Felix Salmon


Felix Salmon
Dec 23, 2010 04:56 UTC

“It’s not all gibberish. Some of it is really great journalism” — Jezebel

“I suspect it was a teacher’s aide who must have been on the ball enough to notice it was unusual for a boy to be wearing 50 jelly bracelets” — Awl

A lawyer with a sense of humor. In 1974 — CleveScene

“People that like Spider-Man and super heroes and villains and violence and kissing would like this play” — Ada Grey Reviews for You

merchant bank,investment bank,hedge fund,index fund — Ngrams

Department of Awful Statistics: Down and Out on $250,000 a Year — DeLong

I now know rather more about Zach Seward’s life than I ever really wanted to — WSJ

The Metropolite of Piraeus Seraphim knows exactly who’s responsible for the Greece crisis. Yep, the Jews! — JTA

Bonus culture datapoint of the day

Felix Salmon
Dec 22, 2010 22:52 UTC

Jake Bernstein and Jesse Eisinger have a great story today about how Merrill Lynch persuaded its internal fund managers to buy the toxic nuclear waste spewing from its out-of-control CDO factory:

Bank executives came up with a fix that had short-term benefits and long-term consequences. They formed a new group within Merrill, which took on the bank’s money-losing securities. But how to get the group to accept deals that were otherwise unprofitable? They paid them. The division creating the securities passed portions of their bonuses to the new group, according to two former Merrill executives with detailed knowledge of the arrangement.

The executives said this group, which earned millions in bonuses, played a crucial role in keeping the money machine moving long after it should have ground to a halt.

“It was uneconomic for the traders” — that is, buyers at Merrill — “to take these things,” says one former Merrill executive with knowledge of how it worked.

Within Merrill Lynch, some traders called it a “million for a billion” — meaning a million dollars in bonus money for every billion taken on in Merrill mortgage securities. Others referred to it as “the subsidy.” One former executive called it bribery.

The money went straight to a small group informally known as the “Super Senior Facilitation desk,” headed by an Asia hand named Ranodeb Roy:

The agreement, according to a former executive with direct knowledge of it, generally worked like this: Each time Merrill’s CDO salesmen created a deal, they shared part of the fee they generated with the special group that had been created to “buy” some of the CDO. A billion-dollar CDO generated about $7 million in fees for Merrill’s CDO sales group. The new group that bought the CDO would usually be credited with a profit between $2 million and $3 million — despite the fact that the trade often lost money…

Roy made about $6 million for 2006, according to former Merrill executives.

It would be fun to dredge up some contemporaneous Merrill statements about their culture of risk management. But my worry is that the culture of risk management at BAML, or whatever Merrill Lynch is calling itself these days, is unlikely to be much better.

Merrill’s antics are the reductio ad absurdum of bonus culture, and show why it’s so silly for investment banks to pay multi-million-dollar bonuses and reckon that they’re protecting their long-term franchise at the same time. Not everybody was as egregious as this. But the differences between Merrill and other investment banks were only of degree, not of kind.


thats ok was sort of waiting for you…

Only saw a little bit about LCR in coverage of Basel 3, unlike the coverage of capital and exotic debt instruments. Haven’t read a thing about FSA – mostly because I don’t care about the UK terribly much any more and it doesn’t pop up that often in what i read.

Also the little i did read still have a built-in trigger namely the hard barrier on the credit rating of the “risk free” bonds counting towards liquidity.

Cheers anyway for the response, always worth reading!

Posted by Danny_Black | Report as abusive

What are the chances of muni doomsday?

Felix Salmon
Dec 22, 2010 20:14 UTC

Meredith Whitney took her muni-doomsaying to 60 Minutes this week:

“There’s not a doubt in my mind that you will see a spate of municipal bond defaults,” Whitney predicted.

Asked how many is a “spate,” Whitney said, “You could see 50 sizeable defaults. Fifty to 100 sizeable defaults. More. This will amount to hundreds of billions of dollars’ worth of defaults.” …

“When individual investors look to people that are supposed to know better, they’re patted on the head and told, ‘It’s not something you need to worry about.’ It’ll be something to worry about within the next 12 months,” she said.

