Felix Salmon

The cost of the insider-trading investigation

Felix Salmon
Nov 26, 2010 21:50 UTC

It’s not just small shops like John Kinnucan’s Broadband Research which have been put out of business merely because they’re being investigated by the FBI. Multi-billion-dollar hedge funds are faltering too: the latest to suffer devastating redemptions is FrontPoint partners. Max Abelson says it’s “on death’s door”, while Henny Sender reports:

Already senior staffers of FrontPoint are interviewing for jobs with other firms, one person with direct knowledge of the matter adds.

“It is difficult for an entity to keep going because at a certain point the business ceases to be viable whether it has crossed the line or not,” said the head of one firm which invests tens of billions of dollars in hedge funds on behalf of clients.

“The regulators effectively put them out of business.”…

Investors in these hedge funds say they have no choice but to pull their money at the first hint of trouble.

“If I get even a whiff of an investigation, I want to get out before the next guy, especially if I know they have illiquid stuff or I don’t know what they have,” says the head of one fund of funds.

The FBI’s insider-trading investigation, then, has already caused hundreds of millions* of dollars in damages — the value of FrontPoint alone has probably fallen a good $200 million since its involvement in the investigation was made public. And of course to date no one’s been convicted of anything.

This makes investigations very difficult: the FBI cannot be certain, when they start investigating a company, that it’s guilty of insider trading. That’s why they need to investigate it. But by the time any conviction actually happens, the damage has long since been done — and indeed will have been done even if there’s an acquittal or no charges at all.

I don’t know if there’s any way around this: certainly the FBI has to be able to investigate companies it suspects of wrongdoing. But does the existence of those investigations need to be made public, at least before any charges are brought?

*Update: I meant hundreds of millions of dollars, but originally posted hundreds of billions of dollars. Apologies, my bad. Thanks to Sean Matthews for noticing.


These are billionaries, Who gives a damn that they loose money with crocks!

They cheated so they got what they deserve!!!!!!!!!!!!!!!!!!!

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The continuing fight against overdraft fees

Felix Salmon
Nov 26, 2010 15:39 UTC

Even before the Consumer Financial Protection Bureau gets up and running, other branches of the government are fighting the good fight against excessive overdraft fees. First came the Fed, of course, which forced banks to get their customers to opt in to the fees, at least when it comes to ATM and POS transactions: no longer can they charge them automatically.

But then something very odd happened. The Fed rule came into effect on July 1, and by mid-September Moebs had some data on the number of bank customers who had decided to opt in:

About 90 percent of overdraft revenue comes from frequent users. The Moebs study noted frequent users, those with 10 or more overdrafts in a year, almost all opted in. For all consumers, consent varied between 60 percent and 80 percent with a median of about 75 percent.

This astonishes and depresses me no end. Most banking customers are relatively unharmed by overdraft fees; by far the greatest damage to consumers, and the greatest profits for banks, came from the poorer customers who could least afford it. Essentially, overdraft fees were a way for the banks to monetize the naiveté and imprudence of their least-sophisticated customers, and the Fed rule was meant to put an end to such predatory price-gouging. Evidently, it failed: Moebs reckons that banks’ total overdraft revenue will hit $38 billion in 2011, a new record high.

David Benoit, today, provides some bank-level data which is only marginally more encouraging:

Earlier this month, Regions Financial Corp. Chief Executive Grayson Hall said at a conference that roughly half of the bank’s customers who have overdrawn their accounts have opted in for protection. He said the impact of the regulation on Regions is less than originally thought.

J.P. Morgan Chase & Co. said earlier this month that, of those who frequently overdraw their accounts, 53% have chosen to sign up for the service. At J.P. Morgan, the service includes a flat $34 fee for insufficient funds, the phrase the banking industry uses to identify the fees.

Of those who overdraw four to nine times a year, 41% have elected the service, and of those who overdraft fewer than four times, 21% have chosen the protection, J.P. Morgan said.

Note here that JP Morgan’s definition of “those who frequently overdraw their accounts” means people who do so ten times a year or more — at $34 a pop. How many times do those people overdraw their accounts, on average? I don’t know, but if it’s over 14.7, then these people are spending more than $500 a year in overdraft fees. Which I can guarantee you is money they can’t afford.

