Felix Salmon

Earlier this month, talking about a housing market unsupported by Uncle Sam’s billions, I said that “the entire housing-finance business in the U.S. would come to a screeching halt. No one could buy, no one could sell, and home values would be entirely hypothetical.” What I didn’t realize was that we were plunging towards that state of affairs even with the vigorous and active involvement of Fannie Mae and Freddie Mac.

The National Association of Realtors said sales dropped a record 27.2 percent from June to an annual rate of 3.83 million units, the lowest level since May 1995.

This number is the lowest that the NAR has ever reported, and I can see why it spooked the markets, sending 10-year Treasuries breaking through the 2.5% level: we’re seeing less housing market activity now than we were even during the depths of the crisis. According to the NAR, there were 4.94 million existing homes sold in 2007, 4.34 million sold in 2008, and 4.57 million sold in 2009. The latest annualized number in that series, for July 2010, is just 3.37 million. That’s a 26% fall from last year’s rate.

The number is so low that it looks like a statistical aberration: let’s hope it is. Because if it isn’t, the news is gruesome. It means that despite record-low mortgage rates, people aren’t able to buy houses: essentially all the benefit from those low rates is going to people who already own their homes and are taking the opportunity to refinance.

The news also means that there’s a big gap between buyers and sellers: the market isn’t clearing. Sellers are convinced that their homes are worth lots of money, or will rise in price if they just hold out a bit longer; buyers are happily renting, waiting for prices to come down. And entrepreneurial types, whom one would expect to arbitrage the two by buying houses with super-cheap mortgages and renting them out at a profit, don’t seem to have found those opportunities yet.

Houses are rarely a liquid asset; they were, briefly, during the housing boom, but now they’re more illiquid than ever. America is a country where two generations of homeowners have learned to consider their houses an asset; they’re rapidly learning that at times like these, a house can look much more like a liability. (And refinancing your mortgage is just liability management.) The enormous repercussions of that change in mindset are only just beginning to be felt.

You probably know, or think you know, that fine wine gets better with age. But how do you know that? It is probably not by tasting a large number of fine wines of various vintages.

Instead, you’re just taking it on trust, often from the kind of wine snobs who will sniff and swirl and spit a wine, but now swallow it, and declare with all the puffed-up authority they can muster that it will be “drinking well from 2017 through 2027.”

Such proclamations tend to be extremely unhelpful except for people who aspire to become wine snobs. Even if wine really does get better with age, you can only benefit from being told such things if you can a) find the wine now; b) afford to buy it without drinking it; c) store it indefinitely in carefully temperature-controlled conditions; and d) somehow be able to cross-reference your wine collection with a database which tells you when the perfect drinking years finally roll around so the wine isn’t forgotten.

Fine old wine is drunk every day, by people who are very happy that it has been aging for a decade or two. But for every bottle that fits that description, there’s another bottle which has been gathering dust for far too long.

If it’s drinkable at all, it’s flat, uninspired, and likely to taste of nothing in particular, especially after 10 minutes in contact with air. There are millions of these bottles, all of which should really have been drunk years ago, and many of which are being treasured by owners who have delayed gratification for so long that it has disappeared entirely.

Meanwhile, the world of vintage wine is becoming more out of reach for the middle-class, with fine Burgundy and Bordeaux now an international commodity beloved of wine investment funds. No longer can such wines be bought for relatively modest prices when young, with the expectation that they would appreciate just as modestly over time.

Once upon a time, colleges, clubs and restaurants would barely change over decades, and would happily replenish the old wine they were drinking now with new wine they intended to drink in many years’ time. Something similar would take place within families: wine-loving patriarchs would drink the bottles bought by their fathers and grandfathers, while building up their own collection for their sons and grandsons.

But we’re living in an increasingly high-velocity world, where clubs and restaurants and hotels come and go quickly. They haven’t had the opportunity to build up a spectacular cellar and probably never will.

But the financial realities are even more important. Few of us have the good fortune to be able to drink bottles bought in the 60s, 70s, or 80s by our fathers or grandfathers — but even when we do, we feel that we need to do so in a special, ceremonious way, if only because those bottles, if they’re any good at all, are now so valuable.

