Felix Salmon

The underwhelming Irish bailout

Felix Salmon
Nov 22, 2010 04:26 UTC

Color me underwhelmed by the Irish bailout. By all accounts it’s going to be less than €100 billion — probably in the €80 billion to €90 billion range — and that sum has to cover the country’s entire borrowing needs for the next three years. The NYT has a breakdown:

While a precise breakdown was not given, analysts and people involved in the talks said that about 15 billion euros was likely to go to backstop the banks. As much as 60 billion euros would go to Ireland’s annual budget deficit of 19 billion euros for the next three years.

That leaves a few billion euros left over for one-off expenses and emergencies — but I worry that Ireland’s banks are going to need a lot more than €15 billion. The banking system is on its knees and it has roughly half a trillion euros in assets. The black hole in commercial real-estate alone — over and above the €50 billion or so that the Irish government has already shelled out — is estimated at somewhere in the €20 billion to €25 billion range and that’s before you even start thinking about residential mortgages:

Where the first round of the banking crisis centred on a few dozen large developers, the next round will involve hundreds of thousands of families with mortgages. Between negotiated repayment reductions and defaults, at least 100,000 mortgages (one in eight) are already under water, and things have barely started.

Banks have been relying on two dams to block the torrent of defaults – house prices and social stigma – but both have started to crumble alarmingly.

When a residential property bubble as big as Ireland’s bursts, there will be always enormous bank losses. But because those losses haven’t materialized yet, everybody in Ireland and the EU is sticking their heads in the sand, pretending that they’re never going to arrive at all.

The best-case scenario, then, is that the EU bailout will kick the Irish can three years down the road. But in implementing the plan, Ireland’s banks will effectively be nationalized and any future mortgage losses will have to come straight out of these bailout funds. Which aren’t remotely sufficient for such a task. If the spike on mortgage defaults comes sooner rather than later, this particular bailout package could prove to be very short-lived indeed.


Well done Felix. How anyone could be bullish on the Euro with all this mismanagement and incompetence at the national level is beyond me.

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Egregious bank fee of the day, Banco Popular edition

Felix Salmon
Nov 22, 2010 01:22 UTC

Commenter Engels has a bank account at Banco Popular. Checking his account online he found these weird charges:


The second charge, for $5, makes sense: if you look at the Banco Popular website, it says that there’s “a $5 monthly service charge if average monthly balance drops below $250″. But what on earth is “debit of ATM with flat fee”? There’s no schedule of fees on the website, and if you click on that line item to get a bit more detail, none is forthcoming:


Eventually Engels managed to get a human at Banco Popular on the phone, and they explained that from now on, Banco Popular will charge him $10 in every month he uses an outside ATM. And yes, that’s over and above any fees charged by the outside ATM itself.*

Obviously, with overdraft fees waning, banks are going to look elsewhere for fee income. But $10 for using an outside ATM is, frankly, beyond the pale. And the opacity and sneakiness with which the fee was introduced and presented to Banco Popular’s clients only goes to show how much of a guilty conscience the bank has about imposing it.

Banco Popular is a bank for the working classes: many of its customers will have to work very hard for well over an hour to earn $10 of post-tax income, if they’re lucky enough to have a job at all. These aren’t people who withdraw $1200 at a time from their bank’s ATM: their cashflow doesn’t allow it. So even when they’re conscientious about avoiding the charges associated with outside ATMs, they might find themselves needing to use such services once a month or so. If they do, it’s downright cruel to slap them with this unexpected $10 charge.

I’d love to see a personal-finance website somewhere put together a list of various banks’ accounts and the fees associated with them; it would ideally include prepaid debit cards, too, and would archive historical information so that customers could see how the fees have evolved over time. The problem, of course, is getting the information: as we’ve seen with Banco Popular, banks are far from transparent about their fees. Maybe someone like Mint or Yodlee could do it?

*Update: Turns out that the explanation Engels got was wrong. But in any case, Popular has changed its ways now. Details here.