Whitney’s appearance on the telly has prompted another round of rebuttals from those who think that the threat to the muni market is massively overblown. Cyrus Sanati, for one, reckons that there’s “a myriad of safeguards” in place to prevent a big round of defaults. And first on the list is the standard logic that we’ve been getting from California, especially, for years:

States are not people or corporations — they cannot declare bankruptcy. A large portion of California’s debt is in general obligation bonds, which are mandated to be paid first before anything else in the state – period. That means it comes before paying for education, pensions, state worker salaries, transportation and the thousands of entitlement programs in the state’s budget.

This is true, but I don’t find it particularly reassuring. A bond is a promise to pay; the mandate that Cyrus is talking about is essentially a promise to keep that promise. If you can break your promise when you default, you can break your promise to privilege bonded debt over other obligations.

The other big argument in Cyrus’s piece is that munis won’t default in the future because they haven’t defaulted in the past:

Even though Orange County, CA declared bankruptcy in 1994 (the largest municipal bankruptcy in US history), it never defaulted on its bonds. It just cut services and raised taxes to pay off the $1.6 billion it owed its creditors. In fact, Moody’s has counted just 54 defaults in the muni market from 1970 to 2009. That’s it – 54 out of the hundreds of thousands of bond offerings that have ever been issued to the public over the last 40 some odd years…

Bondholders will only really lose everything if the entire population connected with that municipality leaves. What’s more likely is that governments will push through higher taxes and slash services to pay their debts — losing access to the debt markets is far worse than anything they can imagine.

My response to this is that access to bond markets is extremely valuable for municipalities, and that they won’t default so long as it stays that way. But if a handful of big municipalities do start to default, then that access will probably disappear for thousands of municipalities around the country. And without access, the incentive to keep on paying rapidly disappears.

Joe Mysak is another commentator pushing back against Whitney, and he writes this:

Hundreds of billions of dollars? The one-year record, set in 2008, is $8.2 billion. You can see how an estimate of “hundreds of billions” would get people’s attention…

Hundreds of billions of dollars in default? The number is in the realm of the fabulous. If pressed, I would say that we might see between 100 and 200 municipal defaults next year, maybe totaling in the $5 billion or $10 billion range.

The problem with this line of argument is that it ignores the way in which correlations all go to 1 in a crisis. There are significant linkages and contagion channels between different municipal issuers: the bond insurers are one, and the fact that a huge proportion of municipal bonds is held by dedicated municipal bond funds is another. If a couple of high-profile defaults cause people to start dumping those funds, the funds in turn will have to start selling into a falling market, and all muni bond prices could easily fall to the point at which funding costs would be prohibitively expense.

Mysak, too, says that the bond market is municipalities’ “best source of finance” — something which is true until it isn’t. But he follows that up with a stronger argument: that debt service just isn’t a big enough deal, in terms of municipal budgets, to make it worthwhile defaulting. In most cases, it’s less than 10% of the total budget, which means that a default — which doesn’t come cheap, in terms of legal and other costs — simply doesn’t look cost-effective.

The strongest argument against Whitney, however, isn’t mentioned by either Sanati or Mysak. Here’s Bond Girl:

Bondholders may also seek a writ of mandamus from a court to compel government officials to take some specific action to cure whatever problem caused the default. (Seeking court mandates to make government officials do things is practically a form of recreation in California, for matters not necessarily related to debt.) For GO bonds, this would involve collecting taxes. For revenue bonds, this would involve, for example, raising rates in accordance with a rate covenant (assuming this covenant exists with a particular bond issue). Creditors can and will make life an absolute living hell for government officials and cost taxpayers a lot of money in attorneys’ fees if it comes to this. Aside from losing access to the capital markets, this is a very good reason governments do not generally repudiate their debt. The legal process of answering for defaults only exacerbates officials’ administrative, financial, and political problems; it does not solve them, as some people have suggested.