Only a fraction of all wine produced globally will age well over 20 years or more. That tiny fraction of the world’s global wine production has appreciated enormously in price, even when it’s brand new. To drink vintage wine on a regular basis, you have to be able to afford to replace it with the same wine from the most recent vintage. That was something middle-class wine lovers could do, back in the 70s and 80s; it’s almost impossible now.

At the same time, the quality of wine which won’t age well has improved immeasurably over the past 30 years. A technological wine-making revolution which began in Australia has long since swept the entire world, to the point at which even the cheapest wines are dramatically better than their counterparts of a few decades ago.

Back in the 1970s, the choice between cheap California jug wine and good French Bordeaux was an easy one. The French wine was significantly better and still affordable while the cheap wine tended to be far too sweet, perfectly capable of ruining an otherwise-excellent meal.

Today, entry-level mass-produced wines like Yellowtail or Ecco Domani are eminently drinkable and for the same price or just a couple of dollars more it’s possible to find excellent wines from France, Spain, Chile and many other countries. That first-growth Bordeaux, by contrast, is utterly out of reach: only millionaires can afford to drink it daily.

It used to make a lot of sense for many people to drink half the wine they bought and lay down the rest. But almost none of the wine that most of us buy and drink is going to get any better with age.

The problem is that winemakers and wine retailers are loathe to admit it, because they know that the ability to age well is universally perceived as a sign of quality.

It can be a lot of fun to drink older wine, if you don’t have too much emotionally or financially invested in it. Recently I poured a 1998 Chianti down the drain without regret: I bought it cheap and the gamble didn’t pay off. But it’s very hard to throw away wine with nonchalance when you’ve paid $50 or $150 or even $500 for it.

So if you find a wine that you love, drink it. And if you want to start exploring the world of older wines, make sure you have a fat wallet and expect to run into some very expensive disappointments along the way.

Will IndyMac unnecessarily foreclose on a church? Looks like it — Shame the Banks

The bogusity of the NYT story about how technology leads more national park visitors into trouble — Slate

Clearly it can pay not to cooperate with a story: Fortune’s piece on Trader Joe’s couldn’t have been more gushing — Fortune

Build tall, yes. But don’t build ugly, if you can avoid it. 15 Penn Plaza is a monstrosity — Archpaper

“I don’t just think outside the box, I stand on top of it. I aim to appease my employer.” — Gawker

I might not have a house of worship or a community of faith, but I’m 100% behind this — War on Prayer

Expected inflation over the next 30 years: 1.9% — SA

Markets in everything: Blagojevich autograph, $50 — Politico

Why would a housewares store like Rejuvenation accept credit cards but not debit cards? Weird — WSJ

How one driver can stop traffic jams — Eskimo

Baruch vs bonds. Compelling — Ultimi Barbarorum

One of the most dangerous phrases in finance: “It’s free money.” — Aleph

Donna Borak has found an upcoming paper from Fed economists Wayne Passmore and Diana Hancock proposing a government backstop for asset-backed securities. This sounds very much like Gary Gorton’s paper back in May, which was a very bad idea back then, and is just as bad of an idea now.

The Fed paper doesn’t go quite as far as Gorton, since it’s based more on an FDIC model where the insurance is paid for by the issuers. But the fundamental problem remains the same: from an investor perspective, the bonds would become risk-free. And we don’t want to create risk-free bonds: we want investors to price risk. If they think they’re buying risk-free paper, in fact what they’re doing is pushing risk out into the tails, where it can explode unpredictably and disastrously.

There is something new and interesting here, though: the idea that this guarantee be used specifically for mortgage bonds, and specifically to replace Fannie and Freddie. Since the government is already guaranteeing Frannie’s bonds, this new scheme can’t be any worse than we’ve already got, from a systemic perspective. So I’ll be very interested to read the paper, when it comes out.

Jenny Strasburg misses the point of the Black Swan Protection Protocol:

Clients don’t hand over their entire account for the firm directly to manage. Instead, clients designate a certain pool of assets, a notional value, that they seek to hedge, or protect against extreme losses.

For example, a client with a $100 million account with Universa would pay the firm a flat annual fee of 1.5% on that amount, or $1.5 million. The client would transfer to Universa typically less than 10% to fund its account in the strategy…

The goal is for the value of the puts to pay off 60% if the market drops by 20% or more in a month…

“The biggest home run would be if we went into ’70s-style or worse inflation,” Mr. Spitznagel said. “If I had a gun to my head, right now I’d fall on the deflation side, but that’s going to flip at some point.”

