Opinion

Felix Salmon

Counterparties

Felix Salmon
Sep 23, 2010 04:27 UTC

Hedge funds say a busier market creates a healthier economy. But the lesson of the last two years is that this isn’t true — Bloomberg

Permanent HAMP mods fall 26% in August — Housingwire

NYC runs a $40k art competition with 150 winners. So far, it’s received 20 entries — NYT

Missing $1.4 Million Painting Found Hanging in Some Dude’s Bathroom — NYMag

Banker gaffe: “Give us a set of rules and then we’ll figure out how to work round them. I mean, work with them.” — Euromoney

Profile of Jack Shafer, who joyfully rips apart trend stories — Poynter

The Fed, Translated Into English — NPR

Be afraid: 32% of the 2010 class of Harvard Business School graduates have found work on Wall Street — Crain’s

Todd Henderson quits the blogosphere — TotM

Agassi:Sampras::Lennon:McCartney? Really? — Kottke

COMMENT

This blog post isn’t precisely what I was looking for, but with slight differences in the calculation it ultimately reaches the same point:

http://mises.org/daily/3822

Posted by TFF | Report as abusive

The new type of stock chart

Felix Salmon
Sep 22, 2010 20:13 UTC

A couple of weeks ago, I wondered whether it was possible to see what a stock graph would look like if it split up the x-axis according to volume rather than according to the time of day. After all, when trading is concentrated at the beginning and end of the day, those are the areas worth concentrating on, right?

Wonderfully, Omer Uzun of Proteus Financial rose to the challenge. And here’s the result:

Volume vs Time - SPY.JPG

The chart splits the 390-minute trading day between 9:30am and 4:00pm into ten chunks. On the normal stock-market chart, seen in blue, each chunk is 40 minutes long. But on the volume-based chart, in red, the first 10% of trading is already over after 17 minutes, while at lunchtime it takes over an hour to see 10% of the daily volume change hands.

I’ve only seen one of these charts so far, but at first glance it does seem as though the volume-based chart seems less volatile — smoother, somehow — than the time-based chart. I wonder what the equivalent chart for May 6 would look like.

COMMENT

I invented volume bar charting 7 years ago. Having researched them and published a few articles on them I can honestly say they are far superior to time based bars because they do not contain any inherent variable aspect like typical charts contains. The markets are traded in volume, NOT TIME. The problem with getting the industry to look at this chart type is that a majority of “market professionals” are closed minded. Thanks for opening the door a bit.

Wm Schamp

Posted by ProfLogic | Report as abusive

Angelgate

Felix Salmon
Sep 22, 2010 15:02 UTC

Mike Arrington loves nothing more than throwing bombs, so you could be forgiven for dismissing his latest exercise in conspiracy-theorizing as little more than self-promotion. But you’d be wrong. It’s an important story, and it’s one which Arrington almost uniquely is able to write. Henry Blodget makes some good points:

It’s this sort of work that makes this new form of journalism so valuable and fun. It’s also the type of work that would make the tech industry barely notice if the mainstream media just rolled over and died.

As Mike observes, many of the folks he calls out for this meeting are friends and sources, some of whom will undoubtedly be furious at him for exposing their little game.

It takes balls to lob a grenade at your friends like that. It also takes finesse and skill (and power) to do it and still have many of those folks rushing to call you after the meeting to preserve their relationships with you.

The only other person who pulls off stunts like this one is Nikki Finke: there’s something fundamentally bloggy about this type of journalism, and it’s very hard to see how bigger, older publications will ever be able to produce anything like it.

As for the substance of the story, nothing backs it up more than Dave McClure’s desperate attempt to knock it down. McClure was one of the investors at the meeting which Arrington crashed, and his description of a meeting where “the agenda was drinks, good food, & shooting the shit” is very telling:

at the dinner, there was a fair amount of kvetching about convertible notes, capped or not, hi/lo valuation, optimal structure of term sheets, where the industry was headed, who was innovating and who wasn’t, and 10 million other things of which 3 were kind of interesting and 9,999,997 weren’t unless you like arguing about 409a stock option pricing.