Still, 53% is better than “almost all,” and across the board JP Morgan’s take-up is clearly lower than what Moebs found, maybe because the overdraft fee is so high. The bank might have been better advised to reduce it, says Moebs:

6.5 percent decreased their overdraft price. “We have never seen this many institutions decrease the price of a fee service in almost 30 years of tracking bank and credit union pricing,” pointed out Moebs. “Our data shows institutions which decreased their overdraft fees, actually maintained or increased their overall revenue in the past year.”

In any case, there’s clearly still regulatory work to be done on this front, and so I’m glad that the FDIC is stepping in.

Under the FDIC’s new rules, which come into force in July 2011, banks are going to have to start trying to help those frequent overdrafters. Banks need to

Monitor programs for excessive or chronic customer use, and if a customer overdraws his or her account on more than six occasions where a fee is charged in a rolling twelve- month period, undertake meaningful and effective follow-up action, including, for example:

  • Contacting the customer (e.g., in person or via telephone) to discuss less costly alternatives to the automated overdraft payment program such as a linked savings account, a more reasonably priced line of credit consistent with safe and sound banking practices, or a safe and affordable small-dollar loan;4 and
  • Giving the customer a reasonable opportunity to decide whether to continue fee-based overdraft coverage or choose another available alternative.

Other parts of the rule are weaker, though: banks just need to “consider,” for instance, “eliminating overdraft fees for transactions that overdraw an account by a de minimis amount,” or alerting customers when their account balance is at risk of generating an overdraft fee.

This, however, I like a lot:

Under new Regulation E requirements that took effect on July 1, 2010, institutions must provide notice and a reasonable opportunity for customers to opt-in to the payment of ATM and POS overdrafts for a fee. In complying with these requirements, institutions should not attempt to steer frequent users of fee-based overdraft products to opt-in to these programs while obscuring the availability of alternatives. Targeting customers who may be least able to afford such products such as through aggressive advertising or other promotional activities can raise safety and soundness concerns about potentially unsustainable consumer debt. Any steering activity with respect to credit products raises potential legal issues, including fair lending, and concerns about unfair or deceptive acts or practices (UDAPs), among others, and will be closely scrutinized.

There have been a lot of complaints about how aggressive and mendacious banks have been in their attempts to get their customers to opt in to overdraft protection. Maybe they’ll back off a bit now that the FDIC has said that it considers such activity to threaten their safety and soundness. It’s just a pity that the FDIC didn’t say as much when the Fed’s new rule was first introduced.


“Financial Drivers License” which tests for understanding of how to manage your money.

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Don Chu is small fry

Felix Salmon
Nov 24, 2010 23:42 UTC

If you read the complaint in the Don Chu case, a couple of things jump out at you. One is how modestly Chu was paid, for someone conspiring with hedge funds to reap a fortune from inside information:

The Firm pays CHU $6,000.00 per month and covers his expenses.

Another is how obvious — you might even say ingenuous — Chu’s dissemination of inside information seems to be:

On or about June 19, 2009, at approximately 6:52 a.m., CHU sent Lee an email message. The subject line of the email message stated: “Just in…” The message stated: “ATHR [Atheros]: Q2 [second quarter] better than expected, over 105M. GM [gross margins] ok. Q3 [third quarter] internal target at 123M [million dollars], guidance pending ?115 [million dollars] or so? will be aggressive in the pc/nb [personal computer/notebook] ASP [average sales price] to stop competitors. Hopes to maintain GM on (1) Nintendo shipment back in and (2) new 65 nm 11n chip[.] Q4 [fourth quarter] likely has GM under pressure with ASP expected even bloodier. Have fun!” From my involvement in this investigation, including my discussions with Lee, my review of publicly available reports, and my training and experience, I believe that CHU in this email was providing Inside Information about Atheros. I also know that the kind of information being disclosed in this message, including revenue and gross margin information, is not publicly disclosed prior to announcements by the company. I believe that, at the time of this email message, Atheros had not yet reported results for its fiscal quarter ending in June 2009 (or, “Q2″), and that it was expected to do so after the close of the market on July 21, 2009. I have also reviewed CHU’s cellular call data, and I have learned that on or about June 18, 2009, at approximately 7:35 a.m, there was a 2-minute call between CHU and a person utilizing a Taiwanese telephone number.