The Black Swan inflation strategy has less than $1 billion in client assets. Clients might have to tolerate steady losses in order to reach a hoped-for bonanza.

In fact, it’s the other way around: clients hope for steady losses on their protection protocol (down 2% this year, down 4% last year), because that means that they’re living in Mediocristan and the rest of their investments are happily and steadily performing more or less as they’re meant to.

If the clients reap a bonanza on their protection protocol, that means that the global economy has gone in a very nasty direction, people are losing jobs and wealth all over the world (including the clients themselves, quite possibly), and we’re entering another era of unpredictability and chaos. I’d hardly characterize any of that as “hoped-for”.

Note that even the fund manager, Mark Spitznagel, reckons that deflation is more likely than the inflation that the protection protocol is hedging. The point isn’t that inflation is hoped-for, or even that it’s likely. But the bet can still make sense as an insurance policy on the rest of the portfolio blowing up. And it can even make sense on its own, if the payoff is large enough: the most successful fund managers, just like the most successful gamblers, tend to be the ones who intuitively understand that it often makes sense to bet on something with a relatively low probability of happening, just so long as your return is high enough in the event that it happens.

The thesis of the Black Swan Protection Protocol is that the risk of chaotic inflation is underpriced, so it makes sense to hedge that risk now, when doing so is cheap. That doesn’t mean that anybody is hoping for chaotic inflation. It just means that clients — who might soon include China’s sovereign wealth fund — sensibly want to be able to protect their portfolios across a wide range of possible outcomes, even if none of them rises to the level of being a probable outcome. And even if — especially if — many of those outcomes are things you devoutly hope will never happen.

It’s possible to quibble about probabilities here. Nassim Taleb and Mark Spitznagel reckon that the probability is actually pretty high, given the complexity of the global financial system, that there will be some kind of blowup sooner rather than later. Does that mean they think that the probability is higher than 50%? The question is silly: it presumes some kind of mathematical model of the world, with various calculable probabilities applicable to various specifiable outcomes. And even if the world does blow up, can one be sure that it will do so in such a way that the BSPP will make lots of money for its clients? Of course not. But at least the BSPP is trying its best to profit from the characteristics of Extremistan. If, and when, they manifest themselves.

The lead story in Sunday’s NYT was by Graham Bowley, and it was quite alarming:

Renewed economic uncertainty is testing Americans’ generation-long love affair with the stock market.

Investors withdrew a staggering $33.12 billion from domestic stock market mutual funds in the first seven months of this year…

If that pace continues, more money will be pulled out of these mutual funds in 2010 than in any year since the 1980s, with the exception of 2008, when the global financial crisis peaked.

Small investors are “losing their appetite for risk,” a Credit Suisse analyst, Doug Cliggott, said in a report to investors on Friday.

The story was picked up by Josh Brown, who said that in fact things were even worse than Bowley made them appear:

This has absolutely nothing to do with “risk appetites”…

What you’ll find is that people are now eating into their portfolios and living on their investment capital, they would prefer to pay bills (ar at least keep bills at bay) than worry about speculating in a market that makes little sense to them anyway (rallies on bad news, anyone?).

The men and women behind these outflow stats have been burned twice in a 7 year period and now there are taxes to pay and small company payrolls to meet and credit card bills to reconcile. There are car leases and financing payments to be dealt with and, oh would ya look at that, the roof done sprang a leak again…

The people are making withdrawals from their portfolios because they are starving for cash.

It’s as simple as that.

Except, it’s not remotely as simple as that. On the same day that Bowley’s article appeared on the east coast, Tom Petruno was writing a very different article for the LA Times:

In the first half of this year, redemptions of stock funds by people who needed or wanted their money were large enough to nearly offset the $724 billion in gross purchases by new buyers. The result was a net cash inflow of just $9 billion to the funds, according to the Investment Company Institute, the fund industry’s trade group.

By contrast, redemptions of bond funds were much less than new purchases, leaving those funds with a hefty net inflow of $156 billion in the half.

So bond fund assets are growing rapidly, but they’re still significantly less than what’s in stock funds. Bond funds held $2.4 trillion as of June 30 compared with $4.6 trillion in stock funds.

