Felix Salmon

Vindictive servicer of the day: ING Direct

Felix Salmon
Dec 29, 2010 00:35 UTC

I’m a longstanding fan of American Homeowner Preservation, which has found a clever way of keeping underwater homeowners in their homes while minimizing the loss to their lenders. Even the red-in-tooth-and-claw capitalists at Goldman Sachs can understand that. But not, it seems, the idiots at ING Direct:

ING Direct, the Dutch bank and internet-based mortgage lender, has objected to American Homeowner Preservation’s program to keep families in their homes, and ING will no longer consider AHP short sales. “ING DIRECT will also be adding your company to our exclusionary list as your company strictly finds investors to keep sellers in their home, while the bank takes a significant loss. This is against ING DIRECT’s short sale policies and guidelines, and as such you will no longer be able to work on this short sale file or any future ING DIRECT accounts,” Adam Agostinelli of ING Direct Retail Asset Management advised in an email to AHP.

If you cut out the excess verbiage, this basically boils down to “you try to keep homeowners in their homes, so we’re not going to deal with you”. Most companies would recognize this, and determine that if their short-sale policies barred sales to AHP, then they should change those policies as fast as possible. Not ING, which has come to the inhumane and self-defeating conclusion that the policies must always come first, even if they make no sense.

ING does allow short sales, of course, where the house is sold, often to an investor, in satisfaction of the loan. If ING were rational, it would want to get as much money as possible out of such a short sale, and therefore make the house as attractive as possible to as many potential buyers as possible. Instead, it is going out of its way to exclude the one set of buyers which actively wants to buy houses in short-sale situations: AHP-backed investors who intend to lease the home back to the current owners.

This is vindictiveness, plain and simple. ING might get more money if it played ball with AHP, but the homeowner wouldn’t suffer as much. Clearly, if ING is going to take “a significant loss”, then it needs an element of suffering on the part of the borrower — it’s a modern-day Shylock, demanding a pound of flesh which can do it no good whatsoever. ING gets no extra money if the homeowner is evicted as part of the short-sale proceedings. To the contrary, it will probably get less, since AHP makes its offers at full market price and doesn’t need to worry about the owners trashing the place when they’re forced out of their home.

Theoretically, AHP could try to do an end-run around ING’s absurd policies. It could give the family in question a place to camp out for a few weeks after being evicted, buy the house out of foreclosure for less than it was offering as a short sale, and then reinstate the family under its original terms. ING would get less money for the house, and on top of that pay large amounts of money to foreclose on the house, evict the family, and then sell the house. It’s a highly unattractive option for all concerned, especially the family which would have to move all of their stuff twice, and suffer the uncertainty of knowing whether they would be able to get their home back or not. In comparison, the AHP solution is a clear improvement for everybody, which leaves the inescapable conclusion that Adam Agostinelli and his paymasters are stupid, sadistic, or some combination of the two.

It’s worth mentioning the moral-hazard response only to dismiss it. I haven’t actually heard this argument made in any seriousness, but theoretically it could be made: if ING Direct allows short sales where the borrower stays in their home, then that reduces the cost of default, makes default more attractive, and therefore is liable to increase the default rate across the rest of ING’s portfolio. But if bankers think like that, they’re doomed.

AHP deals only with houses which are deep underwater, and where there is no way that the borrower can or even should attempt to pay off their mortgage in full. Maybe taking out the original loan was a bad idea, but that’s no crime, and doesn’t deserve gratuitous extra punishment. In all of AHP’s cases, the bank will end up selling the home at a loss. If it wants to minimize that loss, it should work with AHP. If it wants to maximize that loss, it should ignore AHP. In either case, its decision will make no difference whatsoever to other underwater borrowers and their propensity to default.

There’s one other possibility here. Maybe ING Direct is the servicer of the loan but not the beneficial owner of the loan, which has been securitized. In that case, it’s not ING which would get the benefit of a higher sale price, it’s the owners. On the other hand, if ING goes through elaborate foreclosure and eviction proceedings, it can charge those owners fees all the way along the process. Of course, the servicer is meant to be operating on behalf of the owners, but as we’ve seen many times, bondholders have no real ability to monitor what servicers do in their name, and have no control over what the servicers do even if they do find out. If foreclosure proceedings are a profit center for ING rather than a cost center, then suddenly its decision makes a lot more sense. If you can’t make money off the borrowers, make money off the lenders instead!