This is dense stuff, but basically, if you take this at face value, Chu called Taiwan on June 18, and got a bunch of inside information about Atheros’s second quarter. He then emailed Lee — that’ll be CB Lee, a cooperating witness who worked at a hedge fund at the time and who once worked for SAC Capital — on June 19 with the information. The actual second-quarter results were then released on June 21.

But here’s where things get weird: if you look at the highly detailed four-page press release announcing Chu’s arrest, there’s no mention of the email from Chu to Lee. Instead, the release concentrates on what would seem to be a much weaker part of the case against Chu — a conversation between Lee and another insider. Inside information does seem to have been imparted to Lee on that call, but not by Chu, who wasn’t on the call.

And while there is evidence that Chu knew he was dealing in inside information, there’s also evidence that Chu was careful to try to find untraceable methods to impart that information. Which stands in stark contrast to the idea that he would simply plop lots of inside information into an email and send it to Lee, more than 24 hours after getting the information from Taiwan.

In other words, the case against Chu seems a little tenuous to me — it seems like he was a relatively low-level intermediary who would put insiders in contact with traders, and who thought, probably correctly, that what he was doing was legally dubious. Why was it so important that he be arrested before he left for Taiwan, especially since he seems to have been quite happy to talk to the FBI last Sunday?

My guess is that Chu refused to become a cooperating witness on Sunday, or to admit that he brokered inside information to anybody except Lee. But investigators want him to finger other traders, so they arrested him in an attempt to up the stakes, charging him with one count of conspiracy to commit securities fraud, and one count of conspiracy to commit wire fraud. He could try to fight the charges, but his chances probably aren’t that good, and he also probably can’t afford a good lawyer.

Chu’s small fry: you don’t tend to find white-collar criminal masterminds living in Somerset, New Jersey. Investigators want him in the US, helping them with their inquiries. But ultimately, as far as the government is concerned, his arrest is a means to an end, rather than an end in itself.


That’s really valuable information for a guy to be getting for 6 grand a month. That’s a competitive, low margin industry and I as an analyst for another competitive, low margin industry I’m really shocked that any insiders were able to get that kind of information. Then again I don’t deal with Taiwanese companies so the data might be leaky there, but I can’t imagine an American, European or Japanese company letting that kind of data out at all.

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Is Ireland’s problem a Basel problem?

Felix Salmon
Nov 24, 2010 14:34 UTC

Does the Ireland crisis bespeak a major weakness in the Basel capital-adequacy regime? Simon Nixon thinks so: the fact that investors won’t lend to Bank of Ireland, he says, “highlights a major weakness of the Basel capital rules that European banks operate under.”

This is an interesting idea: Ireland’s problem is a banking problem, banking problems are Basel problems, and therefore it stands to reason that Ireland’s problem might be a Basel problem. But if you look more closely at Nixon’s reasoning, his thesis ends up falling apart.

Nixon lays the blame at the feet of Basel’s well-known weakness: the fact that it concentrates on risk-weighted assets rather than total assets. And he implies that there might be large national differences when it comes to the ratio of risk-weighted assets to total assets, while conceding that thesis ” is impossible to prove from regulatory disclosures.”

But there are three huge things missing from Nixon’s piece. First, he takes just one bank from each of four different countries (Santander in Spain, BNP Paribas in France, Barclays in the UK, and Deutsche Bank in Germany) to illustrate national differences. He would be much more interesting, and much more compelling, if he presented a couple more datapoints in each country, to help give readers a better idea of whether French banks in general tend to have a higher ratio of risk-weighted assets to total assets than German banks in general, or whether we’re just looking at idiosyncratic differences between BNP Paribas and Deutsche Bank.

Second, Nixon thinks that the credibility problem in Ireland is a function of the way that the banks’ risk-weighted assets are calculated. He’s right that the market is skeptical that Bank of Ireland really has a core Tier 1 ratio of 8%. And he’s right that risk-weighted assets are a key part of that calculation, and can throw it off. Essentially, the ratio is (A-L)/R, where A is total assets, L is total liabilities, and R is risk-weighted assets. If R is artificially low, then that makes the ratio artificially high.