The point here is that any municipality mulling default will have to have some very good lawyers. Defaulting on your debt might help a little in terms of short-term cashflows, but it doesn’t actually reduce the total amount of debt you have outstanding — which means that the upside to doing it is decidedly limited. Municipalities aren’t sovereign nations: they can’t assume that the courts will find in their favor, and in fact it’s reasonable for them to assume that the courts will find against them.

I also haven’t seen any evidence of the kind of populist anti-bondholder rumblings which tend to precede bond defaults: I might have missed it, but local politicians don’t seem to be making much hay by complaining that money which should be going to teachers and firefighters is being spent on bondholders and financiers instead.

So my feeling is that Whitney is probably wrong, and that we won’t see a lot of municipal defaults next year. But at the same time, the tail risk here is significant. If it gets bad, it could get very bad.


My question is what happens to the whole notion of “states’ rights”, which so passions the Tea Party and any Republicans, if the Federal Government is called into bail them out.

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Why Martin Erzinger’s victim doesn’t need his money

Felix Salmon
Dec 22, 2010 16:33 UTC

Remember Martin Erzinger, the Morgan Stanley broker who bought his way out of a felony charge? He’s been sentenced now—a year’s probation, and 45 days of charity work. (Some people do that kind of thing voluntarily, and don’t consider it a punishment at all.) And Al Lewis has a magnificent column on the case, which uncovers an interesting twist: Erzinger’s victim, Steven Milo, is the son-in-law of Tom Marsico. Yes, that Tom Marsico, the one with $55 billion in assets under management.

Mutual fund magnate Tom Marsico was at the Vail Valley Medical Center on July 3, tending to his son-in-law, Dr. Steven Milo, who’d been hit by a black, 2010 Mercedes while bicycling…

Into the ER rolls Martin Erzinger, a wealth adviser who oversees more than $1 billion in accounts at Morgan Stanley Smith Barney in Denver.

Erzinger says hi to [Marsico's wife] Cydney.

“Marty and I have been acquaintances for some 20 years,” Marsico explained. “I said, ‘Geez, Marty, is there anything I can do for you? He said, ‘Oh, no, I’m just in for some preliminary tests.’”

Erzinger was in and out in 20 minutes, Marsico recounted: “He checked out just fine.” But Marsico’s mind raced. Black Mercedes? Erzinger? “I was putting two and two together and I thought, ‘Oh, God. No. This can’t be.”

The Marsico connection underlines why Milo was naturally more interested in justice than in money, and why it’s unconscionable that DA Mark Hurlbert would ever suggest—as he did, when he dropped the felony charges—that “justice in this case includes restitution and the ability to pay it.”

Milo is going to suffer greatly for the rest of his life as a result of Erzinger’s actions, but Erzinger’s future income isn’t going to help him. Instead, Milo will have to life with the knowledge that his assailant, who left him to die on the side of the road, not only avoided jail, but even blamed “new-car smell” in his attempt to duck responsibility for his actions.

Erzinger should be in jail right now, rather than managing hundreds of millions of dollars of other people’s money. I hope his clients drop him—and that other Morgan Stanley clients, too, move their money elsewhere. Perhaps to Marsico Capital. I can’t see how anybody would want to park their money with a firm which continues to pay Martin Erzinger millions of dollars.


Felix do you work for TMZ or Reuters? I can’t tell after this article. This is not a quality article about the public markets. I can’t believe Reuters let you publish this. This a joke! Why are you writing about some broker in Denver? This is a ‘hack’ article and you know it. You are looking for another Wall Streeters are bad guys article and this is what you found.