What’s going on here? Are mutual fund flows negative, as Bowley has it, or positive, as Petruno has it? The fact is that Petruno is much closer to the truth, and Bowley seems to have cherry-picked the worst number he could find. And Brown doesn’t seem to be right at all.

All of the numbers being cited here come from ICI, whose statistics you’re welcome to browse yourself. But they don’t cover the period through July, which Bowley is talking about: Bowley’s only using estimated July figures, and the official ones won’t come out until next week. Petruno is using the official figures, which run through June.

But even so, they don’t seem to add up. Were equity-fund flows positive through June, as Petruno has it, only to turn sharply negative in July, as Bowley would have you believe? No. The key word to note in Bowley’s piece is the word “domestic” — if you look only at funds investing in domestic equities, they have seen net outflows this year. But if you look at all stock-market funds, including those investing in the rest of the world, the outflows were positive through June; if you add in estimated flows through July, they’re modestly negative to the tune of less than $5 billion.

So really, equity mutual-fund flows are more or less flat so far this year: inflows are roughly the same as outflows. And remember that all of these figures are the difference between two large numbers: in the first half of the year, for instance, $724 billion flowed into equity mutual funds, and $716 billion flowed out. Which numbers help put Bowley’s $33 billion number in some perspective.

What’s more, equity mutual-fund outflows are largely a function of retired people withdrawing their money from the stock market. They would normally be offset by the flows of working people who are putting their money into the stock market. But those people are increasingly moving away from mutual funds and towards ETFs. And if you look at the ETF data, there was positive net issuance of another $38 billion in the first six months of 2010 — significantly more than Bowley’s $33 billion figure. Sure, some of that will have gone into bond and commodity funds. But most of it will have gone into equities.

So the big picture is clear, although you’d never guess it from reading Bowley’s story: people are still putting more money into the stock market than they are withdrawing from it.

And the bigger picture is even clearer: people are saving more and more money, and investing it in the market more broadly. ICI was good enough to send me the estimated year-to-date figures for all mutual funds — not just equities but bond funds and hybrid funds too. Add them all up, and you get a whopping net inflow of $208 billion. Which would seem to put the lie to Brown’s assertion that “people are making withdrawals from their portfolios because they are starving for cash”. In fact, they’re investing their cash to the tune of hundreds of billions of dollars, and they’re withdrawing money from their risk-free money-market funds to do so. (For the first half of the year, money-market funds saw net outflows of $509 billion.)

As Petruno says, people still have a lot more money invested in stocks than in bonds. So if they want to balance things out a bit more, then their marginal monthly investments are likely to be weighted more towards bonds than towards stocks. That’s going to make bond funds see lots of inflows, compared to stock funds. But it doesn’t mean that people are pulling their money out of the stock market. They’re not.

I had a fascinating conversation on Friday with Harold Bradley, the CIO of the Kauffman foundation. He’s something of an expert on high-frequency trading, quantitative strategies, and the like, and he raised an interesting question: why isn’t the SEC banning ETFs which include small, illiquid stocks?

The question arises in the context of a stock market which is demonstrating more lockstep than ever: stocks are ever more correlated with each other, and instead of broad indices aggregating lots of different moves in different directions, as they did in the past, increasingly it’s the other way round, and stocks just move up or down depending on what the broader market is doing.

The rise of ETFs, especially in the day-trading space, surely exacerbates this syndrome. As ETFs tied to the S&P 500 get bought and sold in enormous volumes, arbitrageurs, many of them high-frequency automated algos, jump in to buy and sell the underlying stocks. It’s something that some people are worrying about, in that it cuts against the idea that the stock market is meant to allocate money efficiently between companies.

But when ETFs include small, illiquid stocks, the situation is even worse. Right now, the SEC says that 70% of securities in an ETF must be “actively traded”, or 50% if the ETF includes 200 or more securities. Which means that ETFs can have up to 50% illiquid stocks, which are relatively easy to manipulate.

Let’s say that you’re a predatory algo and you’re looking at activity in these ETFs with substantial holdings of small-cap stocks. When people are buying, you quickly load up on the underlyings; when they’re selling, you go short. Your activity will eat into the returns of the ETF, since you’re making it more expensive for the ETF to buy the stocks, and getting it a worse price when it sells. But more to the point, it will maximize volatility and room for manipulation in the underlying stocks, as well, while minimizing the useful information to be gleaned from their share price. If you buy straddles on these small companies — equity derivatives which pay off when volatility is high — then it’s easy to imagine how you can trigger payouts by playing around in the ETF space.