We want to clarify your post about Banco Popular. The $10-charge in question is not a single-use ATM fee but is actually a sum of five fees or five monthly transactions that Customer Engels performed at ATMs not affiliated with Banco Popular.
Our fee for usage of non-affiliated ATMs is $2 per transaction. Further Banco Popular recently became part of the Allpoint network, meaning customers can access nearly 33,000 ATMs nationwide for surcharge-free transactions. These ATMs can be located at http://www.popular.locatorsearch.com.
However, we do agree that these charges, and our policy, could have been better explained by our customer service representative. We have already taken corrective action immediately to address that. Our system has also been corrected to better describe these fees and to have them post individually along with the corresponding transaction. Banco Popular is proud to serve communities in New York, New Jersey, Illinois, Florida and California.
- Banco Popular

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Can legal due process move online?

Felix Salmon
Nov 19, 2010 21:06 UTC

Sam Glover has a great pair of blog entries up about due process in class-action lawsuits.

At Caveat Emptor, he talks about the sordid tale of Philip Stern and Robert Arleo, two lawyers who brought a class-action suit against a sleazy debt collection agency. With over 1 million consumers potentially affected and statutory damages of as much as $1,000 per case, total damages could easily have exceeded $1 billion. But Stern and Arleo weren’t interested in maximizing damages. Instead, they got the suit classified as an “opt-out class,” meaning that consumers were automatically included in the class unless they knew about it and chose to opt out. Then they put an ad in USA Today to find class members, and settled the suit for $20,000—plus fees of $84,250 for themselves.

This is a great example of a couple of lawyers essentially selling impunity in return for a nice little payday for themselves. Of course, the company wouldn’t have impunity if the class members opted out—but the class members never got that opportunity, as Glover explains in his second blog entry, at Lawyerist.

For one thing, the crime here was that the debt collectors called people without identifying themselves, which makes it pretty much impossible for people to know whether they’re members of the class at all.

And then, more broadly, there’s the fact that an ad in USA Today is not going to reach the people it’s meant to reach:

Because only a tiny fraction of the American public actually subscribe to newspapers, notice by publication is virtually guaranteed to be ineffective. It is also insufficient due process.

Let’s take USA Today as an example, since it has either the widest or second-widest circulation in the United States, and is the publication of choice for national class actions. According to Wikipedia, USA Today has a circulation of 1.8 million. According to census.gov, there are about 293 million households in the U.S. That means just .6% of American households subscribe to USA Today. Although, let’s be honest, as anyone who travels knows, a huge chunk of USA Today’s circulation is empty hotel rooms. And we can be pretty sure that, of those who do subscribe to USA Today or read it in their hotel rooms, most do not read the legal notices.

In other words, there is a better than 99% chance that service by publication in USA Today will be ineffective.

These numbers aren’t exactly right—Glover is confusing households with population, and doesn’t multiply USA Today’s circulation by the number of readers per copy—but the broad thrust of his argument is surely true. And he’s also right that if you’re trying to target a particular class of people, then often the internet is a great way of doing that:

Due process requires—at a minimum—meaningful notice before depriving someone of their property. Property includes the right to bring a legal claim, and so includes opt-out class actions…

On the publication theme, perhaps notice should follow the former readers of newspapers to blogs and websites. Advertisers have, and a legal notice is basically a form of advertisement. For example, service by publication using a one-month banner ad on any of the Top 100 blogs would probably reach a wider audience than USA Today. But that ignores the advantage of advertising on the internet: specific targeting.

Advertisers can reach just about everyone on the internet based on what they are interested in. People tend to complain about their problems and look for solutions to their problems online, on blogs, Facebook, Twitter, and many other websites. Well-optimized ad buys targeted to keywords related to the class action claims could reach a huge chunk of a class. And website analytics could quickly assess the effectiveness of the notice.

Courts have been slow to embrace the power of the internet, but it makes sense to me that they should get serious about due process and should no longer accept ads in USA Today when there are obviously better alternatives online.