But the fact is that it’s not the denominator here that the markets are worried about. Instead, it’s the numerator. The key problematic number is A, Bank of Ireland’s total assets. Many of those assets are Irish commercial real-estate loans for which there’s essentially no buyer right now except for the Irish government. And a huge proportion of the rest are Irish residential mortgages, which might be performing for the time being but which would surely sell for much less than par if the bank tried to sell them on the open market.

Any mark-to-market valuation of BoI’s assets, then, would almost certainly show the bank to be insolvent. (This is not news: it’s true of all banks in all crises.) And the reason that the market won’t lend to BoI is that it fears the bank is insolvent. And that has nothing to do with its risk weightings at all: it doesn’t matter what the denominator is, if the numerator is negative.

Finally, Nixon nowhere mentions any Irish ratios of risk-weighted assets to total assets! The very heart of his thesis would seem to be that Basel understated the riskiness of Irish banks by coming up with an unreasonably low number for their risk-weighted assets. Yet Nixon doesn’t tell us what Bank of Ireland’s ratios were, in comparison to those other European banks, and he doesn’t give ratios for any other Irish banks, either.

I suspect this is more than just an oversight. In general, banks reduce their ratio of risk-weighted assets to total assets in one of three ways. They can be heavily involved in investment banking, where loans tend to be taken out in the repo market and are fully collateralized; they can be heavily invested in structured products with triple-A credit ratings; or they can be heavily exposed to OECD sovereign credits. Ireland’s banks, by contrast, were more old-fashioned than that: they just loaded up on property loans, which tend to carry a full risk weighting. There are clearly lots of things wrong with Ireland’s banks, but I doubt that artificially reduced risk weighting was one of them. Certainly Nixon adduces no evidence that it was.

Is Ireland’s problem a Basel problem, then? I don’t think so—or if it is, then we’d need to see a lot more numbers first before Nixon came close to making his case. I understand that the Heard column has space constraints and specializes in short, punchy analysis, but this piece is so short as to be pretty much useless. At the very least, Heard should allow its writers to put extra material online, showing their work, as it were, to back up the conclusions in the printed paper.


“In general, banks reduce their ratio of risk-weighted assets to total assets in one of three ways. They can be heavily involved in investment banking, where loans tend to be taken out in the repo market and are fully collateralized; they can be heavily invested in structured products with triple-A credit ratings; or they can be heavily exposed to OECD sovereign credits.”

What. On. Earth. Are. You. Talking. About?

You’ve never worked in a bank, I presume?

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Felix Salmon
Nov 24, 2010 07:16 UTC

SEC Allows Asset-Backed Issuers to Omit Ratings Required by Dodd-Frank Act — Bloomberg

SAC tells investors it got government subpoena — Marketwatch

Will DOT eliminate parking spaces to make way for bike sharing stations? (The problem is getting the street hardware out of the way for the ploughs and sweepers) — Gothamist

The utterly horrifying story of Imogene Hall, defrauded out of her home in the dreadful Florida courts — Miami Herald

“It’s like being taken shopping at Spatula City with the world’s most sophisticated personal shopper. At the end of the day, you still end up with a spatula” — Atlantic

The magazine designer’s guide to magazines — Flickr

Hey Apple, change the iPad switch back to screen lock! — Gizmodo

Corporate Profits Were the Highest on Record Last Quarter — NYT


TFF and Danny, the only thing that is keeping this quiet is the fact that few are speaking for the little guy. They have been lost in the shuffle. There is too much business and money to be had for lawyers to also take advantage or this would have blown sky high. As it is, I guarantee you have not seen the last of it. Sadly the defaulters who are sticking it to the banks will be the ones we mostly hear about, but there will be repercussions.

And yes, many people are incompetent with money, but that doesn’t mean they should have been sold mortgages that they could not afford and at inflated prices. The banks had to approve the assessment and loans!