PeterRG, as a servicer it does not directly care about losses on mortgages. It typically gets paid a monthly fee based on a percentage of the ***loan***, plus some fees. The only reason it would care about losses on selling the underlying collateral is because if that sale doesn’t cover the loan principal then their fees come out of the investors pie which means the investors will query everything.

ING as a group needed bailing out because it made bad loans. Nothing to do with the servicer.

Posted by Danny_Black | Report as abusive

A guide to the market oligopoly system

Felix Salmon
Dec 28, 2010 18:22 UTC


A couple of months ago, I bought this drawing from New York artist William Powhida. It’s called “A Guide to the Market Oligopoly System”, and it’s lots of fun, as well as being very astute.

It’s dominated by a big pyramid, with “the yearning masses” at the bottom — “submerged artists”, “deep in debt”, with enthusiasm rather than money. There’s a little dot over on the left, saying “you are probably here”. Powhida explains the economic condition that most artists find themselves in: There are always more people who like to earn their income as an artist than there is demand for them: there is a structural excess supply of labor. So, why do they persist? It’s a labor of love, or willful ignorance of the odds.

At these levels, art-making is simply not an economic activity, and as such it might be the purest art of all. There’s something quite noble about a labor of love, and indeed most artists, galleries, and museums at much higher levels of the pyramid are happy to continue to pretend that the art they’re showing is still a labor of love, even as it sells for millions of dollars. Art is getting bigger and glossier because that’s where the money is, but few artists (Takashi Murakami, perhaps?) will unabashedly admit that they make art for the money.

For the most part, then, as you rise up the pyramid, you encounter a steady increase in hypocrisy and artspeak, with the latter largely designed to obfuscate the former.

sneer.jpgAt the same time, however, it’s easy to sneer at the labor-of-love types: the art world has internalized the idea that labors of love are only worthwhile so long as they fetch a goodly number of dollars, or at the very least have a veneer of art-school sophistication — a veneer which becomes even more important if your art is popular or decorative or minimally functional. (Elsewhere, Powhida notes that “fashion isn’t considered art. Sorry!”)

The next level of the pyramid is what Powhida calls “the broad primary market”, which includes “tons of commercial galleries everywhere” as well as non-profits, pop-ups, co-ops, and the like. This is the point at which art starts being traded for money — the artists in question typically make a three-figure sum selling smallish works, with larger pieces at more respectable galleries going for a few thousand.

At this point, both artists and collectors start thinking in terms of what any given piece might be “worth.” Everybody in the system — artist, collector, gallery — has a natural desire to want to believe that an artwork is “worth” more than the collector paid for it, and that the trajectory of the artist’s future career will mean that in years to come, the collector will be able to sell it at a profit.

This is where the collector hypocrisy comes in: collectors love to say that they buy art just because they love it, and that they will never sell it. For them, just as for the artist, it’s important to keep up the pretense that what they’re doing is a labor of love; when collectors are caught flipping artworks to auction houses and making a profit on the deal, they’re sneered at, especially if they don’t immediately reinvest the proceeds in even more art. But the fact is that beyond a relatively modest initial level, no collectors will buy anything unless they think that it has real monetary value now, or will have it in the future.

real.jpgThis is why galleries are so important: they’re the mechanism through which an artist’s career can be tracked and reduced to a handy dollar figure. Everybody knows that there’s much more art than science to setting the dollar amount, and that’s why they always keep an eye on the auction houses, which are considered more objective. There’s an interesting tension here: galleries and artists love to see new records being set at auction, even as they hate the collectors who take their work to an auction house in the first place.

The auction houses are actually two full notches higher up on the pyramid, above the blue-chip galleries in London, LA, and New York and the major art fairs such as Art Basel and Frieze. At these levels, art becomes more explicitly a commodity: virtually everything bought here has some kind of immediate resale value, and you’ll probably be able to borrow cash money against it if you put it up as collateral. Galleries will nearly always buy back the work they sold you, if not at the price they sold it to you for, and much of the work will happily be accepted by the big auction houses.

