Felix Salmon

Schwarzenegger’s pension math

Felix Salmon
Aug 30, 2010 13:59 UTC

Since I’m interested in the value of a guaranteed real income, this sentence jumped out at me from Arnold Schwarzenegger’s recent WSJ op-ed:

Few Californians in the private sector have $1 million in savings, but that’s effectively the retirement account they guarantee to public employees who opt to retire at age 55 and are entitled to a monthly, inflation-protected check of $3,000 for the rest of their lives.

The problem is, I can’t make the math work. You can argue until you’re blue in the face about proper discount rates, but at the very least any pension plan should be able to invest its money to keep up with inflation. But let’s see what happens with a 0% real discount rate, not least because it makes the math easier.

California’s life expectancy is 77.9 years, so let’s say the average retiree lives for 23 years after retiring at 55*. If they earn $36,000 a year in real terms for 23 years, that sums to $828,000. And the minute you start assuming even the most modest of real investment returns, the less realistic Schwarzenegger’s number becomes: if you invest $1,000,000 at a 5% yield while paying out $3,000 a month with 2% annual inflation, that’ll support payments for 682 months, or about 57 years, taking our hypothetical retiree to the plump old age of 112.

To put it another way, I’m sure that any life insurer in the world would happily take Schwarzenegger’s bargain and accept $1 million of public funds in return for the obligation to pay a 55-year-old California retiree $3,000 a month, in real terms, for life.

The rest of the op-ed is misleading, too: see Paul Kedrosky’s elegant fisking of Schwarzenegger’s chart. But as ever in California, political rhetoric always tends to trump economic reality. California’s finances are indeed pretty gruesome, and it’s true that the state has been making pension promises it can’t afford for decades. But given how bad reality is, there’s no need to exaggerate it for the sake of politics.

Update: Many thanks to all my commenters. First, as many of them pointed out, life expectancy at age 55 is actually somewhere in the 25-28 year range, not 23 years. And especially thanks to DanHess, who actually found a private-sector quote:

I got some quotes for how much a million dollars will buy for a fifty-five year old in terms of a fixed annuity starting presently and going for life. They were generally in the range of about $5000 per month, some a bit more, some a bit less.

I just got off the phone with the Vanguard annuity sales department, where I was told that for a 55-year-old, inflation adjustment knocks off approximately 30% to 35% off the payout of the annuity.

$5,000 minus 1/3 for inflation adjustment brings you down to around $3330 per month. But I’m not convinced that the inflation adjustment should be so expensive these days, given that any life insurer should be able to hedge the inflation risk very cheaply right now.

Finally, there’s the question of survivor benefits, which I admit I hadn’t considered. I don’t know exactly how California pensions work, but if they essentially end up being paid until both of two spouses have died, rather than until the recipient has died, then that obviously increases their value significantly.


hsvkitty, pension padding is widespread (not just California) and a serious problem. It penalizes not only the taxpayers, but also those poor schmoes who don’t play the game. As a teacher, I was contributing 11% of my paycheck to a retirement system that was in dire straits because my (now retired) colleagues contributed at a 5% rate for their entire career and padded their annuity at the end. That is a big part of my reason for leaving public education.

curiosus, I don’t think the size of the annuity is as big a problem as the age. If those workers were receiving $3000/month at the age of 65, rather than at 55, then it would be a very different picture.

I’m still curious to find out more about how those benefits are funded (payroll deductions at what %) and whether they supplement or replace Social Security. Anybody familiar with the California system?

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What are the obstacles to being a landlord?

Felix Salmon
Aug 29, 2010 06:21 UTC

Joe Nocera addresses the question of who might buy houses to rent them out:

It’s even become nearly impossible for well-heeled investors to buy rental properties. This is no small matter. At the peak of the bubble, the rate of homeownership approached 70 percent. Now it is falling toward 65 percent — which is more or less where it was before all the housing madness of the last decade. That means that millions of Americans who were briefly homeowners need to become renters again. They need a place to rent.

