Opinion

Felix Salmon

Making money off students, debit-card edition

Felix Salmon
Oct 4, 2010 21:09 UTC

This was probably inevitable: the minute that Dodd-Frank cracked down on the fees charged by credit cards aimed at students, some other bright financial innovation would crop up. This time, a debit card aimed at students. Which carries lots of fees. Ylan Mui reports that a company called Higher One has started signing up colleges around the country, taking on the burden of providing cash to students. In return, it gets lots of fees:

Students say several of the fees associated with Higher One’s card are particularly irksome, including the $19 inactivity fee, a 50-cent charge for using a PIN to make a purchase rather than a signature, and a $2.50 fee for using other banks’ ATMs…

Higher One said that only 1 percent of customers have been charged an inactivity fee and that more than half are charged the 50-cent fee only once. All fees are listed on Higher One’s Web site, along with tips on avoiding them.

“We have a big effort with educating students on how to use the account,” Smith said. “We’re very passionate about financial literacy.”

If the fees are listed on Higher One’s website, they’re not exactly prominent. I did find this page, eventually, via this blog entry, but it just says that “when you swipe & sign, you won’t be charged the PIN-based transaction fee”. I haven’t been able to find a page showing a 50-cent transaction fee anywhere*, although I did manage to find this page, showing a $25 fee for domestic wire transfers and a $50 fee for international wire transfers. “Higher One offers less costly alternatives for transferring funds”, it says, without giving any indication what they might be; I suspect that what they’re talking about is transfers to or from people who have already registered somehow with Higher One.

It should go without saying that any firm which is “very passionate about financial literacy” would encourage, rather than penalize, simple, cheap and safe PIN-debit transactions. It would not give students a debit card and then tell them that if they want to avoid fees they should select the “credit” option rather than the “debit” option when they come to pay.

And I can’t think of any good reason to charge a $19 inactivity fee to people who haven’t used their cards in 9 months.

The fact is that students are often very naive when it comes to money, and it’s easy to gouge them once or twice before they learn that banks are not necessarily on their side. If you can get your card accepted by a majority of freshmen every year, and then come up with all manner of weird fees to hit them with, that’s a great way of making money out of ignorance.

Meanwhile, all students should have a bank account: giving them a debit card instead only serves to maximize the number of unbanked students. So while I’m sure cards like this are attractive to colleges, it would be great if either the colleges or else the Consumer Financial Protection Bureau started being a lot more critical of them. Prepaid cards only ever make sense if the alternative is being completely unbanked; that should not ever be the case for students.

*At Southern Oregon University, Higher One agreed to waive the 50-cent PIN-debit charge, but only if there was a simultaneous “swipe-and-sign” campaign. If the campaign is unsuccessful and students do the sensible thing by using PIN debit, then the university can be charged $2 per student for “PIN fee elimination”.

Update: Higher One’s Donald Smith responds:

Higher One was founded 10 years ago by three college students (undergraduates at the time) who were looking for streamlining the way financial aid refunds were distributed to students. Today we work with more than 675 campuses across the country, have a 97% client retention rating, and an A+ rating with the BBB.

The OneAccount is Higher One’s optional, no minimum balance, no monthly fee, FDIC-Insured checking account created by students for students. We do not offer a stored value card. We are very open with our fee schedule. We post it on every program website for all to access, explain each fee, discuss how to avoid each fee, and provide students with a web page that tells them how to use the account for free (which you’ve already found). Because of this, we believe that our customers pay less than half the amount in fees that the average bank checking account customer pays per year.

Two of the fees you referenced in your blog are the PIN fee and the Abandoned Account Fee. The PIN fee is easily avoided by choosing a signature based transaction at the checkout. The majority of students uses it in this manner and is in turn protected by MasterCard’s Zero Liability Policy against fraudulent charges (a safer way of purchasing than a PIN based transaction). We do not have an inactivity fee on our fee schedule – we don’t penalize students who do not use their accounts. We do have an Abandoned Account Fee of up to $19, for those who have abandoned their accounts, but this has been charged to less than 1% of all OneAccount holders in our company’s history because of our proactive outreach plan.

Higher One offers no instruments of credit. As a matter of fact, we’re generally in favor of initiatives restricting students’ access to credit cards and promoting financial literacy. This is why we offer a full range of financial literacy resources along with the services we provide.