The barriers to entry, at this level, are high: in the primary market, individual artworks start in the five-figure range and go right up into seven figures or even eight for massive works by megastars. Meanwhile, the same dealers operate a highly-exclusive secondary market where works can occasionally break the $100 million mark.

auction.jpgAs its position on the pyramid suggests, the auction market is even more exclusive. It’s actually smaller, even as a secondary market, than the behind-the-scenes dealings of gallerists, and it’s also much more brutal in its assessments of an artist’s career trajectory. Auction houses are happy to sell relatively cheap works by up-and-coming artists, but they are much warier of more expensive works by artists seen as being on the decline. There’s still a market, for instance, for 80s superstars like Julian Schnabel or Eric Fischl, but you’re very unlikely to find their work at auction: they’ve been kicked out of the auction world, back down to the primary dealers.

It’s worth noting that this mechanism creates a very strong survivorship bias in the official art-market returns, quoted by Powhida at being 0.55% per year. Those returns are calculated by looking at pieces which have come up for auction more than once, but the fact is that in the big auction houses will often simply refuse to accept pieces which are no longer in favor, with the result that those works end up being sold in the opaque secondary market of galleries, and never get incorporated into official statistics. Auction sales are emphatically not a representative sample of secondary-market art sales more generally. What’s more, most art collections are built up in the primary market rather than the secondary market, and art indices give no indication of the rate of return on primary-market purchases, again because those numbers are so opaque.

Most people who buy art will, to a first approximation, “lose” all their money: like most other consumer products, it won’t or can’t be resold after being bought. Many of those people kid themselves that their work is “worth” roughly what it would cost them to replace it; they’re only disillusioned when they actually try to sell the thing and find no willing buyers. And even the clear-eyed often think of their art as a lottery ticket: it might be worthless today, but maybe, in the future, if the artist becomes hugely successful, it could be worth a fortune.

Art only really becomes an asset class at the very top of the pyramid: the auction houses, the museums, and the stars (a/k/a Damien Murakoons). Artists are constantly if slowly being inducted into this world, and museums are constantly receiving donations of art and buying it themselves, thereby taking it off the market. As a result, the total size of the market remains roughly constant, even the art which makes up the asset class is constantly changing. Right now, you’ll find Richard Prince and Francis Bacon in high demand; in ten years’ time it’ll be someone else.

One of the things I like the most about Powhida’s piece is the various different ways that he characterizes what you might think of as the y-axis: the thing that changes as you go higher up the pyramid. One sequence looks at the artists, who go from “submerged” to “emerging” to “established” to “stars.” Another looks at the artists’ net worth, which goes from “deep in debt” to “loaded.” Then of course there’s the price of art: “hundred$” to “thousand$” to “million$.” There’s a line characterizing the art from the collector’s point of view, from “speculation” to “investment.” There’s an upside-down pyramid, showing the art world in terms of effect rather than mass. And then there’s this:


You can argue the toss on some of these, but the main thrust is clear: the value of a work of art is to a very large degree a function of the city where it’s being sold. New York’s at the top of the heap (or, to be precise, Manhattan); Berlin punches well above its weight; Paris, the erstwhile center of the art world, is conspicuous by its absence.

Art schools, too, are ranked: Yale’s at the top, followed by Columbia, RISD, the Art Institute of Chicago, MICA, Cal Arts, UCLA, Bard, and Pratt. No foreign art schools are on the list, which is a shame, but Powhida is a very American artist.

In any case, I love this particular piece — I’m geeky enough to think that there should be much more art with footnotes — and I’m glad to own it. Naturally, I’ll never sell it. But I can still dream of a day when Powhida is famous and it’s worth a fortune.