But somebody has to buy the homes they are leaving behind and turn them into rental properties. The most likely buyer is a professional investor who purchases rental properties for a living. Yet, absurdly, government rules have made it exceedingly difficult to make loans to investors who want to buy up rental properties. This only adds to the shadow inventory.

I wish the online version of his column had a hyperlink in there somewhere, so that I could work out what government rules he’s talking about. As far as I can tell, the most recent change to government rules took place in February 2009, when Fannie Mae amended its rules on loans to investors. The changes made it easier for professional and semi-professional investors to buy houses, but a bit harder for someone wanting to get their toe in the door; they were understood at the time to be an easing of Fannie Mae policy.

The new rules allowed investors to have Fannie-backed mortgages on up to ten different mortgages; the previous maximum was four. At the same time, however, Fannie Mae closed a few loopholes which allowed people buying an investment home to have liquid reserves of less than six months’ worth of payments on the new home. And the definition of what was considered to be a monthly payment, for such purposes, was expanded beyond just mortgage costs and taxes to include things like ground rent and owners’ association dues.

This seems like sensible underwriting to me. The days of lending only against home values are long gone; we have to move back to a world where lenders look at borrowers’ wealth and income too.

That said, it’s worth remembering, in this context, that mortgages in most of the US are, to all intents and purposes, non-recourse. Some states, including California, have no-recourse laws, while in others it’s simply vanishingly rare for a mortgage lender to go after a borrower personally for funds they haven’t been repaid. And I’d assume that individual landlords lie somewhere between homeowners and businesses on the spectrum of how likely they are to simply return a property to the bank if it falls into negative equity.

As a result, even Nocera’s “well-heeled investors” can be bad credits, if they don’t put down a substantial downpayment which gives them real skin in the game. Does that make it “nearly impossible” for them to buy rental properties? Maybe it does, if they don’t want a lot of equity. In which case it might be worth trying to construct a parallel mortgage system which gives bank a bit more recourse than they have at the moment, at least for investment properties.

Nocera’s bigger point stands, though: it’s in everybody’s interest for landlords to be able to buy up properties without silly obstacles being thrown in their way. If such obstacles exist, let’s try to find a way to remove them.


wcw, I think y2k is correct. And at 40% down, why not just pay 100% and skip the loan altogether? If you have enough money to pay that kind of down payment, why bother with the housing market, you are too rich to take on the headaches and risk. Most investors can’t/won’t tie up that kind of cash.

I am a landlord and wanted to get a loan, my bank told me 8% for an investment property and lots of red tape. They really seemed like they didn’t even want to do it, and complained the government has really cracked down. I checked other banks, same thing.

Looks like the government has gone from one extreme to the other.

The problem with the 8% btw is that it makes the mortgage payments too high to make money, because due to the economy rents are low too. A lot of people have moved in with relatives and there is a glut of rentals too, not just for sale homes.

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How credit cards force the poor to subsidize the rich

Felix Salmon
Aug 28, 2010 21:39 UTC

Just after I went on holiday in July, the Boston Fed released a 57-page paper quantifying the subsidy from poor to rich that is the result of credit-card interchange fees. It was picked up by the likes of the NYT and the WSJ, and now Tim Chen, the CEO of NerdWallet, has decided to push back on the findings.

The numbers in the Boston Fed paper, says Chen, don’t pass the smell test:

The popular press had a field day with the idea that card-using households are earning $1,482 annually from cash users. But if we assume that the reward rate is 0.75% on rewards credit cards, as they mention on page 15, then the average card-carrying American has to spend $197,600 on credit card purchases each year. Even if we assume that card users receive the full 2% merchant fee, which is ridiculous, we’re talking about $74,100 in credit card spending. Keep in mind that this isn’t the number for “rich” card-carrying Americans; this is the average, and it doesn’t include any cash that these households might be spending, so something smells fishy.

This does a really good job of misrepresenting the Boston Fed paper. For one thing, the rich don’t just spend more money on credit cards, they spend more cash, too. So a lot of the cross-subsidy on this axis takes place from Americans to themselves: they take the money they overspend when they pay in cash, and get it back in terms of credit card rewards when they pay with plastic. The real cross-subsidy takes place between rich and poor:

On average, and after accounting for rewards paid to households by banks, when all households are divided into two income groups, each low-income household pays $9 to high-income households and each high-income household receives $434 from low-income households every year. The magnitude of this transfer is even greater when household income is divided into seven categories: on average, the lowest-income household (< $20,000 annually) pays a transfer of $23 and the highest-income household (≥ $150,000 annually) receives a subsidy of $756 every year.