It seems to me that Arrington is right, and that this dinner was an attempt by some very powerful angel investors, led by Ron Conway, to collude with each other on a number of different fronts. Quite possibly including 409a stock option pricing. Arrington’s a lawyer by training, and if he says this is illegal, then it’s worth investigating the accusation seriously, rather than trying to dismiss it in a blog entry featuring lots of swearing along with multiple font colors and sizes.

Importantly, it doesn’t matter whether the collusion is working or not. Here’s Fred Wilson:

The angel/seed market is really competitive these days, particularly in silicon valley. Valuations have risen and terms are weakening, as I’ve blogged about here recently. This is not a market suffering from collusion. It is a market where the investors wish they could inject some collusion. But they can’t and they won’t. Market dynamics, at least as they exist today and for some time to come, will not allow it.

I daresay he’s right about all of this. But if investors “wish they could inject some collusion”, and meet at Bin38 with the intention of doing just that, then what they’re doing is probably illegal even if it doesn’t work.

Similarly, it’s no defense against accusations of collusion to say that you were “extremely uncomfortable with the direction the conversation was going,0″ in Arrington’s words. Yes, it can be uncomfortable to break the law. Discomfort is a sign you’re doing something wrong, but squirming a little isn’t the right response. Leaving the meeting, and speaking up about it, is the right response.

I think Ryan Tate has got it right here:

Oh, San Francisco. You do not wear dark, evil plots well.

There’s certainly something pretty amateur-hour about this whole meeting. But that doesn’t mean it’s not a genuine conspiracy.

As Arrington says, “I had a quick call with an attorney this morning, and he confirmed that these types of meetings are exactly what these laws were designed to prevent.” If these men worked for public companies, you can be sure the SEC would be setting up meetings with all of them right now. Since they’re private investors, it’s not so obvious whose bailiwick this falls into, and whether anybody really has any incentive to prosecute. Maybe Arrington himself is our best hope for keeping these people at least a little bit accountable.

*Update: Ron Conway denies being at the dinner or even knowing about it. Which now makes it seem less malign. If Conway wasn’t there, then it wasn’t quite the everybody-who’s-anybody meeting that Arrington was making out to be.

COMMENT

Felix,

Under federal law, criminal investigations would be up to the Department of Justice Antitrust Division. Civil government investigations would be up the FTC’s alley.

Assuming the collusion doesn’t work, the state of California and market participants probably wouldn’t sue under federal law – its not really worth it. There may be state antitrust laws involved as well.

Posted by AnonymousChef | Report as abusive

Chart of the day, consumer credit edition

Felix Salmon
Sep 22, 2010 14:14 UTC

Joe Toms of Lending Club emails me the data for this chart:

rates3

Joe comments:

Consumer credit has been the one area that has dropped the least. Said in a nice way, this points to the structural inefficiency. A more blunt assessment is that banks have been taking advantage of consumers.

The picture is certainly striking: consumer credit rates, as measured by the Federal Reserve, fell by just 3.74 points over the period in question, while Treasuries and corporate debt dropped in yield by over 10 points. Even munis saw a much more striking fall in rates, despite the fact that their tax advantages were seriously eroded as tax rates fell.

Part of what’s going on here, of course, is that the consumer-credit universe became much less creditworthy as banks started giving out credit cards to anybody and everybody. But that’s not the whole story. We’re also seeing a move from relatively low-interest-rate personal loans to relatively high-interest-rate credit cards. And, of course, we’re seeing huge profit margins, at the banks, on consumer credit: the banks in general have done a very good job of competing on everything except lending rates.

The result is a gap in the market for innovative new online companies like Lending Club and BankSimple, all of whom in one way or another are looking to profit from those high consumer-lending rates. Given that they’ve stayed stubbornly high for the past 30 years, it’s probably fair to assume they’ll stay high for the foreseeable future.

