more, even if they do, you’ll probably end up getting your money back eventually in any case. And if you’ve lent to a big state-level borrower like California or New York or Illinois, you can be pretty sure that there will be some kind of government bailout too.

The real worry here is with the monoline insurers: municipalities are more likely to default if they know that their voters are still going to receive their coupon payments from an insurance company which provided a wrap for their bonds. But for the time being, at least, I’m not worried about a complete collapse of the muni market, where local governments in need of funds can’t raise the money at any price. That could yet happen, but I doubt it’s going to happen this year.


CNDRebel? What about the ARS securities they issued that the banks were forced to buy back? I also recollect the mortgage market was the same only a couple of yeahs ago.

Finally, shouldn’t these buysides being doing due diligence anyway? Crazy, outrageous idea I know. After all if they lose money they can just blame it on Goldmans.

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Are basketball economics broken?

Felix Salmon
Jul 8, 2010 15:05 UTC

Amy Shipley has an odd piece today on the economics of signing basketball stars. I know absolutely nothing about basketball, but I do know that Shipley’s story doesn’t convince me that the NBA is suffering the “economic woes” of her headline because “a broken economic system” has resulted in teams spending too much money on players.

For one thing, Shipley never explains the mechanism by which player salaries are being overinflated, beyond waving vaguely in the direction that such salaries constitute “gambling, perhaps foolishly, that the expensive addition of a star player from a historically talented free agent class will generate interest in their franchises and ignite a significant payoff in the box office.” But your foolish gambling is my smart investing, and of course box office revenues are only a fraction of the value that teams extract from players.

What’s more, Shipley concentrates on dubious and vigorously contested cashflow figures, saying that the league will lose about $400 million this year, with the average team losing $13 million. That doesn’t seem like a huge amount of money to me, in a world where players can take home $20 million a year each. Instead, it looks like smart accounting: it’s clearly smart for an owner to lose a modest amount on a cashflow basis, thereby avoiding taxes, and instead build a much higher franchise value for his team, thereby increasing his net worth substantially.

As a datapoint, check out the market capitalization of MSG, the owner of the Knicks, as speculation rises that LeBron James might come to New York. The share price closed at $21.57 yesterday, up a good $2 from a week earlier — that’s an increase in franchise value of $150 million, give or take.

And indeed, as Shipley notes, it’s not the teams paying out monster salaries which are hurting the most:

“The most significant challenge facing the NBA today is the gap between the teams at the top and bottom,” said sports consultant Andy Dolich, a former Capitals executive who has worked for NBA, NFL and Major League Baseball front offices.

Think about it this way: big-name basketball players earn much more in endorsements than they do in salary. It’s reasonable to assume, given how much value they add to the brands they advertise, that they add much more to the teams they play for. And that if smart business owners are competing desperately for the privilege of signing these players, then the chances are that their services are underpriced, not overpriced.


Personally, I couldn’t care less if some billionaire owners want to make a bunch of goofy kids millionaires – my problem is when these billionaires begin to expect and demand that taxpayers subsidize their play toys. That, my friends, is absolute ‘male-bovine solid fecal matter’. And any community that has allowed itself to be blackmailed in this way should be ashamed of themselves.

Posted by CDNrebel | Report as abusive

Zirp and the double dip

Felix Salmon
Jul 8, 2010 14:25 UTC

Greg Ip has an interesting argument: if we were really headed for a recession, he says, the yield curve would be inverted. But you can’t have an inverted yield curve when the Fed sets short rates at zero. Therefore, we won’t have a double dip.

Ip concedes that Japan provides an obvious counterexample of a country which had a recession and Zirp at the same time. But he’s convinced that in the US, loose monetary policy will suffice to keep us growing:

Our entire financial system relies on borrowing short and lending long and profiting from the spread. When that spread disappears, sooner or later, so does liquidity. In 2007, that happened in dramatic fashion, partly because we didn’t realise how precarious liquidity was in the vast shadow banking system. Indeed, the more I study the events of the last few years, the more I’m convinced that illiquidity contributed more to the crisis than insolvency.

What all this tells me is that as long as the yield curve remains relatively steep, it is a powerful inducement to credit creation. Credit is currently contracting, but with time the positive lending spread will recapitalise banks and awaken interest in lending. Right now is an excellent time to start a bank: just check out the enthusiasm among private equity funds for buying failed banks from the FDIC.