I particularly dislike the implication, here, that PIN-based transactions are unsafe. They’re not; they’re just less lucrative, in terms of interchange fees, than signature-based transactions.

COMMENT

Managing FA isn’t all they do. They also offer payroll services to colleges and universities. As Higher Ed costs are going up, Higher One has positioned itself as a free market alternative for what amounts to a contracting out of traditional functions of the Bursar’s Office in a college.

Considering how much is at stake, I find it disheartening that any school would contract essential financial services to private banking and accounting institutions if you look at the recent national-scale frauds. I’m not just talking about the housing bubble, but the earlier accounting scandals as well.

Also, as a more direct note on this story. Higher One boasts 1 million clients. If even 1% of those clients experience an account inactivity fee… well, you do the math.

Posted by Mr_J | Report as abusive

Blogonomics: Dealbreaker

Felix Salmon
Oct 4, 2010 16:47 UTC

Dealbreaker would be a very smart fill-in acquisition for the New York Observer. Bess Levin is already sharing bylines with Jessica Pressler, and the two of them working together at the same shop would be pretty unstoppable.

Nicholas Carlson reports that the Observer has agreed to pay a six-figure sum for the franchise, which seems reasonable to me. The brand is valuable — significantly more valuable than Levin would be on her own. On the other hand, everybody knows that Dealbreaker becomes essentially worthless if Levin leaves. So, sensibly, she’s demanding to get paid.

If I were Levin, I’d want a three-year contract commensurate with the sale price of Dealbreaker. Say a $100,000 signing bonus, and then a salary of $200,000 a year for three years. Contracts by their nature have to be lucrative things, because they carry an opportunity cost: if the Daily Show, say, came calling offering a television-size salary, Levin would have to say no if she was already under contract.

A $200k salary would put Levin on a significantly higher salary than Pressler, and indeed than most other NYO staffers — but that’s what happens when stars get brought on in an acquisition. If the Observer worries about such things, then fine — they should just pay her a higher signing bonus, or else promise her a big retention bonus after three years. There are lots of ways to structure these things.

I look forward to all of this being worked out, because if Dealbreaker isn’t sold to the Observer, there’s a risk that it’ll just disappear entirely if and when Levin decides to leave for greener pastures. For Dealbreaker performs a very valuable service: not only does it lay bare the id of Wall Street, but it also publishes a lot of quarterly letters from hedge funds. That service is hard to monetize, but it’s unique, in the financial blogosphere (Zero Hedge sometimes does it, but not nearly as reliably), and would be sorely missed if Dealbreaker were to cease publication.

Update: Oh dear, that’s embarrassing, I clearly didn’t have enough coffee this morning. Somehow I got the Observer mixed up in my mind with New York Magazine. Whoops. Ignore all references to Jessica Pressler, who is New York Mag, not New York Observer. But relatedly, Barry Ritholtz is already bidding $100k plus equity for Levin sans Dealbreaker.

COMMENT

It’s always about having legitimate choices. The more options you have the easier it is to make an unemotional decision. Good luck to Bess. But she’s playing a game of chicken here. All media is vapor. The impact has a half life that gets shorter on a daily basis. I’d make a decision quickly to trust someone, even if it’s herself on a go-it-alone basis.

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Explaining Carlos Slim’s $175 million NYT profit

Felix Salmon
Oct 4, 2010 16:23 UTC

Jay Rosen asks for an English translation of my calculation regarding the profit that Carlos Slim made on his NYT investment. It does get a bit complicated, but I’ll do my best.

In January 2009, the NYT borrowed $250 million from Carlos Slim. The idea was that he would be repaid in two ways. First, he would get interest on the loan. And second, he would get the right to buy lots of NYT stock at $6.3572 per share in 2015.

Now, the NYT is paying Slim back, three years early. But Slim isn’t just getting that $250 million back. He’s also getting three other things:

  1. All the interest payments that the NYT has to make for three years.
  2. The right to buy that NYT stock — he doesn’t lose the right just because the loan’s been repaid.
  3. An extra payment on top which the NYT agreed to pay if it repaid the loan early.

How much does that all add up to?