Still, Chen’s calculation is mathematically correct: even if they’re getting the subsidy from themselves, card-using households are still getting a gross benefit of $1,482 per year, on average. That number seems high, and it’s derived from the same data used to generate the poor-to-rich cross-subsidy data. So is Chen right? Is the data flawed?

In fact, the paper says, on page 8, that the average household spends $1,190 a month on credit cards — that’s $14,280 a year. How can that level of expenditure generate such benefits of $1,482 a year? The answer is that the $1,482 number has nothing to do with the amount of money that credit-card users spend on credit cards, and it emphatically is not, as Chen implies, an estimate of the total value that card-users get back in the form of rewards: that’s just one part of the total calculation.

The real reason why the $1,482 figure is so large is that credit-card transactions account for only 17% of total expenditures, but raise prices for everyone. Everybody pays the same price, which is higher than it otherwise would be because merchants have to pay interchange fees to card companies. People using credit cards get some benefit from that, but people paying in cash just end up paying more than they otherwise would have to.

The numbers and formulas can be found on pages 17-18 of the paper, and they’re not easy to follow. But boil them down, and it comes to this: total merchant costs are $54 billion per year. Of that, $24 billion is accounted for by credit-card transactions, and $30 billion by cash transactions (which includes debit cards, in this paper, for the sake of keeping things simple). Cardholders also get $8.5 billion back in the form of rewards.

So people paying in cash end up paying 83% of the merchant costs, despite accounting for only 55% of merchant expenses. Meanwhile, people paying with credit cards pay only 17% of the merchant costs, despite accounting for 45% of merchant expenses, and they get $8.5 billion in credit card rewards back on top of that.

The Boston Fed study assumes that it would be fair if cash payers and credit-card payers paid for merchant expenses in proportion to the degree that they caused those expenses. The cost to cash payers is essentially the degree to which they help pay merchants’ credit-card expenses. And the benefit to credit-card holders is the degree to which merchants’ credit-card expenses are paid by cash payers, plus that $8.5 billion in rewards.

Chen has other problems with the Boston Fed study. He complains, for instance, that it includes housing and automobile expenses in the total expenditures split between cash and credit cards, despite the fact that precious few people use credit cards for either one. That’s a fair complaint. He also says that the poor and the rich shop at different places: if you assume that all poor people shop only at dollar stores and only pay cash, while all rich people shop only at Bergdorf’s and only pay with credit cards, then there’s no cross-subsidy at all. The Boston Fed study, it’s true, makes no allowance for the phenomenon of rich people shopping at rich-people shops.

Finally, Chen complains that the Boston Fed survey ignores a lot of fixed costs involved in handling cash, and then parades a long list of cash-related expenses, like the cost of incorrect change and the cost of returned checks, which he considers to be fixed costs rather than marginal costs. But the fact is that the paper does assume $30 billion in marginal costs of dealing with cash payments, and that number is big enough to encompass a lot of what Chen considers fixed costs. As the paper’s authors note, “the data do not distinguish well between fixed and marginal costs”.

Chen concludes that the paper’s numbers might well be “absurd”, and that if they took into account his quibbles, the cross-subsidies might disappear entirely. I’m far from convinced. Yes, the paper makes a number of simplifying assumptions. But for every assumption which might serve to ratchet up the size of the cross-subsidy, there’s another which serves to ratchet it down. Here’s the paper:

We have omitted from the benchmark transfer calculations two very important features of credit card markets—redistribution of bank profits and business credit card use — that most likely would increase the transfer estimates and by much more than the reductions reported in Table 12. In other words, we are confident that we have most likely understated the transfers rather than overstated them.