“We have a lithium battery ETF“, says Bradley. “These are designed for manipulation. What we’ve done is create derivative packages that give people the illusion they can trade small-cap stocks for cheap. Just because they’re in an ETF doesn’t make them liquid.”

I do think that a lot of investors like ETFs precisely because they have a certain degree of liquidity which is often missing from the underlying stocks. But I suspect that it’s even harder to create liquidity out of illiquidity than it is to create a triple-A credit rating out of junk-rated subprime securities. You might be able to credibly pretend that you’re doing it, but there’s a strong whiff of fakery as well.

Clearly the SEC is concerned about manipulation, since it put in place those 70% and 50% limits in the first place. But if limits should be put in place, why not set them at 100%? This is a genuine question, incidentally: I’m not saying that Bradley is right here. But I do think he’s asking an important question.

Update: Some very smart comments below, and be sure too to check out Izabella Kaminska, who does a great job of explaining the market mechanisms in English.

ProPublica’s Paul Kiel crunches the latest HAMP numbers, and gets Treasury’s Herb Allison on the record saying the kind of things which so upset Atrios and others:

Allison put a positive spin on the fact that hundreds of thousands of homeowners have waited for several months for a final answer from their servicers. Homeowners in the trials have “benefited from lower payments … for many months” and from “having time to obtain other solutions to their needs,” he said. And that relief has come “at no cost to taxpayers.”

Kiel also links to an older ProPublica piece, from May, which spells out exactly what the weakness is in this argument:

Once they’ve been denied a permanent modification, homeowners owe the amount they were discounted during the trial. Banks often demand that the entire amount be paid as a lump sum right away or over a short period of time, causing a homeowner’s payments to swell beyond the original monthly payment.

What’s more, homeowners’ credit scores are damaged because trial payments are reported to credit agencies as delinquent or as part of a payment plan.

“Being in a trial modification if you don’t get a permanent modification is worse than having not been in a trial modification. Period,” said Diane Thompson, an attorney with the National Consumer Law Center. Worse yet, people “may have a hard time finding alternative housing because some renters check credit scores,” she said.

This is the real problem with the fact that 629,751 eligible home loans — 43% of the total — have been cancelled. In some cases, such as that of Goldman Sachs subsidiary Litton Loan Servicing, cancelled trials account for more than two thirds of the total. Treasury is trying to persuade us that those loans were still, on balance, a good thing. But I haven’t yet heard anybody outside Treasury attempt this line of argument, which indicates to me that it’s pretty unconvincing.

HAMP might well have been a success in the ways that Treasury enumerates — helping out banks on the solvency front, reducing the rate of foreclosures, that sort of thing. It was almost certainly a good idea politically, as well: you don’t hear much about the plight of homeowners being foreclosed upon, these days, certainly compared to the huge amount of noise on the subject around the time that Obama was elected president. The government is perceived to have Done Something, and the circus has moved on.

But it’s still a tragedy that hundreds of thousands of people who signed up for loan modifications — and who made all of their modified loan payments in full and on time — have had their modifications cancelled. Many of those people blame the servicers; Treasury, meanwhile, is more prone to blaming the borrowers themselves, claiming they’re incapable of verifying their income.

My feeling is that even if income hasn’t been verified, servicers shouldn’t simply cancel the loan mods if they’re performing well. And that if that’s what the servicers are doing, the incentives within HAMP have been designed very badly. That’s a Treasury failure, and it’s impossible to credibly spin it as any kind of success.

Atrios, reading Steve Waldman on Treasury thinking, concludes that they are “truly awful people”:

Conning homeowners by announcing a government program designed to help them when in fact it was designed to help the banksters is, in my world, “cruel.”

It’s a powerful point, and it’s definitely one of those things which Treasury is only going to say off the record. Even when Waldman was told it on deep background, he characterized it as “surprisingly candid”.

Treasury told Waldman — and told my group of bloggers, too — that HAMP, even if it was a failure, was a success. It might not have helped much in terms of its ostensible stated aim of permanently modifying millions of home loans. But it did help in at least three other ways: it gave temporary tax and payment relief to millions of homeowners; it massively reduced the rate at which homeowners in default were being foreclosed on; and, in the words of Waldman, “it helped banks muddle through what might have been a fatal shock”.