Well, the interest payments were set at 14.053% per year. 11.03% of that was in cash, with the other 3% in kind. Let’s assume that the NYT makes the final year’s interest payment fully in cash, but took advantage of the payment-in-kind option for the first two years. So the NYT paid 11.03% of $250 million two years running. That’s $55,150,000. And then in the third year it’s paying 14.03% of $250 million. That’s another $35,075,000.

Next we have the right to buy NYT stock at $6.3572 per share. That’s a valuable option — and in fact you can put a number on the value of that option quite easily, by using something known as an option calculator. You can quibble about the exact value of the option, but the option calculator gives you a good ballpark figure. And in this case, the option calculator spits out a value of $57,176,400 for the right to buy 15.9 million shares of NYT at $6.3572 per share in January 2015. This right is in the form of what’s known as “detachable warrants”, which means that Slim could go out and sell those options on the open market tomorrow if he wanted. It’s not just paper value he has here: it’s real value.

Finally, the NYT agreed that if it repaid the loan early, it would pay the money back at a rate of 105 cents on the dollar. So for every dollar that the NYT borrowed from Slim, it has to pay back $1.05 as a final principal repayment.

How much did the NYT borrow from Slim, altogether? Well, there was $250 million up front. And then, we’re assuming, in each of the first two years, the NYT borrowed another 3% of that sum, or $7.5 million a year. That’s $15 million over two years, on top of the original loan, for a total borrowing of $265 million. In order to pay that money back early, the NYT then needs to make a principal repayment of 1.05 times $265 million — that’s $278,250,000.

Add it all up, and the total amount of value flowing back to Carlos Slim from the NYT over the course of three years comes to $425,651,400. Subtract his initial $250 million investment, and you’re left with $175,651,400 in profit.

(Why did I originally say $150 million rather than $175 million? Mainly because of that options calculation. Options on volatile stocks are more valuable than options on less-volatile stocks, and I didn’t have a number for the volatility of NYT stock, so I used the number for the stock market as a whole. But now I do have a number for the volatility of NYT stock, which turns out to be much more volatile than the stock market as a whole. And so the value of Slim’s warrants is higher than I originally calculated.)

Of course, all of this assumes that the NYT is going to be able to find its $35 million coupon payment, on top of its $278 million principal payment, in January. That’s $313 million in cash which the company needs to raise somewhere. It doesn’t have that kind of money just lying around, so it’ll have to borrow it from somebody. Who’s the new lender? That’s very unclear.

COMMENT

@Citoyen: The Times didn’t prepay the interest. Included in the calculation are the cash payments they paid over the course of the past three years. Essentially what they are paying is 5% simple interest instead of ~14% compounding for the principle still outstanding. That’s a deal if one has the money to pull it off.

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How the subprime crisis hit blacks hardest

Felix Salmon
Oct 4, 2010 14:19 UTC

America’s minorities, it seems, can’t catch a break when it comes to housing. Before the subprime boom, they were much less likely than their white counterparts to be able to get a mortgage. Then, when the subprime boom started, they were much more likely to be sold a predatory mortgage.

A new study by Douglas Massey and Jacob Rugh of Princeton does a great job of quantifying this effect and nailing it down. My colleague Nick Carey has a story about it, but you should read the study yourself: I’ve uploaded it here and embedded it below.

The study is pretty clear. The authors have built a model which explains foreclosure rates, using a large number of variables, including things like overbuilding rates and house-price appreciation as well as demographics including credit scores. And it turns out, after crunching the numbers and doing the regressions, that living in a racially-segregated area is an important predictive factor in terms of how likely you are to experience foreclosure:

Whether measured in terms of residential dissimilarity or spatial isolation, segregation of African Americans is a powerful and highly significant predictor of the number and rate of foreclosures across U.S. metropolitan areas. For instance, a .1 unit increase in black dissimilarity is associated with 37 percent more foreclosure actions and a 34 percent increase in the foreclosure rate.

(“Black dissimilarity,” here, is a measure, ranging from 0 to 1, of how black a neighborhood is compared to the country as a whole.)

To put it another way, an increase of one standard deviation in a neighborhood’s black dissimilarity increases the foreclosure rate by 1.68 percentage points — which is a very large amount, given that the overall foreclosure rate is 4.14%. To put those numbers in perspective, a one-standard-deviation increase in factors like housing starts or house-price appreciation or even unemployment fails to increase the foreclosure rate by even 1 percentage point.