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How the government rebuilt household balance sheets

Felix Salmon
Dec 22, 2010 15:45 UTC

Mark Thoma makes a familiar complaint: that the government’s response to what he characterizes as a “balance sheet recession” has done wonders for the balance sheets of banks, but much less for the balance sheets of the population as a whole. What the government should have done, he says, is “use fiscal policy to help households make up for losses from the recession”:

For households, the collapse of a housing bubble, which also tends to cause a stock market crash, results in a decline in home equity as well as the loss of retirement and education savings. When combined with the loss of jobs due to the recession, and the fact the debts do not decline with the fall in asset values, the effect on balance sheets can be devastating – much larger than, say, the balance sheet impact of an oil price shock…

Policy has done a good job of preventing even worse problems from developing by rebuilding financial sector balance sheets through the bank bailout and other means.

But household balance sheets have not received as much attention. We could have helped households rebuild their balance sheets, and this would have helped banks by lowering the default rate on loans. Instead, we left households to mostly solve their problems on their own, and then helped banks when households could not repay what they owed.

Mark doesn’t go into any detail on exactly how the government should have done “a better job of helping households”. But it seems to me that, quietly and largely invisibly, it’s actually done exactly that.

Balance sheets have two sides, of course: assets and liabilities. And I suspect that what Mark might have in mind here is attacking the liability side of things, through pushing principal reduction on mortgages or allowing them to be reduced in bankruptcy.

But there’s a problem with trying to reduce liabilities: when the markets lose faith in credit instruments, as we saw during the crisis, the repercussions can reverberate around all markets and all countries. So governments around the world made a conscious decision to keep most bondholders whole, while injecting new capital and diluting equity holders in their attempt to shore up balance sheets.

And that’s pretty much what the government has done with the household sector too. The asset side of a typical household balance sheet is mostly home equity, and there has been a concerted attempt by the government to shore up property values — by reducing mortgage rates to all-time lows, of course, and also by dragooning various public entities (Frannie, FHA, etc) into funding substantially all mortgages being written. Without this public-sector support, banks would write many fewer mortgages at much higher interest rates, and prices would be a lot lower than they are now.

Other household assets have also been boosted by US monetary policy — stocks have been surging, as have bonds, gold, and just about any other financial asset that households might hold. And if the Fed could find a way to accept motherhood and apple pie as worthy collateral at its discount window, it surely would have done so by now.

As a result, household balance sheets are probably healthier now than they would have been if a program of cutting household liabilities, including principal reduction on mortgages, had kept investors nervous about the health of the banking system and of the economy as a whole.

The problem with this strategy, of course, is that debts are still high and real, while asset values can go down as easily as they went up. The financial crisis afforded a once-in-a-generation opportunity for an across-the-board deleveraging of the economy: a move away from treacherous debt and towards equity. We flubbed that chance, and systemic tail risk is much higher now as a result. But so are the markets.


The CP market almost completely dried up when the Reserve Fund broke the buck after LEH died. The Asset backed commercial paper market was under stress since 2007. The innovation in the PDCF was the type of collateral accepted and that it was available to primary dealers.

By the way the CP market drying up is something that seems to get very little coverage as to how close the US was to the brink. If that had failed then US companies would be running a cash-in cash-out business. No invoice financing, no terms and conditions for payments, no salaries unless the cash was to hand. For all the fuss people are making that is what Paulson, Geithner and Bernanke brought the US back from under extreme pressure in Sept and Oct 2008.

PS no apology needed all here to learn…

Posted by Danny_Black | Report as abusive

When banks burglarize

Felix Salmon
Dec 22, 2010 14:13 UTC

When Bank of America bought Countrywide, did it know that as a consequence it would start being associated in the public mind with meltwater reeking of rotten halibut?

In Texas, Bank of America had the locks changed and the electricity shut off last year at Alan Schroit’s second home in Galveston, according to court papers. Mr. Schroit, who had paid off the house, had stored 75 pounds of salmon and halibut in his refrigerator and freezer, caught during a recent Alaskan fishing vacation.

“Lacking power, the freezer’s contents melted, spoiled and reeking melt water spread through the property and leaked through the flooring into joists and lower areas,” the lawsuit says.