The loans were never meant to be given to people who COULDN’T pay. You are both in your 50′s and 60′s and perhaps have never been sold a bridge, but few people are immune to being duped, no matter how smug you are that you are financially savvy. (but I still won’t wish it on you)

And sorry Danny, calling everything I write bull **** is odd coming from you when that is 99% of what you do… call bull with nothing to back it up except your having worked in the field. Pulling out the lingo sounds good, but you had nothing to back up siding with the banks other then your bias.

There were mortgages that were made to fail and some of the banks knew exactly which those were and where they were coming from. The banks KNEW where the bad mortgage deals were whether they had a hand in it or not

They fostered the environment that made the loans even riskier. Have you actually forgotten they were also selling the homes to the poor and homeless? Anyone with a pulse? How much financial savvy does a homeless or poor person usually have???

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Banco Popular changes its ways

Felix Salmon
Nov 23, 2010 23:21 UTC

It seems I got results! In the wake of my post about Banco Popular’s ATM fees on Sunday, Banco Popular has been in touch to say that they’re fixing things.

But first, a correction: the charge saying “debit of ATM with flat fee” was not a flat fee after all, despite what the customer-service person told Engels, the account holder. Instead, the $10 was the aggregation of five $2 charges for using five different out-of-network ATMs over the previous month.

As of today, that changes: every time you use an out-of-network ATM, you’ll see a separate $2 fee on your statement, saying “Non-Popular ATM fee”.

That’s definitely a positive change, since up until today, Popular would save up all those bank fees in its back pocket and hit you with them all at once, at the same time as charging its $5 monthly account fee, thereby maximizing the chances of driving you into overdraft territory. That’s less likely now.

What’s more, Larry O’Brien, Banco Popular’s head of marketing, promised me that the bank would put a full schedule of all its fees up on its website. Again, that’s a huge improvement on the status quo, where you’re told the fees once — when you open your account — and then subsequently only on a piecemeal basis as and when they change.

In the case of the $2 out-of-network ATM fee, for instance, Banco Popular customers got a letter on July 15 that as of August 15 they could use the Allpoint network of 33,000 ATMs free of charge. In that same letter — which O’Brien has promised to send me, and I’ll post here when he does — they were also told that the surcharge for using an out-of-network ATM would rise from $1.50 to $2.

Incidentally, this stuff isn’t transparent even to relatively senior bank officers. Enrique Martel, the Banco Popular media relations person, initially told me that existing customers weren’t told about the rise in the ATM surcharge to $2. And even O’Brien said at one point that the $2 charge went into effect for existing customers only on November 8, rather than on August 15. (November 8 is the date that the bank changed the way it reported the charge on its statements.) So it’s hardly surprising that Engel’s customer-service rep got things wrong too. This is why having a public website for such information is such a good idea: it makes it much easier not only for customers but also for employees to get everything right.

In any case, well done to Banco Popular for changing the way it charges so quickly. And let’s hope it doesn’t take too long for them to put their full schedule of fees up on their website.

Update: Here’s two slightly different versions of O’Brien’s letter, and the statement insert. (All PDFs).


Agreed, transparency and employee training/communication are important. And that is the issue more than the fee itself.

Posted by TFF | Report as abusive

Treasury’s plan to fix the mortgage mess

Felix Salmon
Nov 23, 2010 21:23 UTC

Michael Barr’s departure is a serious loss for Treasury. I spoke to him on Friday; he was in Ann Arbor, where he’s returning to law school, and he wanted to take serious exception to my three monkeys post, where I accused Treasury of willfully ignoring the banks’ culpability in the mortgage crisis.

Barr rattled off a laundry list of reviews which are being done by various arms of the government, including what he described as an “11-agency, 8-week review of servicer practices, with hundreds of investigators crawling all over the banks”. That information is finding its way to the state attorneys general, in their review. Meanwhile, said Barr, an alphabet soup of regulators (OTS, OCC, FDIC) is looking at various financial services companies (MERS, along with lots of different servicers, trustees, and banks); HUD is holding everybody to FHA and HAMP guidelines; and the FTC is looking at non-bank lenders. And keeping everything coordinated is the new Financial Fraud Enforcement Task Force which has been put together under the leadership of Justice’s Tom Perrelli.