Update: There was an error in the original chart: I’d labeled the Mortgages as Aaa bonds. Fixed now. Why were mortgages more expensive than consumer credit in 1981? I’m not sure, but it’s probably something to do with negative convexity and prepayment risk, as well as the fact that they’re much further out the yield curve.

COMMENT

 A lot of long-term context is missing in the comments posted so far.  It is vitally important to note that the financial system was very different in 1981.  A huge wave of change was about to unfold over the next 30 years.   Bad credit has been extended throughout man’s history.  If you repeatedly finance there will be mistakes.  The more germane point is that starting in the early 1980’s we began to systematically develop sophisticated ways of providing easy credit to a broad spectrum of poor borrowers in a much larger way.   Over time the absurdity of this was demonstrated by the ARM, no interest pay-as –you-go loan.  The whole financial system levered up and all major fixed income categories (with limited exception) witnessed a large decline in aggregate credit quality.  It is what has led us to the mess we are dealing with today.  Yet, interest rates have plunged throughout this period.  Spreads however, as one comment mentioned, are wider.  Why have rates plunged and spreads widened?  The first question is harder to answer as there must be many factors involved.  A huge shift in Western demographics (baby-boomers of all cultures producing excessive savings), central bank, government and corporate policies have clearly contributed.  The second part is of the question is easy.  Spreads should be wider reflecting the a wider range of credit quality spawned by this evolution!   Finally, a number of statements reflect the misperceptions surrounding consumer credit.  The first association in most people minds with consumer credit is sub-prime.  Yes, just like mortgages and sovereign government bonds, consumer credit quality has deteriorated as it expanded.  You can buy poor mortgages, Greek bonds, or sub-prime consumer credit.  But the broad brush statement that the market is risky is far from the truth.  Unsecured consumer credit (credit cards) is a huge market, approximately $850 billion.  The higher credit quality bands have had a long, consistent history of reliably paying throughout recessions, including the last one.  These people are not sub-prime but yet still pay rates that do not reflect the changes in interest rates over the past 30 years.  Why?  To generate a return on consumer credit you must aggregate enough loans to be reasonably certain of the financial outcome.  The only ones who can are financial companies.   The result is little competition and not surprisingly higher rates.  A number of other factors also come into play.  Nonetheless, the central point is that it’s a uncompetitive market place with the result that rates have remained stubbornly high.

Posted by jtoms | Report as abusive

When corporates trade through the sovereign

Felix Salmon
Sep 22, 2010 12:52 UTC

The CFR’s geographics blog notes that in some European countries, whole sectors of the economy are trading at lower spreads than the government’s debt:

In Greece, Ireland, and Portugal, a number of sectors have negative corporate spreads, suggesting that firms are either less likely to default than their governments or will have higher recovery rates if they do default.

I suspect that we’re seeing a number of things here, but primarily a recognition of the fact that European integration is further along economically than it is politically. The kind of companies which are big enough to issue publicly-traded bonds are also the kind of companies which tend to have operations in a lot of different European countries. As a result, they’re diversified from their home base.

It’s also the case that many individual firms have modest levels of debt, and might be able to keep on servicing it even in the event of a full-blown economic crisis. If, that is, the government allows them to do so. If Greece devalues, for instance, the sovereign will find it impossible to service all its euro-denominated debt. But some corporates might be able to stay afloat.

That said, sovereign defaults are devastating things for any country’s bond markets, and a lot of the hopefulness that the CFR is seeing is likely to vanish should a crisis arise. Those companies might be trading through the sovereign now. But don’t count on that to continue to be the case even in the chaos of a default.

COMMENT

“If Greece devalues, for instance, the sovereign will find it impossible to service all its euro-denominated debt…”

Stop this insanity. There is no way they can devalue. They don’t have their own currency. You don’t honestly suppose they will leave the EUR?

