Felix Salmon

Immoral bankers

Felix Salmon
Dec 14, 2010 22:32 UTC

The UK’s Institutional Investor Council has issued a blistering report on the excessive fees that investment banks charge companies to issue new shares — fees which one issuer are “usually immoral”. It certainly seems that way, looking at this chart: fees have been steadily increasing over time, even as the discount at which the new shares are issued has got larger and larger. The bigger the discount, of course, the less risk taken on by the underwriter, since the more that the share price would have to plunge overnight in order for the underwriter to risk losing money on the deal.


Yes, this chart includes the financial crisis, and it stands to reason that fees for rights issues would rise during a crisis. But we’re not in a crisis any more, and the fees aren’t coming down to their historical levels, even though the discounts are still enormous. And it’s notable that fees hit these highs on a percentage basis just as the amount of underwriting was surging:


What we’re seeing here is a textbook example of banks squeezing every last dollar they can out of their clients just when those clients are most desperate for money. And it stands in stark contrast to legal fees, which were considered fair by issuers and which have not risen visibly at all over the past few years.

None of this is illegal, of course, but it’s fair to call it unethical, if ethics are fundamentally based on the principle of “treat others as you would like to be treated”.

Christina Rexrode had a long article on banking and ethics in Sunday’s Charlotte Observer, and she concentrated on the kind of behavior which steps close to or even over the line into outright illegality. Maybe it’s just so blindingly obvious that banks behave in a fundamentally immoral manner most of the time that her editors considered that not to be news — charging $35 for a $2 cup of coffee, slapping enormous overdraft fees onto those who can least afford them, pushing high-interest credit cards on desperate customers, locating credit-card operations in South Dakota where usury laws are at their laxest, encouraging people to use the bonkers anachronism that is signature debit, steering customers into the financial products which pay the highest commissions, etc etc. All of this is legal, and all of it is designed to funnel as much money as possible from the customers’ pocket to the bank’s bottom line, and none of it is in the customer’s best interest, which means that none of it can really be considered moral.

More generally, Wall Street is an inherently adversarial place, where players are constantly trying to benefit from the misfortune of others. I’ll happily sell this stock to you at $40, because I think it’s going down, and I think that you’ll be sorry you bought it. Ethics and morals are very narrowly defined, when it comes to finance, and generally just mean being honest. Of course there’s much more to morality than simple honesty — and in any event honesty in financial markets is never simple.

So the issuers are absolutely right that the bankers are immoral — and the bankers are going to continue to ignore such questions, because ignoring such questions is how they make the big bucks. Here’s Rexrode:

The Observer broached the topic of banking and ethics with more than 50 people, almost all of them bankers or former bankers. Only 10 of the bankers agreed to be interviewed on the record. Some said they would speak only under anonymity because they feared retaliation from their employers…

People who spoke up could be seen as disloyal. The units that churned out the most revenue held the most sway with executives and other decision makers.

“To throw a flag in the sand and say, ‘I’m not sure about this’ – you’re not having a philosophical discussion with your priest, you’re saying to the guy in the next cubicle, ‘I’m not sure you should be making as much money as you’re making,’” said William Atwood, executive director of the Illinois State Board of Investment, an investor in major banks.

Ethics are great, of course. But money? In finance, that’s always greater.

(HT Dealbook, although they neglected to link to the report.)


Thank you for the explanation.

Posted by Developer | Report as abusive

Don’t buy that internet company

Felix Salmon
Dec 14, 2010 17:20 UTC

“The history of the Internet is, in part, a series of opportunities missed,” says Jim Surowiecki in this week’s New Yorker. Blockbuster could have bought Netflix for $50 million dollars; Excite turned down the chance to buy Google for less than $1 million.

But how valuable were those opportunities, really? If Blockbuster had spent $50 million on Netflix, then it would just have run out of money that much more quickly. There’s no chance that Blockbuster’s management would have let Netflix grow, unencumbered, in the way that it did independently. Similarly, Google would have been stifled as part of Excite: it would have been nothing more than one of many search algorithms competing on the internet.

