Felix Salmon

The Fiscal Times vs Elizabeth Warren

Felix Salmon
Aug 16, 2010 21:22 UTC

What does The Fiscal Times, the online newspaper founded by Pete Peterson, have against Elizabeth Warren?

On Friday, it ran a peculiar piece by Eric Pianin:

Warren’s critics say that her aggressive advocacy and stinging rhetoric make her the wrong choice to head a new agency that will have to mediate between conflicting industry and consumer advocacy interests as it writes and enforces a raft of new regulations.

This just isn’t true: the CFPB does not have to mediate between industry and consumer interests. The whole point of the CFPB is that it exists only to serve consumers. The Food and Drug Administration doesn’t look to balance the needs of consumers with those of pharmaceutical companies; similarly, the CFPB will simply set standards which big banks will have to meet. There are lots of financial regulators charged with ensuring the health of the banking sector; the CFPB the only one charged with looking after consumers. So anybody like Pianin who thinks that the CFPB ought to be at least in part captured by the banks is fundamentally missing its raison d’etre.

Then, today, the Fiscal Times followed up with another piece, by John Berry, saying that she doesn’t have “the balanced judgment needed to direct the new Consumer Financial Protection Agency within the Federal Reserve”. (It’s Bureau, not Agency, but never mind.) Again, it’s not the CFPB’s job to be balanced: it’s the CFPB’s job to protect consumers. But that’s not the real weakness of the column, which zeroes in on one of the reports that Warren released as head of the Congressional Oversight Panel. Warren was critical of Treasury’s actions in the AIG bailout, and Berry says that just isn’t fair:

Warren and the panel simply ignored reality in asserting that the government “failed to exhaust all options” before risking taxpayer money in the rescue…

What might have been the cost to the financial system and the economy if the government had held off hoping for the best as rating agencies speedily lowered AIG’s credit rating — triggering new demands for payments under the credit default swap contracts — and some creditor had forced AIG into bankruptcy? A partial answer can be found on the New York Federal Reserve Bank’s website. The report speculates in detail whether the many AIG insurance subsidiaries might have been able to survive a bankruptcy by their parent. The conclusion was that nobody could be sure — and if worse came to worse perhaps the government could help pay policyholders claims!

“In the ordinary course of business, the costs of an AIG failure would have been borne by its shareholders and its creditors,” Warren said. “But the government instead shifted those costs in full to taxpayers. This meant we rescued highly sophisticated investors who voluntarily accepted grave risks.”

That sort of language is misleading and only reinforces the views that the government wasted taxpayer money to save the fat cats. It’s misleading, first, because AIG shareholders were virtually wiped out. Second, much of the government’s assistance has been repaid and there is a good chance that within two or three years it all will be. Third, the true cost of an AIG failure — with its disastrous impact on the financial system — would have been borne by the additional millions of Americans who would have lost jobs and income during the even deeper recession that would have occurred.

This is wrongheaded on many levels. For one thing, it’s simply true that the government failed to exhaust other options before bailing out AIG, which got rescued by the government pretty much immediately after the government found out it was in trouble.

Berry also fails to link to the Fed report in question, linking instead just to the New York Fed’s homepage. Not helpful. But the fact is that, yes, if AIG’s shareholders and creditors were wiped out, then policyholders might, ultimately, have to get rescued by the government. That’s as it should be: insurance policyholders, like small bank depositors, should be protected from corporate failure. What’s clear is that bailing out small AIG policyholders makes a lot more sense, both politically and in terms of moral hazard, than bailing out enormous AIG creditors like Goldman Sachs, who ought to be able to look after themselves. I don’t know what exactly Berry is trying to convey with his exclamation mark, but taking the risk of bailing out AIG policyholders is clearly preferable to taking the certainty of bailing out AIG creditors.