Was HAMP a bait-and-switch? Did Treasury know all along that it was likely to fail in its stated aim, but go ahead with it anyway because of its second-order effects? That seems to be the message they’re sending — that HAMP was a way of encouraging owners to apply for loan modifications, not because they were likely to get those modifications, but just because the sheer fact of applying for the modifications would help out homeowners generally, by reducing the rate of foreclosures, and banks too.

At the same time, I find it hard to believe that Obama personally was quite that cynical when he announced HAMP. And even within Treasury, I suspect that there was rather more hopefulness and rather less cynicism than the present viewpoint would suggest. On the other hand, if Treasury really did think at the time what it’s thinking now, Atrios is right. It’s undeniably cruel to raise people’s hopes like that if you know those hopes will end up being dashed.

Why are stocks yielding more than bonds? The expected 2011 earnings of U.S. stocks are more than 8% of their current price, while bonds yield much less than that. Rob Dugger has an interesting explanation: the market is looking at fiscal deficits as far as the eye can see, and trusts the US government to close the fiscal gap over the medium to long term. And doing so will inevitably mean hitting corporate profits:

The higher taxes and spending cuts needed to reach fiscal sustainability will echo throughout the economy in millions of ways. Companies that are dependent on the current structure of spending and taxes will be hurt. Their earnings and balance sheets will be weakened. In a sense, fiscal adjustment costs are off-balance sheet liabilities of every US company.

This might also help explain why companies have been so conservative about raising their debt issuance, even as the cost of debt has plunged: they don’t want to add to their on-balance-sheet liabilities even as their off-balance-sheet liabilities, in the form of fiscal adjustment costs, are rising sharply.

The book value of the stock market — the value of its assets minus the value of its liabilities — has, on this view, been declining steadily of late, as the size of America’s liabilities has steadily risen. This is why people lump Spain in with Greece: while Spain’s liabilities are largely in the private sector and Greece’s liabilities are largely in the public sector, ultimately it’s the economy as a whole which is responsible for them.

Of course, we have no idea whether or how future governments might seek to achieve fiscal balance by reducing corporate profitability. But that very uncertainty is something all investors hate: it’s impossible to price in, or to hedge against. Which is why bonds seem — are — so much safer, and yield so much less than stocks.

I’ve been waiting for a good critical review of Sebastian Mallaby’s tome on hedge funds, and the longer that we go without one, the stronger Mallaby’s pro-hedgie case would seem to be. Now, Noam Scheiber comes along in the New Republic, and his criticisms of Mallaby are pretty unconvincing:

The Financial Times reported earlier this month that “many star traders across Wall Street and the City of London are … decamping for hedge funds in their droves amid a crackdown that will sharply curtail banks’ riskier activities.” So some of the same folks who brought you the financial crisis will henceforth be working their magic with more leverage and less regulation. How reassuring.

As Mallaby is at pains to point out on a regular basis, hedge funds in fact have less leverage — a lot less — than banks. Many have none at all; those who do lever up tend to do so only by a factor of two or three, compared to leverage ratios in the 30 to 40 range for many investment banks and even commercial banks, in Europe.

These numbers aren’t precise or perfectly comparable, it’s true: there’s no simple and universally-adopted measure of leverage which includes all the clever ways that investors can get outsized exposure to certain assets. And indeed it’s almost impossible even to directly compare leverage numbers between European and US banks. But the fact is that the first and biggest loser, when an overlevered hedge fund fails, is its prime broker. And since the LTCM blowup, prime brokers turn out to have done a very good job of curbing any attempts by hedge funds to take overlarge risks.

Scheiber is worried that people like Morgan Stanley’s Howie Hubler — who lost $9 billion at what was essentially an in-house hedge fund — will simply now repeat their failures at standalone funds, if banks are barred from taking those kind of bets. But that misses the point. Hubler could put on those bets only because there was no prime broker breathing heavily over his shoulder, and because he had the full faith and credit of all of Morgan Stanley backing him up. The same is true of CDO losses at places like Merrill Lynch and Citigroup. And it’s also true of the pair of Bear Stearns hedge funds whose implosion marked the beginning of the crisis — when their prime broker sensibly withdrew, Bear Stearns itself stepped in to take losses on them.