I’m not a fan of the opt-out class action in many situations, but sadly, this might not have been too far under the biggest penalty reasonably expectable. The $1B number is incredibly inflated.

The maximum recovery for the plaintiffs under a class action is $36,000. So they couldn’t use a class action to find their plaintiffs.

To get to $1B, you would need to find 1 million individual plaintiffs, each of whom is able to prove that the debt collector called them after 1 million trials. But the plaintiff’s attorney is going to have a very hard time finding names for the reason you mentioned – the company’s name wasn’t in the calls! So they’d need to extensively advertise the claims and do a lot of work to trace the alleged phone call to the company.

They won’t be able to use discovery to find the names, as the company would be entitled to a protective order on any lists of phone numbers it called.

In addition, to reach $1B, you would need the judge to issue the maximum penalty for each individual violation, which simply wouldn’t happen. Not on a self-reported error, and not where the effect would be to wipe out all the company’s other unsecured creditors in favor of people who likely aren’t out of pocket anything. (The company’s net worth is 3.6M).

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Should Ireland default and devalue?

Felix Salmon
Nov 19, 2010 18:24 UTC

Mohamed El-Erian weighs in on Ireland today, and is blunt:

What is most desirable is not feasible given the path Europe is embarked on; and, to make things even more complicated, what appears feasible to Europe is not necessarily desirable. As a result, Ireland finds itself stuck in an unstable muddled-middle.

What seems probable in Ireland is a Greece-style bailout. It’s a debt-go-round, basically: the sovereign takes on the bad debts of its banks, becoming less creditworthy itself in the process; and then the EU takes on the debts of the sovereign. Writes El-Erian:

While seemingly exceptional to many, this approach constitutes the path of least resistance. In fact, it is the most feasible. But we should not confuse feasibility with desirability.

At its roots, the approach addresses liquidity but not solvency. It adds to the debt overhang rather than reducing it. And it uses the socially-painful method of income and growth compression as the principal way to promote international competitiveness over time.

This approach hasn’t worked in Greece, which still has sky-high borrowing costs and which is no more internationally competitive now than it was during the bailout. And it’s unlikely to work in Ireland, either.

So what might work? Default and devaluation, basically:

In a wider policy debate, debt restructuring would be considered as a possible pre-emptive option rather than a disorderly inevitability; thought would be given to the possibility of the weakest Euro-zone members taking a type of sabbatical from the club and rejoining on a stronger and more sustainable basis.

These options are still unthinkable politically. But as El-Erian says, the longer they’re put off, the worse the consequences for European growth in general, and the higher the likelihood that the crisis will engulf the entire eurozone. Right now, says, El-Erian, “given the undeniable strength of core Euro-zone countries, anchored by a fiscally sound and economically robust Germany,” it’s possible to structure a default and devaluation in such a way that the country concerned emerges in a strong fiscal position and with a healthy growth outlook. But the longer we wait, the harder that becomes.

I do think that it would be grossly unfair should the lenders to Ireland’s insolvent banks find themselves getting bailed out by Irish and EU taxpayers at 100 cents on the dollar. Is a sovereign debt restructuring the only way to avoid that? I’m not sure. And it’s also politically all but impossible to build a mechanism into the eurozone allowing countries to exit and re-enter again at a more competitive level, now that the currency union has been deliberately designed without that possibility in place.

Essentially, what El-Erian is calling for requires a level of political unity within the eurozone which has rarely existed historically and which certainly doesn’t exit now. Which is why, as he says, “the region as a whole will lose out in terms of both what is desirable and what is feasible.”


Honestly, unless individual sovereignty is abolished (which will never happen without riots and war) and a single government rules all of Europe with a single budget (another fairy tale that will never come true), the concept of a single currency is simply unworkable.

So, perhaps the Euro should disintegrate and let individual countries have their old currencies back. The bail outs cannot continue forever. While payments and trade have clearly been easier under the Euro, who honestly ever believed a single currency would ever work without control of individual EU nations’ budgets? Would France dictate the annual budgets for Italy? Should Germany tell Greece their annual budget is too large? Of course not. So why then should Germany bail out anyone, simply because she has managed her balance sheets properly?