Berry then finds an entirely unobjectionable quote from Warren, which he proceeds to label “misleading”, even when it is no such thing. Certainly it’s a lot easier to understand than Berry’s objections. Warren wants shareholders and creditors to share the pain; Berry says that hey, shareholders were “virtually” wiped out (which means they weren’t wiped out), without mentioning that creditors were paid off in full. The fact that the government may or may not end up being repaid is entirely a function of the degree to which it’s willing to accept a below-market interest rate on its loan, and in any case doesn’t change the fact that AIG’s creditors didn’t realize any of the downside risk that they were voluntarily taking on — and being paid to take on, with higher yields.

As for the idea that “additional millions of Americans would have lost jobs and income” had the government not intervened in AIG as it did, well, maybe. And maybe not. But it’s not the COP’s job to start disappearing down that particular rabbit hole: instead, its job is simply to look at whether TARP money was well spent. And two things seem pretty obvious to me: firstly, if the TARP money were leveraged through the addition of some funds from AIG creditors, the government would have got more bank for its buck. And secondly, the government never seriously considered doing that. It’s right and proper for Warren to point that out. And it’s certainly no disqualification when it comes to the CFPB job, no matter what weird jihad the editors of the Fiscal Times seem to be on.


This notion that the CPFB can ignore industry and only protect consumers is idiotic. They can protect consumers from all fraud by banning all loans. No more mortgages. Does that actually help consumers? In order to figure out the implications of regulations the board will have to figure out how industry responds. It is just a stupid comment to ignore this.

The main part of the argument is also very misleading. I imagine that after Dunkirk was evacuated that Warren and Salmon would be complaining that not all opportunities to save British ammunition were exhausted, at huge cost to the taxpayers.

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Do tech entrepreneurs need VCs?

Felix Salmon
Aug 16, 2010 19:54 UTC

One of the least convincing and most annoying arguments against investing in index funds is the idea that if everybody did it, then the stock market wouldn’t be able to efficiently allocate capital any more. Well, yes — but there will always be people picking and buying individual stocks and funds. That doesn’t mean that you and I should count ourselves among their number.

Mike Arrington, today, repeats a very similar argument when it comes to angel funds:

Very few angel funded startups end up very big or interesting. “An entire generation of entrepreneurs are building dipshit companies and hoping that they sell to Google for $25 million,” lamented a venture capitalist to me recently. He believes that angel investors are pushing entrepreneurs to think small, and avoid the home run swings. And you don’t get a home run unless you swing hard, he says. When you play it safe you nearly always lose…

Some venture capitalists think that this “think small” attitude is driving entrepreneurs who may otherwise build the next Google or Microsoft to create something much less interesting instead, and then everyone loses. No IPO. No 20,000 tech jobs. No new buyer out there for the startups that don’t quite make it.

And without those occasional but huge exits, the entire ecosystem can fail. Venture firms need big returns to raise new funds. Without venture money a lot of the innovation in Silicon Valley would end.

So in effect, the argument goes, the angel investors are like a quickly growing cancer. Without radically invasive surgery, Silicon Valley will eventually flatline.

All of this doom-mongering is based on the existence of angel funds adding up to $200 million, tops, when you put them all together: chump change compared to the kind of money that the big VC firms control.

It is true that as barriers to entry in the tech space get lower, that reduces the amount of money that entrepreneurs need, and can result in venture capitalists being left out of the funding equation altogether. Doesn’t your heart just bleed.

But the idea that an uptick in angel-backed companies will result in fewer huge successes is just silly. Yes, it’s possible that angel-backed companies are happier with smaller exits than their VC counterparts. But if the VCs see an opportunity there to become the next Google, they’re more than welcome to buy the company themselves: they certainly have $25 million lying around to do just that. More realistically, VCs can certainly take over as and when original investors feel like cashing out, just as public stockholders take over when VCs cash out in an IPO.

Reading columns like this, though, does make me a bit more hopeful when it comes to the tech startup scene in second-tier cities like New York. In California, it seems, the funding architecture is incredibly rigid and inflexible, and any threat to that architecture is met with wails of pain. The rest of us, I think, are lucky to live in a world with a bit more optionality when it comes to funding. And who knows — maybe in the future starting an online company will be so cheap that it can be done entirely on debt, with no equity investment at all. That won’t help the people dreaming of getting rich through getting lucky with tech investments. But it might well help company founders avoid a lot of the poisonous funding politics that Arrington talks about.