This is not very convincing: if zero interest rates are so good at fostering new lending, how come credit is currently contracting? After all, we’ve had zero interest rates for a good 18 months now, how long is this supposed to take?

My feeling is that we had a boom and bust in credit, and that most companies — the ones not owned by private equity shops — were sensible enough to avoid levering up during the boom. That’s how they survived the bust so easily, in contrast to banks and homeowners. They’re now sitting on large amounts of cash, and the likelihood that they’re going to start borrowing again in any serious quantity is low. Meanwhile, individuals have embarked upon a long and slow process of saving more and paying down their debts, rather than levering up. In other words, if you’re looking forward to a credit-fueled recovery, you might well be in for disappointment.

At the same time, zero interest rates are still too high: the Taylor Rule would set interest rates in the US at -1.3%. So even a Zirp is restrictive, absent quantitative easing.

None of which means we’re going to enter another recession, of course. And indeed for most people it doesn’t really matter: the key issue facing Americans today is that they can’t find jobs, and it’s increasingly obvious that positive GDP growth isn’t much better when it comes to job creation than negative GDP growth. But it does help a lot on the fiscal side of things. And if you’re worried about government finances, you should be worried sick about the possibility of a double dip. Which is real, zero interest rates notwithstanding.


Or … Paul the Octopus could be asked, for much higher odds of accuracy.

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Felix Salmon
Jul 8, 2010 06:28 UTC

Tal Yarkoni on Dunning-Kruger; he goes on to debate Dunning in the comments — Yarkoni

A good response to the UK govt’s request for “laws or regulations you’d like us to do away with” — Gov.UK

The Volcker rule doesn’t ban all prop trading. You can still speculate in the Treasury market — WSJ

Koblin on Gaby Darbyshire — NYO


I liked the suggestion to repeal the third law of thermodynamics, but my eyes nearly rolled out of my head when I saw a commentor feel the need to point out it’s impossible to do.

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Why do we invest in cap-weighted indices?

Felix Salmon
Jul 8, 2010 04:43 UTC

Felix Goltz and Véronique Le Sourd have an interesting paper (PDF) revisiting the question of why so many of us invest in capitalization-weighted stock indices. It turns out that the theory behind our behavior is pretty weak: first of all, you have to believe in the capital asset pricing model, or CAPM. The CAPM includes lots of assumptions which don’t hold in the real world: that all investors have the same risk appetite, for instance; that they all have the same investment horizon; that they can short securities freely; that they pay no taxes or transaction costs; and that all assets can easily be traded, including assets such as human capital and real estate.

If you make all those assumptions, then the CAPM says that the market portfolio is efficient — the market portfolio being, essentially, everything in the world: stocks, bonds, real estate, commodities, human capital, art, social security benefits, automobiles, everything. But the problem, of course, is that cap-weighted indices do a pretty bad job even of reflecting the performance of the stock market as a whole, let alone all global assets. (The world’s assets have grown a lot in the past decade; the S&P 500, not so much.)

The authors conclude:

In view of these arguments, it seems that financial theory alone does not justify the current practice of cap-weighting. In fact, from a theoretical perspective, cap-weighted stock market indices seem to offer no particular advantage.

So why are cap-weighted indices so popular? One reason might be that indices seem to outperform a simple buy-and-hold strategy. And another is that they’re easy to understand and most of them have been around for a long time. Still, it’s worth noting that the most famous stock index in the world, the Dow, isn’t an index at all, and it certainly isn’t cap-weighted. (Although with the Dow, you would have been better off just holding the original 30 stocks than following the vicissitudes of DJIA itself.)

The main reason for buying cap-weighted indices, I think, is that it’s easy and it’s cheap. (That’s probably the main reason not to buy cap-weighted indices, too, since anything easy and cheap is likely to get crowded.) Of all the assets in the world, stocks are the easiest to invest in and the easiest way to invest in stocks is to simply buy the index. I suspect there are many portfolios which do a better job of simply “investing in the world” than the S&P 500 does. But once you take into account the costs of putting them together, it’s probably not worth it.


Cap-weighted indexes exist for one simple reason. They represent the average return for a dollar invested in a asset class or subclass.

Such a strategy has the advantage of being scalable: i.e. if the strategy was pursued to its fullest, all securities in the cap weighted index would be owned 100% by the index fundholders. No individual security in a cap weighted index is disproportionately affected by the creation or liquidation of index units. With non-cap-weighted indexes, securities that are scarce relative to their index weights get disproportionately affected by the creation or liquidation of index units.