Redistribution of bank profits is basically a function of the fact that credit cards are a profit center for banks, and banks are owned by the rich, not by the poor. So when banks make money from their credit-card operations, that money ultimately benefits rich people with credit cards, rather than poor people who pay cash.

And the Boston Fed study looks only at individual credit card use, ignoring the huge market in corporate credit cards. Many rich people put a lot of their personal spending on corporate or business cards; I myself use a business card for nearly all my credit-card purchases, which dates back to my days as a self-employed freelance journalist. I’m therefore one of the lucky recipients of the cross-subsidy here, but I’m ignored in this study.

Overall, I’m much more persuaded by the Boston Fed study than I am by Chen’s attempted fisking of it. The numbers aren’t completely accurate — they can’t be. But the true cost of interchange fees is clearly paid by the many, with the bulk of the benefits going to the few, and therefore there’s bound to be a cross-subsidy there. And I don’t think that Chen is being intellectually honest: he’s looking only for aspects of the report which might overstate the subsidies, while ignoring everything which might understate them.

Finally, Daniel Indiviglio looked at the study, and concluded that although the costs are real, they’re worth paying:

Ultimately, the question comes down to whether the cost of placing an additional burden on the poor is worth the economic benefit that robust credit card usage provides. Unfortunately, due to the nature of the industry, it’s not clear that there’s a way to have both. In order to encourage more credit card use, the poor end up stuck with the bill.

I don’t agree with this. Of course you can have both: you can mandate lower interchange fees, for one thing. US interchange fees are the highest in the world, for no good reason. And you can pass a law allowing merchants to slap on a surcharge for credit-card transactions. Credit-card usage might decline, at the margin, if you did that, but it would still be “robust” — it just wouldn’t be excessive. And the poor wouldn’t end up paying billions of dollars for benefits which accrue overwhelmingly to the rich.

Update: Tim Chen responds in the comments. He makes some conciliatory noises: “I don’t necessarily disagree that interchange fees should be regulated,” he writes, adding that “cash users do bear the brunt” of the price increases that merchants slap on to be able to pay interchange fees. But overall he sticks to his guns as far as the numbers in the paper are concerned.

One of the biggest problems I have with the paper is the $1,482 benefit. I’m going to stick to this number for simplicity, even though it doesn’t account for income differences or cross-subsidies.

I think this is a silly stance to take, because the $1,482 benefit is entirely theoretical. It’s a benefit accruing to card holders which ultimately comes from those who pay cash — but in the real world, most of us do both. The authors aren’t saying that the average person with a credit card receives benefits which net out to $1,482 a year. If you want to see how the math works for individual people, then you have to look at the way that the authors slice the population according to income. The $1,482 number, rather, includes a lot of benefits that people essentially pay to themselves.

Let’s say I pay in cash with my left hand, and use my credit card with my right hand. Then the paper’s saying that if I’m an average American, my left hand is paying more than its fair share, while my right hand is paying less than its fair share. And the real problem isn’t so much that my right hand is getting benefits from my left hand — rather it’s that poor people are much more left-handed than rich people. And so they end up sending money from their left hands to rich people’s right hands.

The $1,482 number comes from looking at the money flowing unfairly from all left-handed spending, which ends up helping out all right-handed spending. It shouldn’t be confused with the average amount of right-handed spending that the average American engages in. Chen writes:

If I’m a card user spending $15,000/yr, how is it even mathematically possible for me to receive a benefit of $1,500, or 10%? Card companies are siphoning 2-4% off of every card transaction, so shouldn’t this serve as an upper bound on any benefit I can possibly receive?

But the point is that we’re talking about money which left-handed spenders are spending that they shouldn’t be. And that isn’t really a function of how much right-handed spending is going on. Indeed, if the share and amount of right-handed spending dropped from 17% to 10%, then the average benefit to right-handed spenders would go up, not down, because the left-handed spenders would be overpaying even more, to the benefit of ever fewer right-handed spenders.

Chen has another problem with the methodology:

Saying that a reduced burden on the part of the card users is the same thing as a benefit seems to me like double-counting. On one hand the authors are saying that cash payers are giving up $151, and on the other hand they are saying that this added burden is a benefit to card users. This seems logically inconsistent to me. If anything, the amount of rewards should be reduced by the premium that card users have to pay to derive their benefit, no?