Buying internet companies is very, very hard: even if they are set to be very successful on their own, that’s no reason to believe that they will have similar success in-house. Google bought Foursquare back in 2005, when it was called Dodgeball, but then closed it down; only when its founders left Google and recreated the company as Foursquare on their own were they able to succeed.

And so I’m suspicious that Surowiecki’s employer, Conde Nast, is going to do well with its new $500 million warchest. Conde is rich, and can buy companies, but at that point the problems start: it’s always much easier to spend money on acquisitions than it is on internal growth, with the result that those acquisitions can end up starved of money. Conde is a particular case in point: it bought Reddit and neglected it so badly that the site ended up having to run a pledge drive to raise needed funds.

Big established companies with their own revenue streams simply don’t have the skillset needed to be the next Y Combinator or Softbank, and they probably shouldn’t try. If Conde is smart, it’ll restrict itself to taking minority stakes in companies where it can be strategically helpful. Otherwise, it’s liable to end up looking like News Corp with MySpace.


You missed two of my all-time favorite internet acquisitions: Netscape, by AOL, and broadcast.com, by Yahoo.

But I suspect there are dozens of small companies we’ve never heard of that large companies buy to quickly fill gaps in a development project or to hasten a strategic goal, because buying is faster than building. They aren’t sexy but they are also unsung.

I agree that the big company buying the not-quite-as-big company is often doomed. There’s AOL again — buying Time Warner …

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Summers departs

Felix Salmon
Dec 14, 2010 17:00 UTC

I enjoyed Dana Milbank’s farewell to Larry Summers today, complete with cameo from Reuters’s very own Caren Bohan:

It was the final question from the audience following Larry Summers’s final speech as President Obama’s chief economic adviser. “What,” asked Caren Bohan of Reuters, “will you miss most about being in the White House?”

Summers could have taken the chance to wax eloquent about the virtues of government service, but instead he glared at the questioner. “Reporters like you,” he said. Awkward laughter followed. Bohan’s eyes widened, and Summers chuckled at his little joke.

For a man delivering his valedictory, with TV cameras rolling, it was oddly petulant…

The parting shot was vintage Summers: a man who rose to national prominence because of his intellect but is now leaving government known more for his dyspepsia…

In his remarks, he spoke of not a single wrong decision he made.

Summers decided to leave public service with a long speech recapitulating a lot of the economic themes of his tenure at the NEC. There are notable parts to the speech; I’m particularly astonished that Summers thinks the government needs “to make it easier to patent a new idea or innovation”, for instance, in a world where patent-trolling is rife and where Nathan Myhrvold can rack up a multi-billion-dollar portfolio of more than 30,000 patents in a very short space of time, any one of which could stifle genuinely valuable innovation for years.

More notable, to me, is the fact that Summers did not, on leaving the White House, take the opportunity to thank the president for the opportunity to serve his country during this most tumultuous economic period. I don’t think Summers thinks that way: in his mind, the thanks should all flow the other way.

Summers is a virtuoso at not answering journalists’ questions, partly because he doesn’t feel accountable to the public in the first place. Instead, he feels that the public, and its elected representatives, are little more than political obstacles standing between himself and some kind of optimal policy which he would happily implement if only it were politically possible to do so. The public is often wrong; Summers himself, not so much, even as the unemployment rate has remained stubbornly elevated far above the levels that he foresaw when he joined the Obama administration.

It won’t take long, I’m sure, before Summers, like Peter Orszag before him, decides that a hefty academic salary is insufficient for his needs, and starts accepting millions of dollars from the financial services industry which was in large part responsible for the crisis he’s been trying to navigate. And as Summers revolves through that ignoble door, the president will surely be wondering who got the better deal out of the arrangement of the past two years.


Your last 2 paragraphs suffice for any comments I would make about the man …

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Why passwords are insecure

Felix Salmon
Dec 14, 2010 15:23 UTC

There’s been a lot of talk over the past couple of days, since Gawker was hacked, about how embarrassingly insecure its users’ passwords were. More than 3,000 users had “123456″ as their password; almost 2,000 had “password”. There’s a long tradition of servicey journalism explaining how to generate secure yet memorable passwords, and telling those of us with insecure passwords that “what you’re doing now is going to come back to bite you”.