Can you do better than a cap weighted index? Sure, but others must do worse for you to do better. Everyone as a group can’t do better; they will earn the cap-weighted index return less fees.

Posted by DavidMerkel | Report as abusive

Why munis don’t pose a systemic risk

Felix Salmon
Jul 7, 2010 21:48 UTC

David Goldman has reacted with a curious mixture of alarm and reassurance to Dakin Campbell’s story about U.S. bank holdings of municipal debt:

If municipal debt actually defaulted, the capital position of the banking system would be impacted, bank preferred debt might stop paying, and the holders of bank preferred debt–starting with the insurers–would be in serious trouble…

Why buy munis? For all of Warren Buffett’s dire warnings about municipal finances, the fact is that the federal government can’t let major municipal debtors (at the level of states, for example) go under without also bringing down the banking system and everything else.

If it goes, it all will go together. That’s why munis ultimately will be bailed out.

This is altogether far too sanguine. And if you look past the alarmist headline that Bloomberg has put on Campbell’s story, and the out-of-context numbers in his first few paragraphs, he eventually reveals just how much of a non-issue muni debt really is to the banks:

Lenders hold just 8 percent of the $2.8 trillion state and local government debt market, and municipal bonds are only about 2 percent of total bank assets, according to the Fed.

Muni bonds are relatively safe for two reasons. Firstly, they very rarely default; and secondly, when they do default, they generally have very high recovery values.

But let’s get ultra-pessimistic here, and say that 25% of municipal bond issuers will end up defaulting, and that recovery on those bonds will be just 50%. Then banks would have to take a hit of 12.5% on their muni bond holdings, which would correspond to a hit of about 0.25% of their total balance sheets. Needless to say, that’s not the kind of event which would precipitate a default on their preferred debt.

A widespread municipal default would be harmful to the economy more generally. With $2.8 trillion of munis outstanding, a hit of 12.5% would mean $350 billion of losses, spread across individual investors who were looking for safe, tax-free investments, and a lot of monoline insurers. That kind of thing can hurt. But investments in municipal bonds tend not to be leveraged, and for long-only investors, a drop of $350 billion is equivalent to roughly a 2.5% wiggle in the level of the U.S. stock market.

So I don’t think that munis pose a major systemic risk in and of themselves, although a handful of them — California first and foremost — are probably too big and politically important to be allowed to fail. There will certainly be a lot of wailing and gnashing of teeth if munis do start defaulting, since they’ve long been sold as extremely safe investments, and because they’re largely held by individuals rather than institutional investors. But no one’s going to bail them out because they’re worried about the banks.

Time’s weird web strategy

Felix Salmon
Jul 7, 2010 17:31 UTC

Josh Tyrangiel became arguably the most sought-after editor of his generation by boosting Time.com’s pageviews from 400 million to 1.8 billion within three years, and by successfully transforming a bunch of grizzled old magazine journalists into web-speed multimedia content producers:

“Getting Time magazine to be a daily operation? It required me to be my most charming, scheming and belligerent.”

Now that Tyrangiel has left to BusinessWeek, however, Time seems determined to roll back all of his achievements:

We’ve said for awhile that increasingly we’ll move content from the print (and now iPad) versions of our titles off of the web… Our strategy is to use the web for breaking news and ‘commodity’ type of news; (news events of any type, stock prices, sports scores) and keep (most of) the features and longer analysis for the print publication and iPad versions.

If the 1990s saw news organizations set up massive parallel online operations, then, and the 2000s saw the integration of the online operations with the legacy operations, then is this the beginning of the 2010s backswing, where the two become bifurcated again?

My guess is that the answer is no, and that this is just a case of Time making a tactical decision which makes no strategic sense. It wants to sell lots of copies of its iPad edition at $5 a pop, but it’s only putting the magazine content into the app, if all of that can be read on the iPad for free just by firing up the web browser, it fears that sensible consumers won’t bother. So rather than improve the iPad app and make it worth the money, Time is artificially crippling its website.

So long as the iPad app remains broken, however, this idea is doomed to fail. People read the magazine in one of two ways: either they subscribe, at a significant discount to the cover price, or else they buy the magazine at a newsstand, where they have the opportunity to browse through it first. Neither is possible on the iPad, which sells issues only one at a time, and which gives no tasters of what’s inside, just headlines. (The app does have some good free content, if you find the hidden button in the bottom right hand corner, but it’s exactly the same free content that’s available on the website.)