Very good question, it’s difficult to decide between angel investors, micro-funds, venture capital when you are a start-up entrepreneur. All business people keep thinking about great companies such as Microsoft or Google and the big funds they needed and still do to develop and become what they are and, at the same time, most of the entrepreneurs do not aim that high as they do not trust their ideas that much or are simply realistic about what they can do. They do not want to be the big lottery winners and are fine with lower returns and popularity. That is why I think the above mentioned business capital sources should coexist, so entrepreneurs could choose what’s best for them. What is the use of an Angel-VC “fight”, I’ve read so many articles mentioning this notion. I agree with OnTheTimes who said that VCs prefer large projects, but, at the same time, tortoro is also right, some successful businesses can get angel investment funds at the beginning and venture capital in the following rounds.

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Harvard isn’t divesting from Israel

Felix Salmon
Aug 16, 2010 14:00 UTC

The noise surrounding a perceived rotation out of Israeli stocks by the Harvard endowment is really rather hilarious. Benjamin Joffe-Walt has managed to amass a whole sequence of quotes from people who have no idea what they’re talking about: one person is calling on “all academic institutions in the US” to follow Harvard’s lead and “divest from Israeli war crimes”; a second claims Harvard “still have tens of millions of dollars invested”; and a third comes up with the convoluted explanation* that it’s all to do with the fact that Morgan Stanley no longer considers Israel to be an emerging market:

“There are some funds which invest only in emerging markets,” continued Heen, the Cellcom CFO. “So Harvard had to sell our stock because Israel is no longer classified as an emerging market and they no longer have the ability to hold this stock within the emerging markets fund.”

Needless to say, university endowments, more than any other investors, are entirely unconstrained by such concerns.

The fact is that the Israeli holdings itemized in Harvard’s 13-F only added up to $41 million in the first place, or about 0.15% of Harvard’s total endowment. But it’s all pretty meaningless anyway, since the 13-F itself only accounts for a small fraction of the endowment’s total exposure.

The chances of this move being at all politically motivated are remote: the most recent concerted attempt that Joe Weisenthal can find to get Harvard to divest from Israel dates all the way back to 2002. And I’m sure that if you looked at all endowment 13-Fs on a quarterly basis, you’d find that every quarter a pretty large number of endowments will turn out to have sold out of some small market or other. It’s just that by sheer coincidence, this time it’s the two big hot-button names, Harvard and Israel, and hence there’s lots of headlines.

Next quarter, or the one after that, a few Israeli holdings are bound to reappear in Harvard’s 13-F. I wonder whether anybody will notice that.

*Update: The explanation might be convoluted and implausible, but according to a statement from Harvard, it also seems to be true!

The University has not divested from Israel. Israel was moved from the MSCI, our benchmark in emerging markets, to the EAFE index in May due to its successful growth.

Our emerging markets holdings were rebalanced accordingly. We have holdings in developed markets, including Israel, through outside managers in commingled accounts and indexes, which are not reported in the filing in question.

For some reason, it seems that Harvard’s EM holdings get itemized in its 13-F, while its EAFE holdings are run through external managers and don’t get itemized. No big story here.


Yeah it is a non-story but like most anti-Israeli stories is a case of people pushing out lies that get regurgitated by churnalists too lazy to bother do any actual fact checking. Luckily there are enough of these that the anti-Israelis can present it as fact in the never-ending feedback loop.

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The mess that is deposit insurance

Felix Salmon
Aug 16, 2010 06:43 UTC

There are three reasons to have deposit insurance. The first reason is systemic: it prevents bank runs. There’s no rush to pull your money out of the bank if you know that the government is guaranteeing your deposits. As a result, the entire banking system becomes much more stable and secure.

The second reason is one of simple fairness: depositors shouldn’t be expected to do due diligence on the banks where they deposit their money. And when a bank fails, those depositors shouldn’t lose their money.