The authors conclude:

By concentrating foreclosures in metropolitan areas with large racial differentials in subprime lending, segregation structured the causes of the crisis, as well as the geographic and social distribution of its costs, on the basis of race. Segregation therefore racialized and intensified the consequences of the American housing bubble.

It’s hard to read this without being reminded of this chart:

det.jpg

Obviously, there’s more going on in Detroit than just racial segregation and discrimination. But it’s surely an exacerbating factor.

10ASR10_629-651_massey (2)

COMMENT

George Bush set and announced many times his determination to get 5.5 million minorities to become home owners. He told people this would be good for America.

On 9/2/04: “As part of the President’s plan to build an ownership society, he has focused on encouraging homeownership, particularly among minorities and low-income families. In 2003, the number of homeowners increased by 1.7 million as the number of renters declined in the United States by over one million families.”

Some details: “American Dream Downpayment Initiative. To help low-income families overcome the hurdle of a downpayment, the President proposed the American Dream Downpayment Initiative in June 2002 and signed the American Dream Downpayment Act into law on December 16, 2003.” …

“America’s Homeownership Challenge. In June 2002, President Bush issued America’s Homeownership Challenge to the real estate and mortgage finance industries – to encourage them to join the effort to close the gap that exists between the homeownership rates of minorities and non-minorities. Due to the President’s leadership, more than 2 dozen companies have made commitments to increase minority homeownership, including pledges to finance more than $1.1 trillion in mortgage purchases for minority homebuyers this decade.”

That was great leadership President Bush. And the salesmanship? Here’s the October 15, 2002 pitch:

“Owning something is freedom, as far as I’m concerned. It’s part of a free society. And ownership of a home helps bring stability to neighborhoods. You own your home in a neighborhood, you have more interest in how your neighborhood feels, looks, whether it’s safe or not. It brings pride to people, it’s a part of an asset-based to society. It helps people build up their own individual portfolio, provides an opportunity, if need be, for a mom or a dad to leave something to their child. It’s a part of — it’s of being a — it’s a part of — an important part of America.”

Bush used his friends, like Rev. Kirbyjon in his Faith Based programs to push this:

“People — low-income people are going to be able to more afford a home in Texas because of Kirbyjon’s vision and work. He’s answered the call of faith to help people help themselves and to help them realize dreams. The other thing Kirbyjon told me, which I really appreciate, is you don’t have to have a lousy home for first-time home buyers. If you put your mind to it, the first-time home buyer, the low-income home buyer can have just as nice a house as anybody else.”

He lays out how He leaned on Fannie and Freddie to make more money available to meet his goal. Then — this next blows my mind:

And, of course, one of the larger obstacles to minority homeownership is financing, is the ability to have their dream financed. Right now, we have a program that all of you are familiar with, maybe our fellow Americans are, and that’s what they call a Section 8 housing program, that provides billions of dollars in vouchers to help low-income Americans with their rent. It encourages leasing. We think it’s important that we use those vouchers, that federal money to help low-income Americans go from being somebody who leases to somebody who owns; that we use the Section 8 program to not only help with down payment, but to help with continuing monthly mortgage payments after they’re into their new home. It is a — it is a way to help us meet this dream of 5.5 million additional families owning their home.

I’m also going to encourage the lending industry to develop a mortgage market so that this script, these vouchers, can regularly be used as a source of payment to provide more capital to lenders, who can then help more families move from rental housing into houses of their own. These are some of the barriers that home owners face, potential home owners face, and this is what we intend to do about it.

This is insane. Section 8 help is for people who can’t even pay low market rent and Bush is shoving them into being home buyers.

These lengthy excerpts are from Bush White House press releases from Oct 15 2002 and 2003 and September 2004. They are in White House Archives. I downloaded them prior to January 2009. I quoted at length because otherwise this would be unbelievable. But there was more, tax credits to builders, money shoveled out for education on how to buy without any standards or oversight, pushing Fannie and Freddie to do more, deregulation, of course, keeping interest rates and tax rates too low. His theme song was “I’m Forever Blowing Bubbles …” He almost got out of office before the bubble burst.