But in fact the authors of the paper do just that. The amount of rewards is calculated as the difference between what card-holders should pay and what they do pay. It is reduced by the amount they’re paying to derive their benefit — but even after that reduction, the result is still large and positive.

Chen tries another tack:

Another way to look at it is that if all merchants started passing that fee entirely onto me, then I am receiving 0.75% in rewards and paying 2% in fees. In this case, wouldn’t the paper state that I’m theoretically still receiving a benefit from these rewards, even though I’m losing money in practice?

The paper is entirely consistent with a world where cardholders are “losing money in practice”. It just says that if they’re losing money, they’re losing less money than they should be. And people paying cash are losing more money than they should be.

Finally, Chen writes:

The only other thing I would point out is that the Durbin Amendment did give merchants the legal right to offer discounts to cash users, which is the same things as applying a surcharge to card purchases. And even the Boston Fed’s paper states that many merchant agreements allowed this practice beforehand as well. So I’ve always wondered, why don’t more merchants take advantage of it?

No, it isn’t the same thing at all. My business American express card comes with whopping great interchange fees — much more than my free Citibank Mastercard. If surcharges were legal, then a store could happily charge me more if I paid with my Amex than if I paid with my Mastercard. And that would be fair. But you can’t do that with cash discounts. The point about surcharges is that they would and should be used to discourage people from using the cards with the highest interchange fees. Merchants are perfectly happy to accept credit cards with very low interchange fees. And in order to be able to make the distinction, a cash discount isn’t good enough: you can’t offer me a cash discount for not using my Amex, if I don’t get a cash discount for not using my Mastercard. That’s why we need merchants to be able to impose surcharges, rather than just discounts.



Hopefully you remember my user-name and that I’ve often said taht you are the best financial blogger on the web. You are the best financial blogger on the web… I love you’re stuff and ready you religiously.


Think about that for two seconds… it’s maddness.

I worked for MBNA (bought by BofA) all through university. You are right that cards transfer wealth from poor to rich… that’s obvious. But the numbers in the goverment study are obviouly high that they are indefensable on their face.

Write a new post and use your own reasonable estimastes for spending, and fees. This one just dosen’t add up.

you remain my favorate blogger in the world.

Posted by y2kurtus | Report as abusive


Felix Salmon
Aug 28, 2010 05:54 UTC

“More frequent use of swear words indicates deception” — Farnham St

Frannie acquitted of causing the financial crisis. Karl Smith has a good summary — Modeled Behavior

Auto-tune Bob Rubin! — YouTube

The patents behind Paul Allen’s suit — WSJ

Ask 6 economists what the top marginal rate of tax should be. Get 9 different answers — Time

Factbox: What ammunition does the Fed have left? — Reuters

IndyMac Grants Church a Reprieve — Shame the Banks

Should we listen to El-Erian?

Felix Salmon
Aug 27, 2010 23:36 UTC

I’m not entirely clear why Matt Yglesias has suddenly come over all bah-humbug at the presence of Mohamed El-Erian on the Washington Post op-ed page:

If there’s a clash between what policies would be good for PIMCO’s investment positions and what policies would be good for the global economy, El-Erian has a responsibility to push for policies that would be good for PIMCO’s investment positions. Is there such a clash? Well, readers of The Washington Post op-ed page have no way of knowing. So what’s the point of publishing it?

The oversimple answer to the question is that El-Erian controls over $1 trillion in assets: if you wanted to put a face to the famous bond vigilantes, it would probably feature that famous moustache. If you care what the bond vigilantes might be thinking, then you can probably get a pretty good sense of it by reading El-Erian’s frequent op-eds.

A better answer is that there simply isn’t a clash between what’s good for the global economy and what’s good for Pimco, which is overwhelmingly a long-only investment house. Pimco’s long-term health is a function of there being a strong global economy which generates lots of savings for Pimco to manage. If you’re running a few million or even a few billion dollars, then you can significantly grow your assets under management by taking bold bets which pay off. If you’re running a trillion dollars, that’s no longer the case. At that point, your assets under management are much more a function of the global savings rate than they are of your own expertise as a fund manager.