Thanks Ed! I have to admit I’ve always been a bit fuzzy on that front, thanks for clearing it up. There goes my plan to make millions by plastering this picture all over coffee mugs :-)

Posted by FelixSalmon | Report as abusive


Felix Salmon
Dec 28, 2010 03:41 UTC

Wherein Ken Griffin praises an executive for saying that the story of Amaranth’s portfolio platform integration was one she could tell her grandchildren — ZH

You thought Dodd-Frank had been passed? The GOP has other plans — NYT

In 2007, RIM Thought The iPhone Was “Impossible” — Macstories

Wall Street Bull Crocheted! — Animal NY

“Unlike the Washington Post, which obviously has nothing to do with journalism, I actually expect better of Wired” — Salon

Jon Stokes and I wrote this article on algorithmic and high-frequency trading — Wired

Isn’t there something a little unseemly about a business doing $5m/yr in revenue still having a tip jar? — NYT

walk,drive — Ngrams

“This is Deepak Sheti. In a city with over 13,000 taxis, Deepak has picked me up 5 times in the last 3 weeks” — Mr Murray

Car restrictions backfire in Beijing — Guardian

Spain’s finance ministry now has an English-language website — The Spanish Economy

Wherein Bono pulls Spider-Man and replaces it with “Bloody Bloody Sunday Andrew Jackson” — NMATV

Lessons from Japan’s fiscal disaster

Felix Salmon
Dec 27, 2010 21:09 UTC

When it comes to overindebted countries which can’t stop spending, it’s pretty hard to compete with Japan. The fact that everybody picks up on when reporting on the 2011 budget is that debt issuance is going to exceed tax revenues for the second year running — or, to put it another way, that more than half the budget is being paid for by borrowing rather than taxes. For me, however, the scarier fact is that more than half of government tax revenue is going to go straight back out the door in debt-service payments.

If you’re at all interested in Japan’s budget, the Yomiuri Shimbun editorial on the subject is excellent; for a shorter version, James Simms has a good overview in the WSJ. The problem is a familiar one: politicians are happy spending money and incapable of implementing budget cuts, and the result is a slow-moving fiscal trainwreck.

The situation in Japan is particularly depressing because the country has no major ethnic or political rifts. Sure, there’s political jostling, both within and between the parties. But it’s nothing compared to the vitriol and mistrust that we see in the US, and somehow I can’t imagine Greece-style riots in Japan either. But still the technocrats can’t make any headway.

The lesson here, I think, is that it’s very, very hard for a government to enact a serious fiscal adjustment unless and until the bond market forces its hand. The Brits are trying, of course — and we’ll see whether or not the coalition government can succeed. But as we saw with George W Bush, the fiscal rectitude of one administration can be more than wiped out during the course of the next.

Even now, with the attention of the world more concentrated on sovereign fiscal issues than ever, the Japanese government can still contrive to raise agricultural subsidies by 40% and send child-care payments soaring, including payments to families who don’t need the money. It’s even getting rid of highway tolls. Oh, and it’s cutting the corporate tax rate.

From a bond-market perspective, this basically just means an ever-greater supply of JGBs: we’re still a very long way from any real credit risk, given the political power of the owners of those bonds. But as a lesson in fiscal political economy, Japan is much more worrisome. Everybody agrees that the budget must be cut and the country put onto a sustainable fiscal course. But no one is capable of doing that, and instead they go in the opposite direction entirely. It’s the see-no-evil easy choice to make. And I suspect that we’ll see continue to see similar choices being made in other highly-indebted countries around the world. Including the US.


“I guess that a devaluation of the currency *without* a corresponding increase in wages would tend to devalue the living standards for everybody? Is this what you are envisioning?”

That is exactly what I’m expecting… and it’s not much of a reach. Compare the Euro, Yen, Pound, and Dollar against the Brazilian Real, The Korean Yaun, and whatever currencies they use in Tawian, or Vietnam.

I think the trend of stagnant wages and lower living standards relitive to those fast growing countries has been inplace the last 10 years. If you want to get ahead in the U.S. you’ve got to increase the value of your job skills, or take some risks… like buying equities in March of 09 or buying some destressed property and fixing it up.

Working hard and staying out of trouble will still get you bye but they won’t get you too far ahead. Westerners need to get use to the idea that we’re all competing with younger and smarter people from away… people who are willing to work for the good life that we consider our birthright.