Posted by Meriwether | Report as abusive

Replacing Summers

Felix Salmon
Sep 21, 2010 20:20 UTC

It seems that David Warsh nailed it, back in May: Larry Summers is going to quit his White House position in November, according to Hans Nichols. He’ll probably go back to what he was doing before: a day a week for a hedge fund, a position as University Professor at Harvard, maybe even return to writing his column for the FT. And who will replace him?

Administration officials are weighing whether to put a prominent corporate executive in the NEC director’s job to counter criticism that the administration is anti-business, one person familiar with White House discussions said. White House aides are also eager to name a woman to serve in a high-level position, two people said. They also are concerned finding someone with Summers’ experience and stature, one person said.

The corporate-executive idea is a bit weird: of all the positions in the White House economic team, one would expect the NEC director to actually be an economist. And there aren’t many economists who are also prominent corporate executives. (Actually, I can’t think of any. Readers, help me out here!)

I also very much doubt that the presence of a corporate executive in the White House would have any success at all in countering criticism that the administration is anti-business.

If Obama wants a woman with experience and stature, maybe he can persuade Laura Tyson to come back for another tour of duty? But high-profile economists are hard to find, as is evidenced by the fact that so few of them become corporate executives. Filling the position won’t be hard, but I don’t expect Obama to fill it with someone the public has heard of.

Update: Thanks, readers! Gary Loveman, the CEO of Harrah’s, has a PhD in economics. As does Mohamed El-Erian, the CEO of Pimco.

COMMENT

“Good article Guys, Thanks. By the way I found this awesome site for Financial Data and Analysis : http://thinknum.blogspot.com/ You can Search over 7,000,000 datasets. It has a financial data analysis engine which brings the functionality traditionally found on wall street proprietary trading desks to an open platform. You can visualize, save and share data. This tool is similar to PlotTool at Goldman Sachs or DataQuery at JP Morgan. Check it out, You may like it!”

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The stock-bond disconnect

Felix Salmon
Sep 21, 2010 15:46 UTC

I’ve been pondering the disconnect between stock and bond prices of late. It reminds me a bit of late 2007, only the other way around: back then there was a credit crunch, but the stock market continued to hit new highs. Today, stocks are largely sitting out the bond bubble.

Exhibit A in these matters always seems to be Johnson & Johnson, which has a dividend yield significantly higher than its 10-year bond yield of about 3%. Whitney Tilson went on TV yesterday and put the thesis in its starkest terms:

We don’t understand what any long-term investor could possibly be thinking when Johnson & Johnson, a month ago, issued all-time record low 10-year corporate debt at 2.95% and the stock yielding 3.8%.

Clearly the two markets are telling you that what investors rationally might be thinking is that we’re in for ten years of Japanese-style deflationary horrific environment, and I think the odds of that are less than 5%. I think it is 95% likely, for example, in the case of Johnson & Johnson, that if you’re going to own something for ten years, you will do massively better owning the stock, both from the appreciation of the stock and the dividend yield you get over those 10 years, than a mere 2.95% owning that 10-year bond they just issued.

There are two problems with this argument, as I see it. The first is that we’re not faced with a simple binary outcome, where either we have Japanese-style deflation, or else the stock will outperform the debt. It’s entirely possible — there’s a nonzero possibility — that J&J stock will fall over the next ten years, rather than rise: that Whitney’s stock appreciation will be negative rather than positive.

J&J is an extremely creditworthy company, and you can be pretty sure that if you paid $62 for that bond at a 2.95% yield, then over the next ten years the company will pay you a total of $80.29 in nominal dollars. (You’ll see why I chose $62 in a minute.)

Meanwhile, the cashflow associated with buying $62 of J&J stock is much less certain. You might well get a 3.8% dividend next year — that’s $2.36 — but you don’t know what you’ll make in subsequent years. Let’s assume the dividend stays constant at its current level: then over ten years, you’ll get $23.56 in dividend payments.