Let’s face it – the modern notion of a single currency working without complete control of all of annual budgets is simply ridiculous.

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Can you patent financial innovations?

Felix Salmon
Nov 19, 2010 16:49 UTC

Time’s Stephen Gandel says that Loan Value Group’s Responsible Homeowner Reward program is one of “the 50 best inventions of 2010″:

Under LVG’s patented Responsible Homeowner Reward (RHR) program, banks promise to pay borrowers who continue to pay on time a lump sum — typically 10% of their original loan amount — when they sell or refinance their home. Miss more than one payment and the reward disappears. It’s still early (fewer than 5,000 people have been enrolled), but LVG says fewer than 10% of the borrowers in RHR have ended up defaulting, compared with a redefault rate of more than 20% for other loan-modification programs.

I like the program too, and am hopeful it will have lots of success. But what’s with that “patented”?

It turns out that RHR is technically an invention of 2009, not 2010, if you look at its patent application. Loan Value Group hasn’t actually been awarded the patent yet—Gandel was a little bit ahead of himself there—but LVG’s Frank Pallotta told me that applying for a patent on the idea “was the first thing we did” after setting up the company, and that the patent application preceded substantially all of the time and effort that LVG put in to building RHR.

Pallotta is an expert in mortgages, not in intellectual property, but he did say that he hadn’t personally ever come across a finance company applying for a patent on its idea before.

What’s more, it’s generally accepted that financial innovations can’t be patented: it’s an argument that Sebastian Mallaby regularly rolls out, for example, to defend and explain the secrecy of hedge funds. If you can’t apply for a patent, then the only way to stop people copying you is to operate in utmost secrecy.

But I’m not a fan of this development. For one thing, it’s unnecessary. The barriers to entry in this business are high: Pallotta says LVG has spent millions of dollars over the past few years building and marketing the program, as well as running it by a lot banks, servicers, investors, and regulators. And what’s more, LVG would probably benefit, at the margin, if and when its idea was ratified by the entrance into the market of other people doing pretty much the same thing.

More generally, I don’t want to see a world where people wanting to do positive things in the housing market are stymied by worries over patent suits. There is a worry that sleazy operators will put themselves forward as doing homeowners a favor when in fact they’re doing no such thing, but patent law is not the best way to stop such people. LVG had a good idea in 2009. But that doesn’t mean it should be able to patent the idea, and implicitly threaten anybody else thinking about entering the space with an expensive lawsuit.

Update: Mike Masnick points out 1998′s State Street decision, which was the point at which financial innovations started being patented.


Certainly sounds like a business method patent that is uncomfortably close to an “abstract idea,” and attempts at patent enforcement would eventually fail. Then again, clever claim drafting in a patent application can sometimes make a sow’s ear into a silk purse.
http://smallbusiness.aol.com/2010/05/10/ how-to-file-a-patent/

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Rating munis

Felix Salmon
Nov 19, 2010 15:12 UTC

When Meredith Whitney released her magnum opus on America’s municipalities in September, there was lots of grumbling about why an expert in financial stocks should be listened to on the subject of municipal bonds. But she’s serious about this: building on the work that she did for that 600-page report, she’s now formally setting herself up as a credit rating agency in direct competition with Moody’s and S&P.

I see two forces at work here. One is the way that the reputation of Moody’s and S&P was shredded in the crisis, creating an opening for competitors; Jules Kroll sees that too. The second is the continued failure of the independent-research business model to actually make money. Many have tried and few have had any success: while financial institutions on both the buy-side and the sell-side do value high-quality research, they tend not to want to pay for it.

So Whitney is building a second revenue stream here: alongside selling research to investors, she’ll also sell ratings to issuers. I wish her luck: breaking the ratings duopoly is very hard, as anyone at Fitch will tell you.