Happy new year and good luck!

Posted by y2kurtus | Report as abusive

The longevity trend bond arrives

Felix Salmon
Dec 27, 2010 16:39 UTC

Swiss Re reinsures a lot of life insurance. As a result, it could lose billions of dollars if a lot of insured people die young, due to pandemics, terrorism, or the like. To hedge that risk, it has sold about $1.8 billion in mortality bonds to date. Such bonds earn a healthy yield, so long as there’s no big rise in mortality. If there is, then the bondholders lose some or all of their principal, and it’s used instead to make those unexpected life-insurance payouts.

Mortality bonds are an expensive hedge, though — one last year had a yield of 617bp over benchmark lending rates. Swiss Re would much rather hedge its mortality risk in a profit-making manner, by writing longevity risk. That’s what it did last year with the UK’s Royal County of Berkshire Pension Fund: in return for a steady stream of insurance premiums, Swiss Re contracted to pay out Berkshire’s pension obligations. The risk in that kind of deal is that the pensioners live too long, and that Swiss Re’s total payouts will be much bigger than the total insurance premiums.

Insuring longevity risk, then, is a great deal for Swiss Re: not only should it be profitable, if it’s priced correctly, but it also helps to naturally offset the company’s mortality risk. If people live longer, then pension payouts will be higher, but life-insurance payouts will be lower. And vice versa.

As a result, you’re unlikely to see a market in longevity bonds developing alongside the market in mortality bonds. Insurers’ longevity risk is already hedged, by their larger mortality risk, so they don’t need to go to capital markets to buy expensive hedge there.

Still, the hedge is not perfect, and so now we’re beginning to see Swiss Re come to the market hedging its basis risk: the risk that its longevity portfolio won’t act as a hedge for its mortality portfolio.

“We are hedging against the risk that life duration patterns between older, retired British males and younger US males diverge significantly,” said Alison McKie, head of life and health risk transformation at Swiss Re.

Swiss Re transferred $50 million of longevity trend risk to investors through an off-balance sheet investment vehicle called Kortis. “The bond is triggered by how the risks diverge,” McKie said.

This bond is small, at just $50 million, but the way it works is interesting. Swiss Re is essentially short the life of UK pensioners, and long the life of US workers. So the worst case scenario for the reinsurer is that UK pensioners start living longer even as US workers start dying early. And if that happens, the people who bought this bond, which pays a coupon of 4.72% per year through 2017, will lose some or all of their principal.

It’s an interesting concept, but it seems to me that basis risk is a very difficult thing to hedge, just because the sums involved when the two legs of your trade both move against you are so enormous. I suspect that basis bonds like this—the term of art seems to be “longevity trend bond”—are going to be a bit like catastrophe bonds: a good idea in theory, which has difficulty taking off in practice, and which never really reaches the critical mass needed to make a difference. Especially since there’s no natural buyer of this risk.

Update: Be sure to see the great comment from David Merkel below.


Thanks David!

Would love to know more about those three wealthy Canadians…

Posted by FelixSalmon | Report as abusive

The Gordian nightmare of public pensions

Felix Salmon
Dec 27, 2010 14:52 UTC

Maybe it’s because I’m European, but I simply cannot get my head around a developed nation where people with lifelong service in the police or the fire brigade can find themselves with no pension at all. Zero. But if you’re unlucky enough to have served in Prichard, Alabama, that’s the situation you’ve found yourself in for the past 14 months

The NYT had a heart-rending story on the city’s finances last week: it seems that if a city has unfavorable demographics and an incompetent government, then there’s no one—not the state, not the federal government, not any kind of pensions guarantee agency—willing to step in and make things right.

Nettie Banks, 68, a retired Prichard police and fire dispatcher, has filed for bankruptcy. Alfred Arnold, a 66-year-old retired fire captain, has gone back to work as a shopping mall security guard to try to keep his house. Eddie Ragland, 59, a retired police captain, accepted help from colleagues, bake sales and collection jars after he was shot by a robber, leaving him badly wounded and unable to get to his new job as a police officer at the regional airport.