The last reason is by far the least noble of the three, but even the FDIC admits that it comes into play when the deposit insurance limit is raised: every time that happens, depositors increase the amount of money they have in bank CDs. So if the government wants to help shore up a rickety banking system, one cheap way of doing so is to increase the FDIC insurance limit. Suddenly, the banks will see an inflow of relatively cheap funds, and will seem to be in much better shape.

So what are the reasons to have a cap on deposit insurance? Why not make it millions of dollars?

One reason is that bank CDs always yield more than Treasury notes, while carrying exactly the same government guarantee. Without a cap on insured deposits, investors would desert the Treasury market in droves, getting the same safety and much higher yields from their local bank.

The second reason is moral hazard. Waving an FDIC guarantee makes it almost too easy for banks to attract deposits. And when every bank has an FDIC guarantee, they’re forced to compete by offering higher and higher interest rates — which in turn forces them to take greater and greater risks with their lending. If the guarantee is set too high, the resulting increased risk in the banking system will more than offset the decreased risk from bank runs.

All of which brings me to Nassim Taleb, who recounts a tale from early 2009:

I was interrupted by Alan Blinder, a former Vice Chairman of the Federal Reserve Bank of the United States, who tried to sell me a peculiar investment product. It allowed the high net-worth investor to go around the regulations limiting deposit insurance (at the time, $100,000) and benefit from coverage for near unlimited amounts. The investor would deposit funds in any amount and Prof. Blinder’s company would break it up in smaller accounts and invest in banks, thus escaping the limit; it would look like a single account but would be insured in full. In other words, it would allow the super-rich to scam taxpayers by getting free government sponsored insurance. Yes, scam taxpayers. Legally. With the help of former civil servants who have an insider edge.

I blurted out: “isn’t this unethical?” I was told in response, “We have plenty of former regulators on the staff,” implying that what was legal was ethical.

The product in question is CDARS, and Blinder is a founder of the company which invented them. When Blinder wrote an op-ed complaining about an attempt to broaden deposit insurance, I was underwhelmed, writing that “Blinder has a massive conflict: he’s the vice-chairman of the company which runs CDARS, a financial instrument designed solely to get around FDIC deposit limits.” Without deposit limits, of course, CDARS become moot, and Blinder loses a large chunk of income.

I first wrote about CDARS back in 2003, shortly after they were introduced, in a Euromoney article which is behind a paywall. I wrote then that Promontory, Blinder’s company, was “doing a job that almost seems as if it should be performed by the Federal Reserve, or some other branch of the government”. But it wasn’t until Bloomberg’s David Evans came along in September 2008 that it became clear exactly what the problem is here:

Promontory charges banks more in fees, about $12.50 per a $10,000 one-year CD to get access to federally insured funds, than the FDIC itself charges in insurance premiums, typically $5-$7 per $10,000 deposited.

Essentially, Promontory is selling an insurance product, and collecting insurance premiums, even though it’s the government, and not Promontory itself, which is providing the insurance. That’s why Taleb calls the whole thing a scam.

In October 2008, the FDIC temporarily raised the insured limit on deposits to $250,000 from $100,000, making it very clear that the limit would come back down to $100,000 at the end of 2009. But in May 2009, the FDIC extended the “temporary” period all the way through the end of 2013. And in July of this year, the inevitable happened, and the $250,000 limit was made permanent.

The increase in the FDIC limit does increase the amount of moral hazard in the system; it also increases the amount of protection that depositors have. It does not meaningfully reduce the chance of bank runs, which is the main reason for FDIC insurance to exist in the first place. But it does help banks to hold onto deposits which would otherwise depart for money-market funds and the like.

While banks were getting all of this lovely support from the government, money-market funds were spending a whopping $12.1 billion to prevent their funds from slipping below the $1 mark, and more than 200 of them would have done so without injections of capital from their parents.

The whole thing is an ad hoc legal and regulatory mess, cobbled together largely on the basis of who has the best lobbyists: one minute it’s Promontory, next minute it’s the banks, and almost never does it seem to be the money-market funds. If you were starting a system from scratch it would never look like this, as can be proven by the fact that products like CDARS don’t exist in other countries, and also by the fact that CDARS don’t have any competition.