As someone whose password was on the Gawker list, I’ll agree it’s annoying. But I think that what’s being missed here is the element of sheer protest. All of us hate being asked to come up with passwords all the time — especially for silly things like Gawker comments. Now it’s not enough simply to have a password, it also has to be secure? Come on.

My general feeling about using insecure passwords is much like my feeling about hopping on to an unencrypted wifi network at the local coffee shop: the real safety comes from the fact that no one has the slightest interest in cracking into my Gawker commenter account or getting a preview of a blog entry I’m writing about sovereign debt negotiations.

On top of that, as Gnosis has shown, if a sophisticated computer hacker is really determined to crack into my life, then they’re likely to be able to do so. Using stronger passwords will slow them down, but it won’t stop them. The most common password in the Gawker set — 123456 — was used by just 3,000 of 1.5 million people, which is 0.2% of them. If you’re trying to guess my password, using brains rather than computer-assisted brawn, it won’t be easy, even if it’s in the dictionary somewhere. And if you’re using computer brawn to try to crack into my life, I’ve likely got bigger problems than having insecure passwords.

What’s needed here, I think, is some kind of empirical data on people who have had their passwords stolen or hacked. How often does this happen? What are the chances of it happening to me? And how much safer do people become if they move from insecure to secure passwords? Without any numbers for any of those things, it’s easy to understand why people refuse to buy into the paranoia of techies.


If this were such a really big deal, web sites would refuse to accept passwords that were too weak. If you tried to use 123456 as a password, it would be rejected.
Of course, if we made the web site financially accountable for the security of its passwords, that might happen.

Posted by RZ0 | Report as abusive

Secondary market datapoints of the day

Felix Salmon
Dec 14, 2010 14:28 UTC

Many thanks to Peter Lattman and Diana Henriques for answering my question from last week. Yes, as I suspected, there is a secondary market in Madoff claims — although from the tone of the article it seems more like a primary market, where hedge funds compete with each other to buy claims from people who have been defrauded, rather than a well-functioning secondary market where those funds actually trade the claims between each other. The going rate seems to be about 30 cents on the dollar, with an expected payout, somewhere down the line, of roughly double that amount.

For the Madoff victims who can afford to sit tight for the time being, then, the eventual losses are likely to prove manageable: the pretty healthy final recovery comes on top of the massive tax refund they got immediately after the fraud was uncovered, returning to them the taxes they paid on all that fictional investment income.

The NYT report comes from Dealbook, the bloggy arm of the business section, so maybe if I ask a question they’ll answer it. The story says that in October, “claims were trading at about 25 cents on the dollar” — does that mean that victims were willing to sell for 25 cents, or does it mean that there was an actual brokered market and that hedge funds or other non-victim investors were selling at that level? If so, that’s a very interesting datapoint, since it implies that the sellers either managed to buy their claims at a very deep discount indeed, or else got quite demoralized, for some reason, about the prospects for recovery.

Incidentally, while I’m on the subject of opaque secondary markets, Kerry Dolan is reporting that Facebook shares are now being valued at $23 each. That’s $115 on a pre-split basis, which works out at a valuation of over $50 billion — roughly the same as General Motors, somewhere between Morgan Stanley and Boeing. Wow.


Looks like a bid of 25/30c is way to low. From the WSJ: “The trustee as a result of today’s settlement will be in a position to make a distribution of approximately 50% of the estimated allowed claims in the liquidation proceeding,” said David Sheehan, Mr. Picard’s counsel.” Source: http://online.wsj.com/article/SB10001424 052748704034804576025392596402176.html

And this is just the start of the settlements. It’s a fair bet Picard will recovery most of the money for victims with approved claims.