Far worse was the retired fire marshal who died in June. Like many of the others, he was too young to collect Social Security. “When they found him, he had no electricity and no running water in his house,” said David Anders, 58, a retired district fire chief. “He was a proud enough man that he wouldn’t accept help.”

Back in March, Prichard was given two months to work out how it was going to pay its pensioners—and that was after they’d already gone without pay for half a year. Today, we’re told, “a mediation effort is expected to begin soon.” And according to Michael Corkery, the city has proposed capping benefits to current retirees at about $200 a month.

The problem here isn’t gold-plated pensions—Prichard was paying out only $1,000 a month on its average pension when it defaulted back in October 2009. Neither is it, as Mish would have it, the Alabama legislature, which passed various bills amending city pension plans over the years. And it’s not greedy bondholders, either, asserting their seniority over pensioners: Prichard doesn’t have any outstanding bonds, and even bank loans don’t seem to be an issue.

Ultimately, the problem here is a confluence of two factors. On the one hand you have the nationwide—and indeed global—issue of unfunded public pension liabilities. On the other hand you have the statistical inevitability that in a country with thousands of municipal pension plans, some of them are going to run out of money.

One thing I’m pretty sure about: if and when a city with bonded debt arrives at the same place as Prichard, all the covenants in the world won’t be enough to protect bondholders from default. It’s politically impossible to pay creditors on Wall Street while short-changing people who worked for the city for decades and who have no other income to fall back on.

And more generally, the problem of municipal pensions is shaping up to be a Gordian nightmare. Cities which have diligently funded their own pension plans won’t ever want to bail out those who haven’t, or see federal funds used for such purposes. But on the other hand, situations like Prichard’s are clearly unacceptable, which means that there has to be some kind of bailout. Public pensions, I fear, could turn out to be the biggest moral-hazard play ever.


“It’s politically impossible to pay creditors on Wall Street while short-changing people who worked for the city for decades and who have no other income to fall back on.”

Many of those “creditors on Wall Street” are pension funds or other retirees on fixed income. Who makes the decision as to which retirees are more deserving to keep their retirement income? Robbing Peter to pay Paul?

Posted by anonym0us | Report as abusive

Union contract of the day, NCUA edition

Felix Salmon
Dec 25, 2010 05:57 UTC

Robin Sidel reports on the NCUA’s new budget:

The 2011 budget for the National Credit Union Administration, which insures about 7,400 credit unions, will rise 12% from the prior year, fueled partly by contractual pay raises for unionized employees…

The agency’s employee pay and benefits are set to climb 12% to $163.2 million in the current fiscal year. Most of the jump is unavoidable because of contractual obligations to unionized employees, who represent about 80% of the NCUA’s work force.

I would love to see more detail on this. Yes, the NCUA is hiring more examiners. And yes, I’m sure that the cost of benefits is rising fast. But 12%?

The NCUA explains, in a press release, that 37% of the increase in pay and benefits is due to a “6.1% pay increase mandated by the Three Year Collective Bargaining Agreement entered into in 2008″.

It’s worth bearing three things in mind, here. Firstly, the NCUA failed miserably in its job over the past three years, overseeing as it did the complete collapse of the corporate credit unions which underpinned pretty much the entire credit-union system. Secondly, we were already in a highly disinflationary world in 2008, when the NCUA happily signed off on a 6.1% annual pay increase in 2011. And thirdly, credit unions in general, and their trade associations in particular, have all been critical of these pay hikes.

It’s important that financial regulators can pay well to attract talented staff. But collective bargaining agreements with across-the-board 6.1% pay rises are not a smart way of doing that. And, frankly, there’s not much evidence that the NCUA’s staff is particularly talented: if you were a talented financial regulator, would you want to work for the NCUA?

It’s ridiculous that the NCUA can simply vote itself as much of a budget increase as it likes, showering money on its headquarters and its employees, sticking the cost onto the credit unions, with no real checks or balances at all. At most institutions, there’s some incentive somewhere to keep the budget in check. At the NCUA, there seems to be none.