The best answer, however, is that it doesn’t really matter who wrote the op-ed: it should stand or fall on its own merits. El-Erian makes the case that we’ve lost the global cooperation and determination to change our ways that we saw 18 months ago: essentially, we’ve wasted our crisis.

An already polarized political environment is becoming even more fractured by real and far less substantive issues. There is virtually no political center that can anchor consensus and enable sustained implementation of policy. Meanwhile, as anti-Washington sentiments rise, interest in a national agenda is increasingly giving way to the election cycle. Internationally, the impressive degree of cross-border coordination seen during the global financial crisis has been reduced to inconsistent — and at times contradictory — national responses.

This worrisome trio of increasingly ineffective national and global policy stances, intense political polarization and growing social pressures speaks to the risk that the economy’s recent soft patch will evolve into something even more troublesome and sinister.

El-Erian has a global perspective, and from that point of view it’s pretty clear that another one-off stimulus package, even if it’s a big one, isn’t going to achieve very much. Instead, the former IMF technocrat is looking for something much more coordinated and strategic, where the G8 construct a vision of where they want to be, and then work out how on earth they’re collectively going to get there from here.

It’s not like El-Erian’s prescriptions are those of a fiscal cheapskate. Quite the opposite: this kind of shopping list comes extremely expensive.

Specific measures would include pro-growth tax reform, housing finance reform, increased infrastructure investments, greater support for education and research, job retraining programs, removal of outdated interstate competition barriers and stronger social safety nets.

The point is rather that when Republicans can’t agree with Democrats, and Germans can’t agree with Americans, on any of this, the prospects for the global economy dim. And when the world is sick, the US can’t thrive. That’s not a function of who El-Erian is, or whether he’s conflicted. It’s just international geopolitical reality.


I agree with the previous posts insofar as we realize that: (1) No one really knows anything at any given time, and (2) we all must have our own “view” of the world, the geos, the markets, the economy, ad nauseum. It’s funny, we all get caught up in saying that El-arian or Gross move markets, or know what they’re talking about (or don’t), or have this political sway or that…when all it comes down to is YOUR view. One vote doesn’t mean much, or does my half mil in the market to the macro, but it means a lot to me. Bottom line: we can make money in this environment – those who complain will not or cannot.

Posted by Oscarwildedog | Report as abusive

Foreclosure datapoint of the day

Felix Salmon
Aug 27, 2010 20:44 UTC

HAMP might not have helped lots of homeowners stay in their houses over the long term, but it did push back the point at which they got foreclosed on. To now. Here’s a graph from the latest report from Lender Processing Services:


What you’re seeing here isn’t subprime dreck: it’s sensibly-underwritten conforming loans which were bought by Fannie and Freddie. Through 2009 and the first half of 2010, the rate at which those loans entered foreclosure proceedings was pretty steady. But as we enter the second half of 2010, there’s a huge spike, especially in the loans which have been delinquent for more than six months.

That spike is loans which entered the HAMP modification process, but then got kicked out, for reasons good or bad. Without a successful permanent HAMP modification, foreclosure comes soon enough.

As homes move out of HAMP and into foreclosure, the amount of distressed real-estate sales will rise, and home prices will of course fall in the effected areas, pushing ever more homeowners into the negative-equity status which is very highly correlated with default risk. And so the vicious cycle continues.

We should break that cycle, by forcing loan servicers to allow homeowners to stay in their houses at a market rent. HAMP did its job in terms of pushing off foreclosures for 2009. But now it’s causing more harm than good. And pretty soon, if they continue to rise at this rate, foreclosures are going to be a big political issue again. Some inventive replacement is desperately needed. Ideally one which isn’t cruel and bound to fail.


Please try to knock some holes in the following logic:

The goverment substantially inflates home values through the tax code, (interest diduction.) And now even more directly through other means like the tax credit for purchace, and by using the GSE’s to depress morgage rates.

These goverment subsidies flow mostly to the upper and middle classes.