But she’s chosen the right corner of the market to get involved in: municipal ratings are a racket. Municipalities are forced to pay big fees three times every time they issue debt: first to the bankers and lawyers for the debt issuance, then to the ratings agencies for a rating, and finally to the monolines for a wrap. The ratings agencies make sure that the ratings they give municipalities are lower than the ratings they give the monolines, so that the municipalities are forced to pay up to bridge the difference.

John Carney has published his theory that investors are wise to the idea that monolines are rated more leniently than municipalities, so none of this matters:

We’d only want to require the same criteria for corporate bonds and muni bonds if we discovered that measuring them by different criteria created some serious market failure. But markets aren’t as stupid as that. Markets are very much aware that muni bonds rarely default, regardless of the rating. This is why muni bond investors accept lower yields—they know they are getting less risk…

Rating munis according to the same criteria as corporate bonds would reduce the amount of information available to the market by obscuring differences in the risks of different municipalities. If two-thirds of munis were rated triple-A, investors would lack guidance about real differences between the issuers.

The truth is that different types of debt are rated on different scales, and the market is very well aware of this.

Muni spreads have gapped out since Carney wrote that, and so he’s changed his tune a little:

Without an exchange traded equity market, and free from many financial disclosure rules governing public companies, muni investors are dependent on analysts and ratings agencies to discover information about the financial health of issuers.

How bad can things get for munis? Very, very bad. During the 1873 Depression more than 24 percent of the outstanding municipal debt defaulted.

I’ve been saying something similar for a while, although I’ve been concentrating more on moral hazard than on financial considerations. (When a municipality’s bonds are insured, the cost of default falls quite a lot.)

What’s clear is that there’s real credit risk in the muni market, and that bond investors are very bad at doing the enormous amounts of legwork needed to measure it. Whitney sees profit there. And the more trouble munis get into, the more money she’s likely to be able to make in this market.


Kid Dynamite asks exactly the right question. No one pays for bad ratings and that’s the only kind Whitney will be giving out relitive to Moodys and S&P.

I’m kind of supprised that Bill Gross wouldn’t higher her and groom her for succession.

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Felix Salmon
Nov 19, 2010 06:51 UTC

“I’d – I’d really prefer to live in a doggy-dog world” — Dinosaur Comics

Fabulously bonkers argument that Dodd-Frank is unconstitutional — Federalist Society (PDF)

A European sovereign bailout is really a bank bailout. Here’s the list of banksAlphaville

Dan Primack owns the Rattner story. His response to Rattner’s statement — Fortune


Dear Lady Godiva: < vuvuzelas >

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The three monkeys of mortgage bonds

Felix Salmon
Nov 18, 2010 22:11 UTC

Have you forgotten about the mortgage-bond scandal yet? I’m sure a lot of bankers are hoping that you have. But Adam Levitin hasn’t, and his written testimony today to the House Financial Services Committee is well worth reading in full. He concludes:

The foreclosure process is beset with problems ranging from procedural defects that can be readily cured to outright fraud to the potential failure of the entire private label mortgage securitization system…

In the worst case scenario, there is systemic risk, as there could be a complete failure of loan transfers in private-label securitization deals in recent years, resulting in trillions of dollars of rescission claims against major financial institutions. This would trigger a wholesale financial crisis…

A critical point in any global settlement must be removing mortgage servicers from the loan modification process. Servicers were historically never in the loan modification business on any scale, and four years of hoping that something would change have demonstrated that servicers never will manage to successfully modify many loans on their own. They lack the capacity, they lack the incentives, and the lack the will…

For many, the preferred course of action is not to deal with a problem until it materializes and certainly to avoid any loss allocation that might threaten US financial institutions. But if we pursue that route, we may well be confronted with an unmanageable crisis. We cannot rebuild the US housing finance system until we deal with the legacy problems from our old system, and these are problems that are best addressed sooner, before an acute crisis, then when it is too late.

David Dayen reports on the consequent follow-up, in oral testimony, between Levitin and Brad Miller, who’s arguably the most sophisticated member of the House when it comes to mortgage finance.