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Counterparties

Felix Salmon
Oct 4, 2010 05:06 UTC

Last year, CNN generated $500 million in profit, its best year ever — NYM (Also: why were both Klein and Zucker fired just after signing new contracts?)

This story implies that The Atlantic’s digital ad revenues will rise by 42% in 2010 over 2009 levels — AdAge

Transsexual finds his old friends asking him for tech-related advice now he’s a man — Good Men Project

The AP has no idea how the S&P 500 works — Yahoo

Abusing the Fed’s revolving door — Reuters

Landline nostalgia: “a communal phone makes an apartment feel like a home and makes me feel like I have a family” — Noah Brier

“There must be a renaissance, because nobody bothered to dislike puppetry before” — Puppet

We should build Park51 for architectural reasons alone — NYT

Maine class action against GMAC — CRL

The high cost of corner-cutting at foreclosure mills — NYT; See also ZH

Saul Bass letterhead — Letterheady

The IMF recommends we “End the Credit Rating Addiction” — IMF

The news here is surely that Steve Jobs helicoptered in to Rupert Murdoch’s Carmel ranch in June, to talk iPad — Valleywag

Another way Iraq is worse than Belgium: it’s just broken the record for longest time with no government — WaPo

Wall Street’s trolls

Felix Salmon
Oct 3, 2010 23:03 UTC

There are anonymous commenters on blogs like mine, and then there are the elite and sophisticated investors invited to join a conference call with Ireland’s finance minister. Which group would you think is better behaved? Silly question, really. It’s not even close:

Mr Lenihan had been speaking for less than two minutes on Friday before a mistake by Citigroup meant that the bank’s clients were all able to be heard on the line.

Between 200 and 500 investors are understood to have been on the call, and as they realized their lines were not muted many began to heckle Mr Lenihan.

Some traders began making what one banker on the call described as “chimp sounds”, while another cried out “dive, dive”. A third man said “short Ireland” before adding “why not short Citi too?”

As the call descended into chaos, with one participant heard to say “this is the worst conference call ever”, Citigroup officials shut down the line.

This says a lot about the effects of anonymity on public behavior, and about the manners of Wall Street types, and about the regard in which the markets hold both Ireland and Citigroup.

But I think it also says something about the way in which even rich and sophisticated investors feel as though they don’t have a voice and aren’t being heard. Remember that the Tea Party started with a rant on CNBC. This is a sign of the times, I think: this kind of fiasco wouldn’t have taken place pre-crisis.

Update: The Irish Times pushes back on this story, quoting spokesmen from the National Treasury Management Agency and the Department of Finance saying that the heckling never happened, and that the Telegraph was sold a line by holders of Anglo Irish Bank’s subordinated debt. The Irish spokespeople might well be right, but so far no one has managed to produce a transcript or recording of the call, which would presumably clear things up.

COMMENT

“Sophisticated investors” – are they the ones that do or do not need government bailouts to stay solvent? I keep forgetting.

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Taking leave

Felix Salmon
Oct 3, 2010 21:04 UTC

I’m a month late to the debate about paid and unpaid leave, but I think there are a couple of points worth making which seem to have been missed. In general, I’m with Ezra on this one: paid leave is a good thing, and we should have more of it. And on a personal level I also agree with Reihan when he says that “unpaid vacation is a valuable perk”. Reuters has a mechanism for letting its employees take unpaid vacation when they run out of paid vacation days, and that was something I was very happy about when I joined.

On the other hand, the unpaid vacation at Reuters is not sold as a valuable perk — quite the opposite, in fact. When I was talking to Reuters about the possibility of taking more vacation than they were offering, the response was basically “you can’t do that, because if you do, you’ll have your pay docked for the extra days you’re on vacation”. It’s a very different way of spinning “yes, you can do that if your boss is OK with it; once you run out of paid vacation days then at that point your vacation days become unpaid”.

But there are good reasons why HR types might assume that employees would consider unpaid leave to be something other than a perk. For one thing, it can easily double the cost of a vacation: it’s a great way of making concrete the notion of “opportunity cost”. When I was a freelancer, there was little if any opportunity cost to taking a vacation: I just did all my work when I wasn’t on holiday. But my wife, who was paid by the hour, had a substantial opportunity cost: every day she spent on vacation meant lost income. For people on payroll, unpaid leave is a real disincentive to take vacations, which are normally expensive enough to begin with. Matthew Rognlie puts this well:

Paid leave makes leisure time more enjoyable, since you’re not incessantly bothered by the fact that you’re losing money by being away from work. Employees are willing to sacrifice wages and flexibility for this psychological comfort.