Hedge funds, especially big hedge funds, need more regulation than they get right now, as Mallaby readily admits. They might not have caused this crisis, but they still pose a potential systemic risk, and someone needs to be looking not only at the risks that individual funds take, but also the risks that they pose collectively. After all, given their extreme secrecy, they simply don’t know when they’re entering a crowded trade — as many of them discovered painfully during the quant meltdown of 2007.

But in general there’s one thing that the hedge fund system does well, and that’s confine hedge fund losses to the investors in those funds. Hedge funds will blow up occasionally, and that’s fine; the investors in those funds will lose money, and people betting against those funds will make money, and there will be few if any systemic repercussions. Even if the losses exceed the amount invested in the fund, those excess losses will be borne with few systemic implications by the fund’s prime broker.

Scheiber worries that “the hedge fund industry will never fulfill its promise if its rank-and-file has a Hubler-esque weakness for market fads”. But the way that the hedge fund universe is set up, there’s really no such thing as a rank-and-file. And Hubler wasn’t jumping on to a market bandwagon: in fact, he thought he was betting against subprime bonds. He just funded that bet in a very unfortunate manner. His story is not, I don’t think, a cautionary tale for hedge fund managers. Instead, it’s Exhibit A in the annals of why the Volcker Rule makes a great deal of sense.

Update: Scheiber responds, saying that I “way overstate the benefits” of hedge funds. I didn’t think I’d come up with any benefits at all!

Mikael Blomkvist vs Andrew Sorkin. Hardly seems fair — NYT

Forgot Your Password? The game — Wonder Tonic

Viacom Digital Boss Greg Clayman Headed to Rupert Murdoch’s iPad Newspaper — All Things D

Ten year annualized real GDP has dipped to 1.62%, the lowest level since the early 1950s — Econompic

The Tragic Death of Practically Everything — Technologizer

AABender1 leaves me a very smart comment on closed-bank vs open-bank resolution — Reuters

Whom would you rather date: a guy with lots of expensive stuff, or a guy with lots of savings? — NYT

NOAA Claims Scientists Reviewed Controversial Report; The Scientists Say Otherwise — HuffPo

Things People Believe — Yglesias

How the social security trust fund works — Drum

Mortgage rates hit new all-time lows, ranging from 3.53% to 4.42% — WSJ

Charles Komanoff slaps down the energy-savers-are-delusional meme — Grist

There are bond buyers, and then there are scripophilists — Bloomberg

E.J. Graff on the jurisprudence of gay marriage — The Nation

Remember the ShoreBank rescue, back in May? Well, it got lots of headlines at the time, but it didn’t pan out in the end, and now ShoreBank has failed. The FDIC’s deposit insurance fund is taking a $367.7 million loss, and the money which was going to be invested in ShoreBank by Goldman, JP Morgan, Citigroup and others is now going to be invested in ShoreBank’s successor institution, Urban Partnership Bank. UPB will have a whole new management team, led by former Bank One executive William Farrow — something which rather puts the lie to conspiracy theories which said that Goldman et al were only investing in ShoreBank because its CEO was a friend of Barack Obama’s.

This clean-sweep approach makes a certain amount of sense: it’s right that ShoreBank’s shareholders should be wiped out when it managed to lose so much money. But it’s interesting to me that the government, given the choice between losing $368 million of the Deposit Insurance Fund or investing an extra $75 million in bailout funds, chose the former option. The deposit insurance fund, I guess, isn’t really considered taxpayer money, and will ultimately (eventually, hopefully) be repaid with future insurance premiums.

I wish Urban Partnership Bank well, and look forward to it proving that community-based urban lending can not only perform a crucial social function but can also be reasonably profitable. It’s sad that ShoreBank failed, but the main reason for the failure seems to have less to do with its community lending and more to do with its overexposure to speculative commercial real estate ventures. Urban Partnership Bank, I trust, will stick to its core competency, and do well for all concerned by doing so.

What’s scarier than Pride and Prejudice and Zombies? That’s easy: Pride and Prejudice and Structured Finance! Which is essentially the theme of Monetizing Emma, a play which I finally got around to seeing at the New York Fringe festival last night. As playwright Felipe Ossa puts it:

Girls have always been involved in economic compromises. We wanted to pose the question: In the 21st century, would a mother be marrying her daughter off to a suitor, or to the marketplace?