The NYT‘s Andrew Martin does a good job of presenting four cases where houses were improperly raided by bungling banks. But of course this is the NYT, where there always has to be a broader national significance:

In an era when millions of homes have received foreclosure notices nationwide, lawsuits detailing bank break-ins like the one at Ms. Ash’s house keep surfacing. And in the wake of the scandal involving shoddy, sometimes illegal paperwork that has buffeted the nation’s biggest banks in recent months, critics say these situations reinforce their claims that the foreclosure process is fundamentally flawed.

It’s pretty much impossible to feel sorry for the banks here, especially when they throw out a woman’s family photos, ski medals, and husband’s ashes. (Yeah, that was BofA too.) But that said, the story does carry a faint whiff of bogus trend, when Martin concedes that “Identifying the number of homeowners who were locked out illegally is difficult.”

The curious thing is that the banks seem to be able to overcome that difficulty:

Banks and their representatives insist that situations like Ms. Ash’s represent just a tiny percentage of foreclosures…

Banks and their contractors insist that the number of mistakes is minuscule given the hundreds of thousands of new foreclosure cases filed each month.

In order to know that cases like these are “a tiny percentage of foreclosures,” you need to know what that percentage is, n’est-ce pas? So this defense is not particularly convincing, unless and until we can see some numbers. Surely, mistakes like these would happen occasionally even during the boom years. But if the percentages are rising, that’s clear empirical evidence that overwhelmed servicers are doing an increasingly shoddy job.

Next time a newspaper wants to write about this particular trend, then, let’s get the names of those bank representatives on the record, let’s ask them how they know that the proportion of dreadful mistakes they make is “tiny” or “minuscule,” and let’s be a bit more determined that we should be the ones making the determination as to how small the percentage is, rather than the bank’s own flacks.

It’s sad that the settlements in these cases are invariably kept confidential. Obviously, any given case is bad for the bank, which would have been better off not illegally breaking into someone’s private property. But it’s easy to guess that the cost of preventing such break-ins is larger than the cost of settling with enraged homeowners, and that the banks consider that settling such suits is a natural cost of doing business, rather than something which they should try to bring down to zero. Getting numbers on percentages and settlements would surely help in determining whether the banks are cynically allowing this to happen because doing so means that their overall costs are lower.


One way to ensure foreclosures stay in the news is to have journalists picked on by the banks…we can expect better journalism when they are ensconced in the story!

http://www.washingtonpost.com/wp-dyn/con tent/article/2011/03/04/AR2011030404615. html

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Felix Salmon
Dec 22, 2010 05:42 UTC

Recalibrating Microfinance: A Six-Point Program — CGDev

Questioning the Benefits of Maturity Transformation — Macro Resilience

What’s not to like about your big, fat bonus? — WaPo

BankSimple supports low debit interchange fees — BankSimple

Wherein I try to turn the bike volume down a notch — NYT

“Mike Bloomberg. You could disagree with him, but then you’d be wrong” — Forbes


Incidentally, the American word for “macadam” is “asphalt”.

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Cuomo lashes out at Ernst & Young

Felix Salmon
Dec 21, 2010 17:33 UTC

Say what you like about Andrew Cuomo, he gives good complaint:

E&Y substantially assisted Lehman Brothers Holdings Inc., now bankrupt, to engage in a massive accounting fraud, involving the surreptitious removal of tens of billions of dollars of securities from Lehman’s balance sheet in order to create a false impression of Lehman’s liquidity, thereby defrauding the investing public…

Not only were the transactions concealed, but Lehman’s financial statements affirmatively, and falsely, stated that the only securities subject to repurchase (“repo”) agreements were “collateralized agreements and financings” (i.e., loans), even though, as E&Y well knew, Lehman was treating the transfer of tens of billions of dollars of securities in Repo 105 transactions as “sales,” not “loans.” Rather than expose this fraud as auditors must, E&Y expressly “approved” this practice..