These subsidies flow ENTIRELY from the upper and middle class as they are the only groups who pay net taxes to the goverment.

The working poor and non-working poor are as a group net recipiants of goverment transfers, (as they should be!)

The goverment has historically favored the working class owning homes rather than renting homes. Simply put the goverment is (rightly) afraid of people who have nothing to lose.

Prior to the massive massive massive spike in morgage equity withdrawal , or MEU, people tended to build equity over the course of their working lives with most seniors ending up owning their homes outright about the time they retired. Even now this is still the case. Nearly 40% of homes have no debt attached to them at all.

For those who propose reducing (or god forbid eliminating) the goverments preferential treatment of homeowners what other program do you propose to force/incent/subsidize a lifelong savings program?

If you want to level the playing field for renters and homeowners… that’s fine do that. Just plan on the percentage of Americans who reach their “golden years” with virtually no assets to increase more than it has already.

I advocate forced tax advantaged savings in a 401k style plan at 10% of wages. This could be introduced gradually to avoid the total distruction of the consumer discressionaly sector.

Posted by y2kurtus | Report as abusive

GDP: the best kind of bad news

Felix Salmon
Aug 27, 2010 14:11 UTC

If you’re going to have a sluggish growth figure, this is the best sort of sluggish growth to have:

Growth in the last quarter was stifled by a 32.4 percent surge in imports, the largest since the first quarter of 1984, dwarfing a 9.1 percent rise in exports. That created a trade deficit, which sliced off 3.37 percentage points from GDP, the largest subtraction since the fourth quarter of 1947.

Obviously, a trade surplus would be better than a trade deficit, especially in terms of generating employment growth domestically rather than abroad. But exports did rise, at quite a healthy clip. They were just eclipsed by this whopping rise in imports — which are a sign that there’s still a lot of demand in the economy.

This is a subject which came up at the Treasury blogger meeting last week: while no one at Treasury is exactly overjoyed at seeing imports rising so much faster than exports, any sign of increased economic activity is being taken as a good sign. Certainly this kind of thing is preferable to seeing the opposite happen, where exports fall and imports fall faster. Even if that would have a better effect on GDP.



Actually, I don’t care whether foreign interest in U.S. securities disappears, altogether. The U.S. government has no need to trade T-securities for dollars. A monetarily sovereign nation produces its own money by spending. Borrowing its own money is a relic of the gold standard days.
Rodger Malcolm Mitchell

Posted by rodgermitchell | Report as abusive


Felix Salmon
Aug 27, 2010 09:00 UTC

El-Erian: Stimulus isn’t enough — WaPo

Suing your servicer for not allowing you to modify your mortgage under HAMP: It works! — ML-implode

The story of round rectangles — Folklore.org

Which countries’ citizens have the most freedom to travel without a visa? — Economist

Matt Goldstein on Harbinger’s metamorphosis from a distressed debt fund into a mobile telecom incubator — Reuters

The CDO shuffle

Felix Salmon
Aug 27, 2010 05:41 UTC

It’s impossible not to love any story about the insanity of high finance during the bubble years which not only goes into hugely geeky detail but also comes with a cool cartoon and which includes the phrase “cheerfully feckless”. So, go read ProPublica’s latest CDO piece right now.

It’s long, of course — and for good reason: it’s full of juicy details. For instance, did you know that Wing Chau, the CDO manager who was one of the prime villains in The Big Short, ran one CDO called “888 Tactical Fund”?

More substantially:

ProPublica found 85 instances during 2006 and 2007 in which two CDOs bought pieces of each other’s unsold inventory. These trades, which involved $107 billion worth of CDOs, underscore the extent to which the market lacked real buyers. Often the CDOs that swapped purchases closed within days of each other, the analysis shows.

That $107 billion — an enormous number — was more than enough, at 20% of the total market, to provide the marginal demand that the market needed to keep prices frothy and bonuses high.