Levitin said that we don’t have the full data sets from the servicers, or any comprehensive data to see whether there is a full-on crisis of unclear title and improper mortgage assignment. In other words, we don’t quite know the full extent of the problem. Levitin said, essentially, “The federal regulators don’t want to get info from servicers, because then they’d have to do something about it.” They don’t want to recognize the scope of the problem because it would require them to act.

And Levitin in particular singled out the Treasury Department. “The prime directive coming out of Treasury is ‘protect the banks’ and don’t force them to recognize their losses.”

Essentially, there’s a three monkeys act going on here: the servicers will hear no evil, the trustees will see no evil, and Treasury will speak no evil. And so long as they all remain deaf, dumb, and mute, they can ignore the problem as it slowly approaches systemic levels.

One very suggestive datapoint here comes from Tomasz Piskorski, Amit Seru, and Vikrant Vig, who have written a very dense but important paper on what happens to houses and mortgages when borrowers are delinquent on their loans. One finding is that banks are much less likely to foreclose on delinquent loans if they own the mortgage themselves than if they’re simply servicing the mortgage on behalf of RMBS investors. Foreclosure destroys value for the owner of the loan—but, crucially, it does not destroy value for the servicer, who therefore has very skewed incentives.

And then there’s this chart, at the end of the paper:


What you’re looking at here is the percentage of delinquent mortgages which are put back to the lender after they turn delinquent. All of these mortgages had early pay default clauses, which allowed investors to put back any loan which went delinquent within three months.

The investors, of course, can’t put back the bonds themselves: they have to rely on their trustee to do so for them. But the trustees are so otiose that they don’t do that.

Look at the y-axis: the highest number there, about 14%, is the fraction of loans which went delinquent in the very first month, and which were returned within three months. For loans which went delinquent in the third month, less than 5% were ever put back.

By rights, 100% of those loans should have been put back: that’s the whole point of having an early pay default clause in the contract. But the otiose trustees instead simply do nothing.

Levitin makes an extremely strong case that it’s much better to bite the bullet now, even if that involves socking the banks with losses, than to wait for the situation to continue to deteriorate to the point at which a devastating crisis is unavoidable. But Treasury, it’s clear, is not going to act, any more than the servicers or trustees are. Maybe because the technocrats at Treasury don’t really mind seeing pain being borne by homeowners and investors. Just so long as the banks are OK.


Danny_Black, this is just to let you know you are read and appreciated.

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Book pricing datapoints of the day

Felix Salmon
Nov 18, 2010 18:52 UTC

When a big new book comes out, the publisher has two choices. It can allow Amazon to sell the Kindle edition at a much lower price than the hardback, increasing the number of copies sold but possibly cannibalizing hardback sales. Alternatively, it can force Amazon to charge a high price for the Kindle edition, garnering a passive-aggressive note on the website saying “This price was set by the publisher.”

The result looks something like this. All the Devils are Here, published by Penguin Portfolio, is $16.99 on the Kindle; Decision Points, published by Crown, is $9.99. And in return for allowing Amazon to subsidize the Kindle price, it seems that Crown has agreed not to sell the book in Apple’s iBook store:

All the Devils are Here Decision Points
List price $32.95 $35.00
Amazon price $17.50 $18.77
Amazon sales rank 7 1
Kindle price $16.99 $9.99
Kindle sales rank 16 1
iBook price $16.99 N/A
Audiobook price $20.98 $26.25

And here’s the tag cloud for the Kindle edition of All the Devils are Here:


It’s easy to overstate how representative the vocal protestors are, but it’s certainly clear that e-book buyers are price-sensitive. Has an e-book priced at more than $10 ever made it to the top of the Kindle bestseller list?


Off topic:

Felix, huge story on the collapse of microcredit in the Times. This is right up your alley.

http://www.nytimes.com/2010/11/18/world/ asia/18micro.html?_r=1&src=me&ref=homepa ge

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