The FDIC itself is reasonably serious, these days, about charging realistic premiums for its services. (Premiums were unforgivably set at zero between 1996 and 2006, which isn’t the fault of the FDIC but of Congress.) But with the Dodd-Frank bill now signed into law, root-and-branch reform to the deposit-insurance landscape has become a political impossibility — which is fine by Congress, which loves to be able to meddle in such things when their local bankers ask them nicely.

And when the entire system is as politicized as this, it’s hardly surprising that the likes of Alan Blinder will embark on highly-lucrative regulatory arbitrage. He should probably just avoid trying to sell those schemes to Nassim Taleb in future.


Worth notiing – Promontory acknowledges having $55Bn in its system. Does someone want to apply the CDARS rate haircut on $55Bn to figure what this is worth in real money?

Posted by TKaz | Report as abusive

The Sheriff Warren rap

Felix Salmon
Aug 16, 2010 05:25 UTC

Somehow I can’t imagine anybody doing this for Michael Barr.


Felix Salmon
Aug 14, 2010 05:30 UTC

Sick of office politics? Get a puppy! — Economist

The very wittily written PE-2 instruction manual — Sparkfun (PDF)

Wapo declares in headline that Elizabeth Warren is “likely to head new consumer agency” — WP

The Rise and Fall of the Waterbed — Atlantic

Journalism Warning Labels. Oh wouldn’t it be nice — Tom Scott

“There is talk on the Right of not appealing the Prop 8 ruling in order to keep the case away from Scotus” — Right Wing Watch

Freakonomics: if you hated the book, you’ll loathe the movie — YouTube

Why Santelli is right, and wrong, about housing

Felix Salmon
Aug 13, 2010 23:59 UTC

In what Zero Hedge calls one of his top 3 rants of all time (beginning around 5:40 in this clip), CNBC’s Rick Santelli unloaded today on Steve Ricchiuto of Mizuho. The ultimate cause of the rant was a quote from Pimco’s Bill Gross, saying that he would only buy mortgages sans a government guarantee if first-time homebuyers were forced to make 30% down payments.

The immediate cause of the rant, however, was Ricchiuto, who was proposing that the government solve the problem that people can’t refinance their homes. “They’ve got to go out and change the ability to refinance,” he said, prompting Santelli to ask why. When Ricchiuto responds that it’s “because the banks won’t do it”, Santelli’s rant arrives:

Banks won’t do it because the government has subsidized lending to a level no rational person — you wouldn’t, with your money, sir, let somebody buy a house with nothing down and basically a free ride to risk on an unsecured loan.

Richhiuto is game enough to respond, saying that government intervention is “the only way to get the housing market going.”

Santelli, however, is having none of it:

Then the housing market’s no good, and we should let it seek its bottom. The government can’t fix it.

Putting aside the sheer volume of the exchange, Santelli has a good, substantive point here. The housing market is being artificially inflated by underpriced government funds and guarantees, and every day that continues is every day that taxpayers in general, and renters in particular, subsidize homeowners in general, especially those in states with high house prices like California and Connecticut.

Which doesn’t mean that Richhiuto is wrong. On the contrary, Santelli is angry precisely because he’s right. The government does need to get the housing market going, because the alternative is unthinkable: if the government just kicked away the housing market’s multi-trillion-dollar scaffolding overnight, as Santelli suggests it should, then the entire banking system would become insolvent, and we’d soon be reminiscing wistfully about how painless and shallow the 2008 financial crisis was, compared to the one of 2011.

I would love to see a world of much more affordable housing, where lenders underwrote mortgage loans without government help. The problem is that there’s no way of getting there from here without causing an unacceptable amount of pain. Homeowners would hate it, of course — they love it when property values rise, and are very upset when property values fall — but the biggest losers would be the lenders.

Which is why my long-term forecast is for house prices to decline steadily in real terms over a few decades: that’s the amount of time it will take to get back to a system which can sustain itself without artificial government support. The Santellis of the world won’t like it, but I can assure them that they’d like the alternative even less.