Essentially, the CDO business, in 2006 and 2007, became a con game. Ostensibly, independent managers were picking bonds with the aim of maximizing risk-adjusted returns for their investors. In reality, they existed only to provide a veneer of independence for bankers desperately trying to offload toxic waste that nobody wanted:

“I would go to Merrill and tell them that I wanted to buy, say, a Citi bond,” recalls a CDO manager. “They would say ‘no.’ I would suggest a UBS bond, they would say ‘no.’ Eventually, you got the joke.” Managers could choose assets to put into their CDOs but they had to come from Merrill CDOs. One rival investment banker says Merrill treated CDO managers the way Henry Ford treated his Model T customers: You can have any color you want, as long as it’s black.

It wasn’t just Merrill, either. Goldman was in on the game too:

The firm wrote a November 2006 internal memorandum about a CDO called Timberwolf, managed by Greywolf, a small manager headed by ex-Goldman bankers. In a section headed “Reasons To Pursue,” the authors touted that “Goldman is approving every asset” that will end up in the CDO. What the bank intended to do with that approval power is clear from the memo: “We expect that a significant portion of the portfolio by closing will come from Goldman’s offerings.”

The whole thing is summed up quite elegantly in that cartoon and also in a damning infographic:


ProPublica isn’t the only entity looking closely at all these smelly deals. The SEC is, too:

Asked about its relationship with managers and the cross-ownership among its CDOs, Citibank responded with a one-sentence statement:

“It has been widely reported that there are ongoing industry-wide investigations into CDO-related matters and we do not comment on pending investigations.”

None of ProPublica’s questions had mentioned the SEC or pending investigations.

One can only assume that Citi has received Wells notices about all this — and has decided that they’re not material enough to disclose, even though they’ve clearly had the effect of making Citi go very quiet indeed on the subject.

So go read this story, and all its sidebars: it’s great stuff. If I had to quibble, it would be only over this:

But the strategy of speeding up the assembly line had devastating consequences for homeowners, the banks themselves and, ultimately, the global economy. Because of Wall Street’s machinations, more mortgages had been granted to ever-shakier borrowers. The results can now be seen in foreclosed houses across America.

That is a slightly separate issue from the CDO Shuffle. Insofar as new CDOs were buying tranches of old CDOs, they weren’t buying new mortgages which would ultimately end in foreclosure. But ProPublica gets the big picture spot-on:

Nearly half of the nearly trillion dollars in losses to the global banking system came from CDOs, losses ultimately absorbed by taxpayers and investors around the world. The banks’ troubles sent the world’s economies into a tailspin from which they have yet to recover.

Well done to ProPublica for holding the perpetrators’ feet to the fire.


Yes Danny Black, there was greed and demand, which is why they were rebundled and why so many mortgages changed hands and are difficult to trace. The high yield/high risk is like crack in the finance world. I don;t deny that.

I see CDOs as a fantasy bet. One which was continued to be kept afloat by fluffing it up with fake ratings. It wasn’t just existing mortgages, it was subprime… and when they dried up the brokers went out to coerce anyone who could be duped into buying one.

I would think that being 25% of US mortgages were ‘unconventional’ that the subprime mill was a great place to play such high finace lottery. Being mortgage brokers were selling mortgages to people with no little or no credit and the banks were quite aware AND those who were shorting were quite aware which banks and lenders were allowing such mortgages to go through … and those mortgages ended up in an AAA rated CDO packages … and people like Paulson were allowed to pad the CDO package he was about to short himself… etc… i would say there were lots of instances where insider trades and shorts with insider knowledge were more then a possibility. The kind of money made from other people’s money is just too good to pass up.

Make a product so complex and backed by third party independents like Paulson, who isn’t independent at all as he helped package the CDO and is going short and that’s how you can design a product to fail. Should I have said fall short of implied expectations? It gives a whole new meaning to calculated risk. Pass the bonuses please.

That the further watered down CDOs which were still left in someone’s hands were now a hot potato didn’t stop the mill after they were found to be as worthless as those who had faked their value KNEW them to be… it just became the hot potato with bonuses given to those who were able to rid of them, kept the demand high as well as the ratings.

The hot potato time bomb..CDO shuffle… watered wine …call it what you will, but it was still repackaged junk, no matter the ratings.

http://www.calculatedriskblog.com/2007/0 2/wsj-mortgage-hot-potatoes.html

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