“Why are we investing these resources and including Tom Perelli in the discussions?” asked Barr. “We’re holding the banks accountable to fix it.” I asked him whether he thought that was even possible. “Their conduct suggests they can’t,” he said, adding that “they can be held accountable for not following the law. HUD can assess significant fines on them.”

Barr was clear about what he expected to happen in 2011. Specifically, he said, “if there are legal violations found, banks are responsible for fixing them and for addressing the problems.” And more generally, the government’s actions “will increase the chance that when foreclosures happen, they will happen according to established law.”

The timetable for all this? The reviews should be largely completed this year, with the full scope of the problems being apparent by the end of January. By the end of the first quarter, the banks should be in serious discussions about how they’re going to fix what’s broken. And then it gets necessarily hazier: “Institutions are resistant to change and have difficulty implementing,” said Barr, but “you’ll see flow improvement over the course of the next year.”

Could I hold Treasury to that? Sort of: “You should hold us to whether things get better or worse. If a year from now nothing has changed, that would be a reasonable criticism.”

I have two fundamental reasons to be skeptical of this approach. Firstly, it won’t work: the banks and the servicers simply aren’t set up to magically make their processes perfect, and the threat of lawsuits isn’t going to change that. And secondly, insofar as the problems are systemic and threaten the solvency of the banks, Treasury is going to blink first. As we just saw in Ireland, today’s governments are constitutionally incapable of forcing real pain onto banks.

But at the same time, there’s zero chance of getting any kind of resolution to the mortgage-mess problems if the government doesn’t have a firm grasp of exactly what they are. Barr told me that they’re doing file reviews which take between five and eight hours to go through a single loan file: this is hard, detailed work, and at the end of it all there will be a real understanding of what needs to be done—something necessary, if not sufficient, to finally resolve this mess.

Barr is a very honorable man, and a very hard worker, and I give him a lot of credit for the (mostly) excellent CDCI project. (I have quibbles about it, but can’t go into detail about what they are because most of what I know I learned as a board member of LESPFCU.) I think that Treasury is entering into this whole mortgage investigation in good faith, and will do what they can to push the banks to fix what’s fixable.

But I’m also pessimistic about their prospects: I suspect that only a radical restructuring of the entire securitization architecture—and especially the broken relationships between investors and trustees, and between trustees and servicers—has any chance of actually working. That is clearly not going to happen. But if you believe in the power of legal action to effect change, then maybe Treasury’s approach might work.


This whole mess reminds me of the old game of pick-up-sticks, but among those sticks are some related to just poor technical (as in ‘detailed’, not computer techy) practices. Risky loans, with no increase in reserves, paperwork practices that simply didn’t exist.

There are healthy banks out there, especially outside of New York. They are doing pretty well given the magnitude of the mess. They are financing new tractors, covering the inventory ’til the end of the month, depositing my receipts and giving me cash when I ask for it. My local banker is still the best analyst I know on conditions in the local market, and what I need to do next in my business.

Contrast that to Wells Fargo and BofA where they admit that they had people do mass signatures of critical legal documents because the management couldn’t be bothered to spend the time doing it right. Forcing these guys to go back and jump through every hoop, pay every fine, and absorb the losses will be instructive to them and beneficial to the country.

Posted by ARJTurgot2 | Report as abusive

Trying to read credit-card agreements

Felix Salmon
Nov 23, 2010 18:28 UTC

How long will it take to get readable credit-card contracts? My guess is somewhere in 2012, if we’re lucky. Right now, although we’re moving in the right direction, we’re also moving far too slowly:

In a follow-up to its July 2010 credit card agreement readability study, CreditCards.com looked at the 20 most difficult to read and the 20 wordiest contracts to see if any had improved between July and October. Only six of the 20 most difficult-to-read contracts showed improvement. Nine of the 20 had the same reading level, three were more difficult to read and two were no longer offered by the credit card issuer. All were still rated at the 12th grade reading level or higher — too difficult for four out of five adults to understand.