But more to the point, it’s ridiculous that the NCUA exists at all: it should by rights have been abolished, along with the OCC, in Dodd-Frank. One thing pretty much everybody agrees on is that we have too many regulators; the FDIC should simply absorb the NCUA, along with its examiners and its insurance fund. The examiners would be part of a larger, higher-profile regulator with real teeth; occasional failures would be less prone to cause an unfair burden on credit unions; and credit unions in general would be brought closer into the financial mainstream. But sadly, if this never happened in Dodd-Frank, it’s not going to happen at all.


Seems that the NCUA was playing “catch up” with this contract. As a credit union member, I am concerned with anything that will increase my costs, this being one. At the same time as a union member, I am all for my bretheren getting a fair deal, which you really don’t address if they did or not.

Posted by neeros | Report as abusive

Accountants in the firing line

Felix Salmon
Dec 23, 2010 15:40 UTC

As Caleb Newquist notes, most financial reporters cover the accountancy industry “once in a lunar eclipse on the winter solstice.” So it’s fantastic to see Bloomberg’s Jonathan Weil coming out with two incisive, hard-hitting columns in succession on the subject.

Last week, Weil drew a bead on PricewaterhouseCoopers, which has signed off on a $2.2 billion accounting benefit at MBIA. That number represents “estimated recoveries,” most of which are due to come from Bank of America; they’re essentially bonds which MBIA is allowed to put back to the lender because they didn’t conform to the lender’s own representations and warranties.

At the same time, however, PricewaterhouseCoopers is also happy signing off on Bank of America’s accounts, which include no liabilities to MBIA at all.

Weil concludes:

The job of an independent auditor should be to ensure that the numbers make sense.

At MBIA and Bank of America, they don’t.

Is this illegal? Probably not. But this week, Weil comes out swinging at Ernst & Young, dismissing its defense against Cuomo’s charges as “insane” and “nonsense,” and placing it in the broader context of E&Y’s corporate culture:

Allegations of misconduct at E&Y have become such a routine part of the firm’s business that they’ve come to be expected…

E&Y had established itself as a repeat offender long before Governor-Elect Cuomo filed his suit. In recent years we’ve seen four former E&Y partners sentenced to prison for selling illegal tax shelters, while other partners have been disciplined by the SEC for blessing fraudulent financial statements at a variety of companies, including Cendant Corp. and Bally Total Fitness Holding Corp.

(Note Weil’s mastery of the hyperlink: would that all journalists were as good.)

Weil effortlessly dismantles E&Y’s statement that “there is no factual or legal basis for a claim to be brought against an auditor in this context where the accounting for the underlying transaction is in accordance with the generally accepted accounting principles,” by pointing out that Cuomo’s whole case is based on the assertion that the transaction was not in accordance with GAAP:

In the footnotes to its audited financial statements, Lehman said it accounted for all its repurchase agreements as financings. This was false, because Lehman accounted for its Repo 105 transactions as sales, a point the Valukas report chronicled in exhaustive detail.

As any freshman accounting major can tell you, it’s a violation of GAAP for a company to tell investors it’s using one type of accounting treatment when it’s actually using another, especially when the method it’s secretly employing makes its balance sheet look stronger.

Meanwhile, Francine McKenna is doing sterling work on this case as well, pointing to the parts of the Valukas report where E&Y comes off as particularly obstructionist:

I think the NY AG’s investigators questioned EY and its partners first as part of building a case against Lehman executives. When EY was as difficult and non-cooperative as they seem to have been with Valukas, the NY AG decided to redirect their energies to the auditors. They had the Lehman Bankruptcy Examiner’s report as a road map, an almost-ready for prime-time template for a complaint against the auditors.

McKenna singles out this passage from Valukas:

Prior to this invitation and during [E&Y partner William] Schlich’s four‐day interview as an Ernst & Young representative, the Examiner invited Ernst & Young to opine on why Repo 105 transactions were proper and did not result in Lehman filing materially misleading financial statements…Schlich replied that the transactions were proper if they complied with Lehman’s self‐defined Accounting Policy. Despite an additional invitation from the Examiner, Ernst & Young has not offered any further explanation.