The play displays a lot of sophistication about structured finance, as you might expect from a playwright who has also written for the International Financing Review. It’s also very funny and sharply written, which you might not. And, lots of Jane Austen!

I went to see it with someone who knows pretty much nothing about high finance, and she loved it, but the finance-geek in-jokes are great too. Go for the Paris Hilton jokes, stay for the close reading of a bond prospectus. It turns out to be dramatically much more riveting than you could possibly expect, and the sold-out audience of downtown New Yorkers last night loved it.

(Incidentally, the theme of the play is a financial instrument not dissimilar to the jock exchange that Michael Lewis promised us back in 2007. Whatever happened to that?)

Shahien Nasiripour has some excellent detailed notes from the Treasury blogger meeting. And he doesn’t hesitate to call out the senior official when doing so is warranted:

The official pointed to the futures market where traders are betting that home prices will remain stable through the fall of 2014.

But there have been just 40 trades all year through Wednesday, said Mary Haffenberg, a spokesperson for the CME Group, which runs the S&P/Case-Shiller Home Price Index Futures market, the market the administration uses as its benchmark.

Meanwhile, Matt Yglesias wishes that the meeting had been on the record:

DC officialdom ought to realize that its obsession with off the recordy-ness has some serious downsides. Treasury did two meetings this week, one that was with professional blogger types and one that was more with professional economists who also blog, and most of the attendees seem to have come away quite impressed. If that’s the case, wouldn’t people able to listen to a recording of the full session likely also be impressed?

My feeling is that the answer to that question is “not necessarily”. Having a meeting with a Treasury official is interesting and worthwhile, although I admit that my mind did wander in parts, when the conversation got too political. Listening to a recording of someone else having a meeting with a Treasury official? You need to be a real wonk to do that, and although you might come away impressed, most people doing it are likely to be on the lookout for some kind of news.

Nasiripour is reporting, for instance, that at this meeting a senior Treasury official “said that home prices will likely decline in the near future” and “argued that taxpayers should continue to prop up small banks due to their exposure to toxic assets”. I don’t recall either statement, but I was neither taking detailed notes nor recording the conversation. It would be great if we could simply go to the tape and report exactly what was said and who said it. But then the news cycle would glom onto the “X said Y” story, in a world where administration officials can get fired if they say the wrong thing.

Putting the whole conversation on background makes it almost impossible to turn the briefing itself into a news event, and that in turn allows officials to speak without worry that their words will end up being used against them in the kind of fevered political-media frenzy which regularly appears out of nowhere and nothing in Washington.

What’s more, Treasury officials in general, and the Secretary of the Treasury in particular, really can and do move markets when they start talking about things like the dollar. There is a lot of value to open conversation, but it’s pretty much impossible to have an open conversation, in public, on the record, with a sitting finance minister of any country, especially when sensitive topics like the dollar or capital adequacy standards are on the agenda.

That’s all in theory; in practice it’s even worse, at least with this Treasury. During the Great Moderation, Paul O’Neill would happily chat away to reporters, on the record; he would occasionally find himself in hot water for doing so, but he was never very important. Politico and HuffPo didn’t exist in those days, but even if they had existed, they wouldn’t have covered Treasury. As a result what O’Neill said never really mattered that much. Plus, he liked engaging in wonky Socratic dialogue with FT reporters.

When Barack Obama picked Geithner over Summers for the Treasury job, he knew he was getting a buttoned-down technocrat rather than a natural debater and schmoozer. And Geithner learned his lesson early on: first in the nomination process, when he caused a storm on the subject of whether China was manipulating its currency; and then with his hugely-anticipated speech on the financial stability plan, which contained no real detail or concrete proposals, and which looked dreadful on TV, and which sent markets tumbling. Since then, Treasury has simply understood that it has to be very careful about exactly when, where, and how it says things in public.

I’m a reporter; I naturally want as many things to be on the record as possible, and ideally to be able to link to them directly online. I also think that it’s important for news organizations to be much more transparent than they are at present about the degree to which they’re meeting and talking to the most senior administration officials — Obama, Geithner, Bernanke, Biden, Clinton, Gates. We don’t need to necessarily know what these people are saying in those conversations, but it would be a step in the right direction if news organizations simply revealed that the meetings were taking place.