“Which is why my long-term forecast is for house prices to decline steadily in real terms over a few decades”.

Felix, I love you man but here you’re puffing a magic dragon. If this shit is overvalued, then it must be priced CORRECTLY. So that young families, etc. can AFFORD to buy a house. Why should I, a renter, subside a $500k purchase of a shack in San Fran? This is bullshit, plain & simple.

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Deflation and negative TIPS yields

Felix Salmon
Aug 13, 2010 18:07 UTC

In one of those classic understated TBI headlines, Vincent Fernando today says that “Actually You Should Panic” if TIPS yields go positive. His argument: “if TIPS yields hadn’t fallen to where they are now, then we’d truly have something to worry about — Deflation.”

The problem is, Fernando’s math doesn’t add up. Expected annualized inflation, over the next five years, is equal to the yield on 5-year government bonds, minus the yield on 5-year TIPS. (We’ll ignore things like the liquidity premium for on-the-run Treasuries.) The 5-year Treasury bond is currently yielding 1.47%, so if the 5-year TIPS yield is slightly negative, that puts expected inflation at about 1.5%. On the other hand, if the 5-year TIPS yield were up at 0.5%, then that would put expected inflation at 1%. Which does not count as Deflation, and is certainly nothing to Panic about.

Of course, it is a bit more complicated than that. For one thing, we’re talking about average inflation over five years, which given that inflation rates tend to bounce around a bit, might well mean a brief amount of time in negative territory. But that, again, isn’t the kind of deflation to panic about.

Meanwhile, deflation does provide one technical reason why negative TIPS yields aren’t necessarily as weird as they look. If we do have a brief bout of deflation, then TIPS coupons will be zero — which is actually positive in real terms. TIPS investors never need to give money back to Treasury. So it’s not necessarily true that you’re getting a negative real coupon: if there’s negative consumer price inflation for any length of time over the next five years, the zero bound on coupon payments might even things out. There’s also a lower bound of 100 on principal repayments, which may or may not come into play depending on the price/yield at which you buy your bonds.

So really, negative TIPS yields can be taken as a sign that the markets are beginning to price in some brief dip into negative-inflation territory. They’re not a sign that the markets are expecting no deflation.


Efficient market types take prices from the market (which must be right, har har) and infer things about the real world. Like inflation.

Ok, so we learned that Internet stock prices don’t reflect their true value. We learned that house prices don’t reflect their true value. We learned that Greek bonds prices didn’t reflect their true value.

Yet somehow we keep believing that markets prices are rational. Prices are just prices.

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Can Treasury justify suing homeowners in default?

Felix Salmon
Aug 13, 2010 17:46 UTC

House Democrats John Conyers and Marcy Kaptur have put together a strong and compelling letter asking Tim Geithner and FHFA director Edward Demarco to put an end to the silly and counterproductive way in which Frannie have decided to start suing homeowners they consider to be strategic defaulters: “pursuing expensive litigation against a vulnerable population when there appears to be little to no economic incentive is questionable at best,” they write.

The letter also points out that a lot of the onus here will be on servicers to decide who counts as a strategic defaulter — and no one, inside or outside government, trusts the servicers.

Other questions also seem to be open, for instance the proportion of received monies which will end up with Treasury as opposed to mortgage investors; the degree and way in which homeowners will be engaged prior to being sued; and the criteria which Frannie and the FHFA used when they decided to implement the policy.

I look forward to reading the replies from Geithner and Demarco: although the letter is mainly asking for action rather than a written response, a formal letter in reply would surely shed some useful light on what exactly is going on with this idea, and how committed the administration is to following it through.


Don’t the managers of Fannie and Freddie have a fiduciary obligation to their shareholders, whomever they may be? That fiduciary obligation is their legal duty, and it certainly doesn’t stop when the shareholders are taxpayers.

On a practical note, if Fannie and Freddie give up any pretense of acting like a business, the whole edifice crumbles. Since they are the *entire* housing market, we need them to act rationally.

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