In order for the stock to outperform the bond, then, it has to be worth more than $56.73 in ten years’ time. (I chose $62 because that’s the price that the stock is trading at today.) That’s hardly unthinkable: in fact, it’s pretty much where the stock was trading just three weeks ago.

Of course, you can tweak your assumptions. You can start reinvesting dividends — but then you’d need to make assumptions about reinvesting the bond coupons, too. You can say that some kind of dividend growth is likely — but then you’d also need to price in the probability of the dividend being cut. And so on and so forth. What’s more, there’s something safe and attractive about just getting $80.29 in cash, compared to getting $23.56 in cash and a stock certificate which you could theoretically sell for something over $56.73.

More generally, if you buy J&J stock, you’re making a bet on the future prospects of a particular U.S.-based consumer-goods company. Those prospects might be good, but there’s still a lot of idiosyncratic risk there. The bonds, meanwhile, are almost certain to be paid back in full whatever happens to the company. (Unless of course J&J takes Tilson’s advice and runs with it, levering up enormously in order to buy back its stock. But it seems unlikely it’ll do that.)

It’s entirely rational for investors to be risk-averse, and to prefer a certain $80.29 over ten years to a very uncertain future direction for J&J’s stock price and dividends. After all, J&J stock could perform wonderfully well for the next nine years, increasing its dividend and generally being very healthy, only to suddenly plunge in 2020. Stranger things have happened, in this volatile market.

What’s more, Tilson’s numbers aren’t the only numbers you could use to perform this calculation. J&J’s average bond yield, for instance, is 3.2%, and some of its debt yields as much as 4.6%. Meanwhile, Reuters’s numbers put its dividend yield at 3.48%, rather than 3.8%. And in any case J&J is something of a special case, because its bonds are so very safe. It’s up there in the top four companies in terms of the difference between their dividend yield and their bond yield: the other three are Exxon Mobil, Nestle, and Procter & Gamble.

All that said, I do suspect that a long-term investor putting money into stocks right now is making a more sensible bet than someone putting the same money into low-yielding bonds. Stocks have unlimited upside, and tend to keep pace with inflation over the long term: they’re real assets, not nominal assets. And bonds have a lot of downside, as a quick look at the extent of the recent bond rally will demonstrate.

It’s impossible to invest these days without taking risk; I just feel that the risks in the stock market are more known and more priced in than the risks in the bond market. Interest rates will surely rise at some point. And when they do, you don’t want to be invested in bonds. Buy-and-hold investors, pretty much by definition, don’t have a strategy for selling the bonds that they’re buying right now. But are they prepared for possible future price declines? I don’t think so.

COMMENT

Enough money passes through Wall Street that it is possible for the traders to siphon off massive amounts and still leave a respectable return for small investors. Long-term investing is not a zero-sum game.

I know people are discouraged by the 1/2000 to 1/2010 returns, and fearful of the large bounces down and up in between, but they HAVE to realize that the situation today is very different than the situation in 2000. Ten years ago, expectations were sky-high and the economy looked great. Predictably, both fell back to earth and the market returns suffered. Today, expectations are in the toilet and people are talking “depression” and “double-dip recession”. Predictably, that will also moderate over time and the market returns will respond.

Investor sentiment may be a good predictor of short-term movements, but it is a CONTRARY indicator of longer-term trends. Because whatever the mood, it will eventually shift.

Posted by TFF | Report as abusive

The GMAC fiasco

Felix Salmon
Sep 21, 2010 14:05 UTC

Yves Smith has been doing a fabulous job covering the latest fiasco at Ally Financial, the state-owned bank which used to be called GMAC. But to get a quick idea of how dysfunctional the situation is, all you need to do first is read the official GMAC memo to its agents in 23 states around the country, and then read the official GMAC press release on the subject.

The memo could hardly be any clearer. “Do not proceed with evictions, cash for keys transactions, or lockouts,” it says. “All files should be placed on hold, regardless of occupant type. Do not proceed with REO sale closings.”