There are echoes, here, of the way in which Cuomo decided to file suit against Steve Rattner after being angered by his incomplete responses to initial questioning. It’s natural for individuals and companies not to want to incriminate themselves when being questioned by the attorney general. But when dealing with Cuomo, it seems that being as cooperative as possible as early as possible is the way to go. He hates being given incomplete information.


I agree with your general criticism that accounting firms need to work on their PR and that maybe more upfront cooperation with Cuomo would’ve yielded an ally further down the line.

But I have three disagreements with the above post;

1) The E&Y-Lehman suit was a foregone conclusion, even moreso after the Valukas report (which stated there was evidence of a colorable claim, which, in legalese, requires less presumption of wrongdoing than a civil or criminal charge). I have doubts that E&Y really could’ve avoided this lawsuit, and it is telling that only civil charges have been filed using expanded powers of the Martin Act.

2) The Main Stream Media’s coverage of accounting matters is, as you state, abysmal. But there is a reason why, accounting rules mirror those used in law, except tend to be more technical and thus, more boring. I see no attempt by the MSM to cover the particulars of accounting literature, or even the over-arching purpose – which is not to protect us from all failures or fraud, but to have some type of system of consistency in standards which is verified by an independant third party. E&Y will wage a losing battle trying to communicate this to the masses without assistence by an informed member of the MSM.

3) There are 4 major accounting firms auditing tens of thousands of companies and with 100k plus employees each. Cherry picking specific failures is no great accomplishment or evidence of general erosion of standards. In this case, the tax and audit divisions share little overlap in leadership or standards, and a couple failures are no implicit presumption to change the entire structure or internal workings of an organization.

Posted by ScottVE | Report as abusive

Using Twitter to predict stock moves

Felix Salmon
Dec 23, 2010 14:06 UTC

This paper, which has now become a fully-fledged hedge fund, is certainly good at hitting buttons: not only does it include Twitter and stocks, but it even finds room to include an important role for Google n-grams!

The beating heart of the paper is this chart, which purports to show a connection between two data series. The blue line is the amount that the Dow rose or fell on any given day; the red line is the frequency with which people are saying “I feel calm,” or words to that effect, on Twitter.


To my untrained eye, I have to admit that all I see here is two random lines layered on top of each other. But according to the paper, if you run this data through a Granger Causality Analysis and then a Self-Organizing Fuzzy Neural Network, you get all manner of enticing predictive power out the other end. In the chart, the shaded areas supposedly show the periods where Twitter successfully predicted where the stock market was going.

Conceptually, I suppose it makes a certain amount of sense that stocks would fall when people stop feeling calm (nervousness causes selling) and rise when they do feel calm, and therefore more comfortable betting on the future.

It also makes sense that if you’re going to try to use Twitter to predict moves in the stock market, you want to concentrate on what it’s good at, which is giving a real-time glimpse into the sentiment of millions of people. As Pascal-Emmanuel Gobry points out, the algorithm here deliberately strips out stock-related tweets.

I’m sure that the new hedge fund, called Derwent Capital Markets, will be shelling out the maximum $360,000 a year for access to 50% of Twitter’s live stream. So someone’s making money here. But I’m skeptical that Derwent is going to be very successful. After all, predictive power isn’t enough to make money in the stock market: it’s perfectly possible to make money 87.6% of the time but still lose money over the long run.

I also suspect that these kind of algorithms are going to have difficulty keeping up with Twitter as it evolves away from people broadcasting the minutiae of their lives, and towards more sophisticated conversations which are less susceptible to n-gram analysis. But the Derwent crew will certainly be doing some very sophisticated and interesting research on Twitter in the coming months and years. I hope that, eventually, they’ll make some of their results public.


We are seeing much more mood reactions to stock, usually driven by media stories. Twitter seems to be the second wave of mood and investment reaction. If you analyze company-specific information, news articles and return the “media mood” you get a much clearer picture.

FlameIndex.com is a source that seems to be getting much closer to predicting what is about to happen on Twitter. It analyzes 10 K media sources per day and ranks companies based on how “on fire” they are in the media. It filters up the news articles as well. Now all they need is a stock overlay and we’ll be able to see the correlation instead of doing the calculations by hand.

Posted by jmedia | Report as abusive