To give an idea of what we’re talking about here, take a look at Fifth Third’s credit card agreement. For one thing, it’s 15 pages long. And for another, it includes crystalline passages like this:


I’m using an image here, rather than quoting in text, to show that banks have made no graphical concessions to readability at all: prose is presented in dense paragraphs, in the kind of hard-to-read narrow sans-serif text which just screams “don’t read me.”

And of course there’s no point in reading this kind of thing: I doubt one cardholder in a hundred could even begin to say what it means to “honor claims of privilege recognized at law.” I certainly couldn’t.

To put this in context, check out this two-pager from the University of Illinois Employees Credit Union. It leaves something to be desired in terms of graphic design, and parts of it could be cleared up a bit, but there’s certainly no gratuitous legalese. It’s possible, bankers! Don’t let the lawyers stop you!


Of course if they didn’t have all this boilerplate then some journalists would be making a big deal about “lack of disclosure”….

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Expertise mission creep datapoint of the day

Felix Salmon
Nov 23, 2010 17:01 UTC

Last week, Chris Whalen appeared on Tech Ticker with Henry Blodget; he said, in the accurate if sensationalist words of the Business Insider headline, that CALIFORNIA WILL DEFAULT ON ITS DEBT.

The interview was actually pretty intelligent and informative, by the standards of financial TV. Whalen talked about the politics of federal-state relations; about prior cases where states defaulted; about California’s pension obligations; about the ability of a Republican-controlled House to pass any kind of bailout bill—all things which are decidedly germane to anybody looking at California’s credit.

But Brett Arends didn’t like what he was hearing, and decided to push back a bit. The results were much more illuminating than anything Whalen said on Tech Ticker.

When I e-mailed Whalen, asking him for specific calculations, none were forthcoming.

“My general comments have to do with my guess as to the impact of mounting foreclosures and flat to down GDP on state revenues,” Whalen replied.

Your guess? These are important problems, to be sure. But do you have any actual numbers?

“Revenues fall and mandates rise to the sky,” he wrote. “You do the math.”

Er, no, actually. It’s your assertion. You do the math.

Whalen blamed the matter on Blodget.

“I am a bank analyst,” he wrote. “I have not written anything on this. My comments have taken on a life all their own… This is all Henry’s fault.”

Henry’s fault? Not really: Henry wouldn’t have started asking Whalen questions about California if he didn’t already know pretty much what the answers were going to be. And Whalen was clearly prepared for Blodget’s questions.

In reality, what we’re seeing here is expertise mission creep, and a rare example of an expert admitting to it. Whalen’s company is highly regarded when it comes to analyzing banks’ balance sheets, and as a consequence of that regard, Whalen has gotten for himself a nice perch in the punditosphere, as well as a new book.

But Whalen, as he admitted to Arends, is no more an expert on municipal finance than Freeman Dyson is on global warming. And so the proper stance for Blodget to take was not to deferentially pose questions to Whalen and then passively receive his oracular words of wisdom, but rather to push back and have a proper debate about Whalen’s assertions, much as Arends might have done.

The California debate is an interesting one: the state has massive future liabilities, in the form not only of debt payments but also of public-sector pensions, but at the same time its legislature is incapable of raising taxes in order to ever pay for them. It’s a fundamentally unsustainable status quo—something has to give—but realistically no one knows what will give, or when, or how. It might be those debt payments, but a debt default wouldn’t really solve California’s problems, since California’s debt isn’t actually all that large, as a percentage of GDP.

More generally, the municipal bond market is a very complicated place, where expertise is hard-earned and voluble new entrants are inherently mistrusted, normally for good reasons. (See Bond Girl on Meredith Whitney; she doesn’t even mention the conflicts inherent in having a rating agency give investment advice.)

But complex doesn’t play well on TV; strongly (if briefly) held opinions do. So, as ever, expect more heat than light whenever you see an expert on TV talking about anything.


I don’t see how they get from budget shortfall to default? The ‘juice’ they pay is roughly $6B in a $85B budget… the gap is about $25B! Defaulting would only be a drop in the pan of a single year’s shortfall, and so wouldn’t serve any purpose except to curtail their ability to borrow tremendously.

The talk of Cali default is dumb, but discussing the shortcomings of California legislature and budget practices DEFINITELY warrants more conversation.

Posted by CDN_finance | Report as abusive