Yet here’s how the press release begins:

Recent reports have stated that GMAC Mortgage instituted a moratorium on all residential foreclosures in 23 states. This is not true. In fact, all new residential foreclosures are continuing in the ordinary course of business with no interruption in our usual practice.

There’s no good reason for this kind of misdirection and mendacity. Ally is meant to be the friendly, transparent bank; instead, at the first sign of trouble, it retreats into Clintonian language (didja spot that “new” in the press release?) which only serves to reinforce the impression that no banks, including Ally, can ever be trusted.

The substantive problem here seems to be a series of affidavits — tens of thousands of them — signed by Jeffrey Stephan of GMAC Mortgage/Homecomings Financial. The states where GMAC has put its evictions on hold are the ones where you need to go to court to get an eviction. And when you go to court, you need to provide an affidavit signed by someone with personal knowledge of the case in question. Stephan, it seems, had no such personal knowledge: rather, he was something of a “robo-signer”, who would put his name to affidavits without even reading them.

As Smith details, this problem is just as likely to get much bigger as it is to quietly get sorted out in the coming weeks. GMAC was not the only mortgage lender using robo-signers. And during the housing boom, all manner of legal corners were cut when mortgages were written, which can make them very hard to legally enforce.

And although the GMAC moratorium is so far only in 23 states (including Florida, but excluding California), the legal issues are surely substantively the same in the 27 other states as well. Just because you don’t need to go to court to get an eviction doesn’t mean you can toss someone out of their home without your legal i’s dotted and t’s crossed.

All of this is complicated, too, by the fact that the US Treasury owns 56.3% of Ally. At most banks, it’s generally assumed that the shareholders just want to see the maximum possible returns, over the long run. That’s not a safe assumption, however, when your shareholder is Treasury, which has been ploughing billions of dollars into schemes designed to prevent evictions.

It would be wonderful if GMAC could take the high road here, and act with full transparency in a manner consistent with the best possible practices that Treasury would like to see in the mortgage market. Judging by its press release, there’s not much indication that’s happening yet. But maybe a couple of phone calls from Washington might change its mind. I wonder how Elizabeth Warren is settling in to her new job.

COMMENT

I arrived here one year later via links in current stories. Nothing has changed

rowhalen posted on Sept 23, 1010 “We’ll see some attorneys go to jail over this nonsense regarding documentation in FL and elsewhere”

I would have thought so too. Today, even Florida’s “Foreclosure Baron,” David J. Stern appears untouchable. This says it all:

“And yet, despite all this David Stern walks around as a member in good standing of the Florida Bar, even today. Not a blemish. Ignore everything else about this train wreck….just consider how many millions in taxpayer dollars were spent with judges and courts trying to unsort the mess he caused when he walked away. And Pam Bondi….what about the millions spent investigating all this and still nothing…..our state, a state of corruption.”
Matt Weidner, 10:26 AM, 9/24/2011 orig posted here http://www.palmbeachpost.com/money/forec losures/fannie-mae-ignored-robo-signing- abuses-in-florida-1876292.html#comment-1 876997

Posted by KSinCFL | Report as abusive

Counterparties

Felix Salmon
Sep 21, 2010 07:06 UTC

CNN email: “Stocks rally to 4-month highs after economists report recession ended in June.” Yes, that’s June 2009 — HuffPo

Correlations are high at the open and close, lower mid trading day — Zero Hedge

Looks like Hempton’s still short UTA, which is recovering impressively from his blog-hit — Bronte Capital

WSJ screengrab of the day — EWT

COMMENT

Re: HuffPo

This IS the recovery. Over the past thirty years we’ve seen remarkable growth for an already-mature economy, some of that growth built on sustainable gains in productivity and other parts of that growth built on economic imperialism. As that latter foundation crumbles over the coming decades, our economy will face strong headwinds. GDP growth will be severely muted for a while.

Plan for 1% or 2% annual growth and we probably won’t be disappointed. Insist on planning for 4% annual growth and we risk running the economy over a cliff.

Posted by TFF | Report as abusive
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