On top of that, our lifestyles are very much based around regular payments. Rent, or mortgage payments; car payments; credit-card payments; utility and phone bills: they all come around with distressing regularity, and they can be very hard to pay if you suddenly find yourself sans a paycheck, even temporarily.

More generally, having employees take time off from work is a good thing for employers — to the point at which most financial-services companies have compulsory-leave policies. It’s worth remembering that almost all workers in the US get 104 days of paid leave per year just from getting weekends off alone: those two days are hugely valuable and necessary to prevent burnout. And it’s important for companies to have constant real-world stress tests, ensuring that they can function well in the absence of any given employee.

As the wired world sucks people in to work weekends, a Netflix-style vacation anti-policy starts to look like the only sensible response. Although that kind of thing can only realistically be applied to people in the knowledge economy — the workers that Robert Reich calls symbolic analysts.

Rognlie offers a thought experiment:

Suppose that two otherwise identical companies, A and Z, differ in their vacation policy: company A offers higher wages but no paid vacation, while Z has slightly lower salaries and paid leave. In general, who will choose to work at company Z instead of A? People who like to take time off! To the extent that this is correlated with general laziness (not easily detectable in other ways at the hiring stage), it will make company Z’s labor pool less effective, discouraging it from offering paid leave in the first place.

I’m not at all sure that a desire to take paid leave is correlated with general laziness. If anything, the opposite might be true. If A and Z were truly identical but for their vacation policy, I’d be inclined to go long Z and short A. Company A might outperform a little in the short term. (Or, it might not.) Either way, it would be much more prone to the tail risk of a catastrophic blow-up.

My feeling is that the less paid vacation you have, the less vacation you’ll take. And the less vacation a company’s employees take, the higher the risk of that company falling apart through burnout or blowup.

Now, if you’ll excuse me, I need to take some time off from blogging on a Sunday to plan my upcoming holiday in South Africa.

COMMENT

Look into the field of radiology. There are groups where you might get up to 12 weeks vacation, but when you’re working, you’re working very hard. There are other groups where you might only get 4 weeks, but the work is not as stressful day-to-day.

The assumption that people who want more time off will be generally lazy is false.

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How Carlos Slim made $150 million from the NYT

Felix Salmon
Oct 3, 2010 19:21 UTC

The New York Times is going to pay back the $250 million loan from Carlos Slim three years ahead of schedule. It’s very expensive debt, so it makes sense that it should be the first debt to be paid down. But this also turns out to have been a great deal for the Mexican billionaire, if you look at the terms of the deal.

For one thing, he’s getting a 14.053% coupon for three years. That’s $105,397,500 right there. And then on top of that, the call option which allows the NYT to repay the bonds three years early is exercisable at 105 cents on the dollar. So Slim’s principal repayment is going to be $262.50 million, not $250 million. There’s another $12.5 million for Slim.

Finally, Slim gets warrants for 15.9 million shares at a strike price of $6.3572. Plugging the relevant numbers into a basic options calculator, I get an option value of $2.179 per share. (I don’t have easily-available volatility numbers for NYT shares, so I’m using the 22.5% level of the VIX, a share price of $7.85, and an option expiry date of January 2015, or 4.25 years from now.)*

So add on another $34,646,100 for the value of the options, and you get a total return on Slim’s $250 million investment of $152,543,600 over three years.

In fact, that number is something of a lower bound. The NYT had an option to pay 3 percent of the coupon in kind, rather than in cash; if it did that, then Slim would have ended up with even more bonds, which are now going to be paid off at 105 cents on the dollar.

And that doesn’t even include the strategic value of becoming the single-largest non-family shareholder of the New York Times Company.

All of which only serves to underline the dire straits in which the NYT found itself at the beginning of 2009. If the company had been able to spend $150 million on the newspaper, rather than on Carlos Slim, then it probably wouldn’t today be sprinting towards implementing its financially-dubious paywall. The NYT is now making new investments, most visibly in Andrew Ross Sorkin’s Dealbook franchise. But the paywall won’t help Dealbook one bit. Maybe Sorkin should borrow some money from Carlos Slim to buy off the NYT’s executives and keep Dealbook free.