As the financial crisis deepened in 2007 and 2008 and Lehman’s liquidity problems intensified, E&Y was aware that Lehman was dramatically increasing the Repo 105 transactions in a desperate effort to stave off collapse. At a time when it was critical for investors to make informed decisions as to whether to keep or buy Lehman stock, E&Y assisted Lehman in defrauding the public about the Company’s deteriorating financial condition, particularly its leverage…

As the public auditor for Lehman, E&Y had the absolute obligation to ensure that Lehman’s financial statements complied with GAAP and did not mislead the public. Instead of fulfilling this obligation, E&Y gave a clean opinion each year, erroneously stating that Lehman’s financial statements complied with GAAP. E&Y sat by silently while Lehman deceived the public by concealing the Repo 105 transactions and misrepresenting the Company’s leverage. By doing so, E&Y directly facilitated a major accounting fraud, and helped Lehman mislead the public as to its true financial condition. E&Y, which reaped over $150 million in fees from Lehman, must be held accountable for its role in this fraud.

E&Y knew this was coming—we all did—but despite that fact, its only public reaction so far has been to refuse to comment. That doesn’t look good, and it forces us back to what the company said in the wake of the Valukas report—that its work as Lehman auditor “met all applicable professional standards,” whatever that’s supposed to mean.

If I had to guess, I’d wager that there will be a large settlement—more than $150 million, anyway—and that E&Y will avoid admitting blame and also avoid criminal prosecution. One notable thing about the complaint is that the only defendant is Ernst & Young LLP; there are no named individuals on the list. So E&Y’s partners are probably safe too. Sadly.


The core issue here is who pays for the audit. It’s the same issue as the credit rating agency mess.

The SEC should perform annual audits on all exchange listed companies and bill them for the time the same way the FDIC audits banks. If you are allowed to shop your audit around to the accounting firm most willing to bend the rules than you are always going to have Enron style blow-ups.

Even if a govemental agency did the auditing you would still have some problems… but I’d bet they would be more infrequent than under the current system where companies essentially pay a firm to swear to shareholders their annual reports aren’t works of fiction.

Posted by y2kurtus | Report as abusive

Chart of the day: The working poor

Felix Salmon
Dec 21, 2010 16:22 UTC


poverty.jpg This chart comes from a Working Families Project report, and it underscores how the Great Recession has hit the working classes just as much as it has the unemployed. The baseline here — 200% of the poverty level — might sound high enough to be comfortable, but it isn’t: we’re talking a total household income of $36,620 for a family of three, or $44,100 for a family of four. (I’ve put the full chart, taken from here, over to the right.)

As the report says,

Nearly 1 in 3 working families in the United States, despite their hard work, are struggling to meet basic needs. The plight of these families now challenges a fundamental assumption that in america, work pays.

The workers in these families have a much greater risk of becoming unemployed than the population as a whole, and of course they’re financially much less prepared for any period of unemployment than most of the rest of us.

Michael Fletcher has a good write-up of the report, describing the working poor starkly as “people who earn wages so paltry that they are struggling to survive”, and showing that they’re unlikely to get much help from the government:

With a spate of fiscal conservatives poised to enter Congress and with policymakers more tightly focused on the nation’s huge budget deficit, the prospects of maintaining past spending levels on programs that help enable social mobility are dimming.

Many states also are reeling, causing them to raise college tuitions and, in some cases, consider cuts in public school funding.

If the unemployment problem risks becoming politically invisible, then the plight of the working poor was never visible in the first place. But looking at this chart, it’s easy to see why large swathes of America are angry at their government. If Barack Obama wants to understand and fight back against the fundamental drivers of Tea Party sentiment, he should concentrate on precisely these numbers.


@Felix I am 100% percent on board with the main point of this post, which I would summarize as “the Great Recession has negatively affected the working class.” However, I am going to have to disagree that the situation of someone at 200% of the poverty is worthy of the word “plight”. Or that these people are somehow, “struggling to survive”. Obviously this is contextual, based a lot on where that family resides, but even here in Los Angeles a person making 22k per year would be capable of enjoying a fairly decent living standard. Especially when put into the context of the world’s population as a whole.

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