My guess is that none of this would have happened had Tyrangiel stayed at Time, but that once he left, the heart of the website that he helped to build was doomed. It won’t be long, I’m sure, before Time’s journalists settle happily back into their weekly routine, and the website is left to a very different team of people, producing very different content. Which is clearly not a sustainable model.

Can America improve its bad jobs?

Felix Salmon
Jul 7, 2010 16:44 UTC

The problem of falling wages for people without a high-school diploma is well presented by Richard Florida, in an op-ed headlined “America needs to make its bad jobs better”:

The problem is that on average, service workers earn only half of what factory workers make – and only a third of what professional, technical and knowledge workers are paid. The key is to upgrade these jobs and turn them into adequate replacements for the higher-paying blue-collar jobs that have been destroyed.

I’m less impressed with Florida’s proposed solutions, such as they are.

He first points to a handful of companies (Whole Foods, Zappos) which pay more than average for hourly workers, although they don’t pay anything like the sort of money that blue-collar factory workers can command. But it’s simply a statistical certainty that some companies will pay high wages and be successful, just as others (like Wal-Mart or most hotels) will pay low wages and be successful, and others still will fail no matter what they pay. Demanding that the entire service sector should gravitate to one particular quadrant is, I think, unhelpful and unrealistic.

Florida also reckons we can apply some smart technology here:

Service jobs are the last frontier of inefficiency, providing abundant low-hanging fruit for the innovation and productivity improvements that can undergird higher wages.

Florida wants a service-sector equivalent to the kind of technical assistance that the government has long provided in manufacturing and agriculture. It’s not a bad idea, but it’s harder to implement in the service sector, because employers tend to be smaller and more heterogeneous, and because technical assistance aimed at a broad range of service-sector employers risks becoming a series of bland management mantras rather than anything specific and actionable.

What’s more, productivity improvements don’t necessarily result in higher wages for the less-skilled: they’re just as likely to result in greater returns to capital, as owners extract more profits from the business, or else to result in the jobs going to better-educated workers instead.

So while it’s undeniable that America needs to make its bad jobs better, it’s also, I fear, something which is too difficult to succeed at — certainly for any government bureaucracy. If it’s going to happen at all, it will happen from the bottom up, rather than from the top down. And so far there’s zero evidence that’s happening.


hsv, I’m guessing my read of that chart is a little different from yours…

38% percent of the population has a high school degree or less. Yet they make up 55% of the unemployed and 54% of the long-term unemployed.

The job search may be a few weeks longer for the older and educated workers (not surprising, because those skills are more specialized and the interview/hiring process is longer). Yet this doesn’t alter the fact that a less-educated person is more likely to find themselves unemployed and less likely to find a rewarding job. The difference between 28 weeks and 36 weeks is significant — and we both understand the reasons behind that difference — but it doesn’t fundamentally change the picture.

I would encourage the older unemployed to look for unconventional opportunity. When you are 25, you have neither the experience nor the resources to strike out on your own. When you are 45, you have the skills and savings to make your own path. Do you truly need a corporate boss? I don’t.

Posted by TFF | Report as abusive

Income inequality chart of the day

Felix Salmon
Jul 7, 2010 15:20 UTC


Catherine Rampell features this chart today, showing how wage inequality has increased over the past 30 years, especially for men. But in fact what we’re seeing here understates how bad things have been for most men over the past generation. If you go to the source, this chart only shows data for people working full time. And, at least when it comes to men, that’s much less common now than it was in 1979.

The labor force participation rate for men 20 years and older was 79.8% in 1979; today, it’s just 74.4%. And I don’t think that most of that drop can be explained in terms of a larger number of students: the rate was as high as 77% as recently as August 2000, and then dropped to a low of 73.9% in December 2009.

You can be sure that most of the drop in labor force participation is coming from the less well educated Americans. Which means that if you’re a man with less than a high school diploma, your real wages have fallen by 28% over the past 30 years if you’re lucky enough to have a job at all. At the same time, the number of such men without a job has been growing steadily. It’s a depressing set of data, and there’s no sign of it turning around in the foreseeable future.


There are more variables than the figures cover.
How many “2-income” families are 2 income by choice, and how many have no choice?
How many men over 50 who are out of work will ever get a job again?
Just within the educational segmentation, what are the differences by decade?

Posted by Neil_in_Chicago | Report as abusive