*Update: Thanks to Mark, in the comments, who says that current implied volatility for NYT stock is just over 50. Which would put the value of Slim’s options at $3.596 apiece, or $57,176,400 in total. Which means that Slim’s total return on his investment reaches $175 million, not $150 million.

COMMENT

Jay,

I agree it was a little bit in finance-ese. Here you go:

The “coupon” is the interest rate.

An stock warrant is a contract where you can force the company to sell you stock at a specified price. That price is the “strike price.”

So Slim loaned the Times $250M at a 14% interest rate. He made $105M in interest. In addition, the Times had to pay a 5% prepayment penalty of $12.5M. Finally, Slim gets stock warrants worth $35 million. This is a lower limit of how much money Slim made, because part of the interest could have been paid in bonds – if that happened, the Times would now have had to pay a prepayment penalty on it, too.

Those warrants are valuable because he can buy them for $1.50 cheaper than the current public share price, and because the volatility of the Times’ stock (if the Times’ share prices jump around a lot, they’re more valuable, because there is no limit on how high they can go, but they can’t go lower than zero.)

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ETFs aren’t derivatives

Felix Salmon
Oct 1, 2010 20:27 UTC

Herb Greenberg misreads the SEC flash-crash report, in an attempt to justify his silly claim that ETFs are derivatives. I agree with Herb that there are serious questions which should be asked about ETFs, especially ones which include small-cap stocks. You can’t turn an illiquid stock into a liquid stock just by throwing it into an ETF, and illiquidity is one of those things which goes hand-in-hand with volatility and attempts at price manipulation.

But that doesn’t mean that ETFs are derivatives. They’re not.

Herb quotes this bit of the SEC report:

The E-Mini and SPY are the two most active stock index instruments traded in the electronic futures and equity markets. Both are derivative products designed to track stocks in the S&P 500 Index, which in turn represents approximately 75% of the market capitalization of U.S.-listed equities.

There is a way in which this is true, but it’s best read as a slightly clumsy attempt to lump the E-Mini and the SPY together with some inartful phrasing.

The E-Mini is a derivative product by dint of being a derivative. It’s a futures contract, a zero-sum game, an instrument whose value at expiry is a wholly transparent function of the value of some other financial instrument.

The SPY, by contrast, is a derivative product only by dint of the fact that it’s a product — a security, not a derivative — which is derived from aggregating 500 different stocks. You couldn’t have the SPY without the S&P 500, so in that sense the SPY is derived from the S&P 500. But if you own shares of SPY, you have real wealth: real claims on real assets of 500 real companies in the real world.

Think about it this way. If all of the shares of SPY were to become vaporized tomorrow, then the S&P 500 itself would rise, since the total number of shares outstanding in the stock market would have fallen. Since the value of those 500 companies wouldn’t have changed, the value per share would be higher.

If all of the world’s E-Mini contracts were to become vaporized tomorrow, by contrast, then the effect on the S&P 500 would be de minimis. E-Mini contracts are side bets on the S&P 500: they’re not real-world claims on it.

What the E-Mini and the SPY have in common is that they’re both trading vehicles: both of them are used to make bets on the short-term direction of the S&P 500. That’s why, pace Greenberg, there’s so much short interest in SPY. If I want to short the S&P 500, I’ll borrow a few shares of SPY and then sell them in the market. Those shares will be bought by my counterparty, who will then turn around and lend them to someone else who wants to short the S&P. And so on and so forth: the same shares can end up being shorted many times by many different people.

But that doesn’t make them derivatives.

The distinction between securities and derivatives is a useful one. It’s always possible to argue that the value of any financial instrument is ultimately derived from the value of some other financial instrument: if you wanted to, you could probably come up with a colorable argument that senior unsecured bonds are derivatives of stock options. But in the real world, stocks aren’t derivatives, and ETFs are stocks. Derivatives, meanwhile, are something you call financial instruments you don’t like. Which is why occasionally people will erroneously say that CDOs, say, are derivatives. They’re not, any more than ETFs are.

COMMENT

So. ETFs for Dummies….which ones are considered scarey?? There must be some that are secured with real commodities, e.g. SGOL

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