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Felix Salmon
Dec 14, 2010 07:17 UTC

TNW and Geekosystem interview Gnosis. “The timing for the release was quite a rush; we will not disclose why this was” — TNW, Geekosystem

This xkcd is just amazingly cool. It’s like a funny, perfect, free, nerdy, gorgeous Sol Lewitt — xkcd

You can now link to, or highlight, every separate paragraph on NYTimes — NYT

Among black men in NYC age 16 to 24 who do not have a high school diploma, just one in 10 had a job — NYT

If you are not paying for it, you’re not the customer; you’re the product being sold — SSPNet

Warhol Foundation Demands Reinstatement of Censored Art Work or Will Cease Funding all Smithsonian Institution Exhibitions — Warhol Foundation

Here are Nick Denton and Tom Plunkett being very sorry — Gawker

Attention data journalism, infographics, development geeks: Hans Rosling’s latest video — YouTube

Here come the ’99ers — CR

Wall Street bonus datapoint of the day

Felix Salmon
Dec 13, 2010 21:01 UTC

In a Bloomberg poll, 88% of respondents said that Wall Street bonuses should either be banned outright or taxed at 50%. Just 7% said they should remain an incentive:


To put that 7% figure in perspective, 6% of Americans believe the moon landings were a hoax; 7% believe Elvis lives; 24% believe that Barack Obama is a secret Muslim; 41% believe in ESP; and 48% believe in creationism.

Americans will believe anything, it seems—except the idea that incentivizing bankers at systemically-important institutions to take big risks makes any sense at all. Now all we need to do is find one or two people in the Obama administration who are aligned with the 88% rather than the 7%. I’m not holding my breath.


Ernie, Socialist no. Plutocracy yes.

Posted by hsvkitty | Report as abusive

Betterment: Overpriced simplicity

Felix Salmon
Dec 13, 2010 19:06 UTC

Sean Park is so excited about Betterment that he bought a stake in the company:

Betterment allows anyone to quickly, easily and without mystery manage asset allocation and risk budgeting using a simple, multi-asset class portfolio. No hassle, no time wasted, no blizzard of trade confirmations. The first time I saw it, I immediately wanted to be able to manage all my cash balances using their platform.

Except Sean Park is a sophisticated venture capitalist, and Betterment doesn’t manage cash balances. Instead, it manages investments. Basically, it provides an easy way of sweeping money out of your checking account and into your Betterment account, where it’s then invested across eight different ETFs. Betterment does most of the asset allocation; you just tell the company how much you want invested in Treasuries and how much in stocks, and they will do the rest.

This is a handy little service — but the amount that Betterment charges — 0.9% per year — is way too much, especially since it comes on top of the expense ratios of the underlying ETFs, which net out at 18.2bp for stocks and 17.5bp for bonds. In these days of ultra-low interest rates, buying a bond fund and then paying out 107.5bp per year in expenses is likely to leave you with a negative real return, and quite possibly could leave you with a negative nominal return as well. Or, to put it another way, right now it makes very little sense to have Betterment manage your bond funds and charge you a 90bp fee for the privilege: you might well be better off just keeping your money in a savings account, where there’s no risk of a nominal decline.

The idea behind Betterment — that investing should be very easy and simple at the front end, even if there’s lots of complicated stuff going on at the back end — is a good one. And I look forward to the time when banks offer Betterment-style services to their depositors, making it easy and painless to save money. I’m sure those banks could learn a lot from what Betterment is doing, and even maybe license some of their technology. But it only really becomes attractive when it’s free. And when, at the very least, it gives some kind of an option to invest internationally and in credit — two enormous asset classes that Betterment completely ignores. I’m pretty sure that Sean Park, for one, would never find it genuinely attractive in its current incarnation.

Update: Betterment’s CEO, Jon Stein, responds in the comments, and he sure knows the way to a blogger’s heart — by referencing an old blog entry which even I’d forgotten about:

I agree with you that we should offer our customers exposure to international stocks. Our users are all US-based, and so are naturally overweight US. We plan to add international exposure soon, and perhaps a real-estate component or credit component, as well. All of these asset classes are components of the “market portfolio” – and would be represented in the “everything bagel” that you talked about in a previous post. It’s that everything bagel that we’re working toward – it takes time to make it just right.


Many fee-only investment advisors I know who work exclusively in the index space charge between 50-75bps for their human service. Hell, I charge 75bps and include personalized financial planning. Many brokerages do something similar for next to nothing. While a great idea (and I say this as someone whose business model is threatened by the idea), Betterment is charging WAY too much for what they do.

Curious where and how the client funds are custodied…

Posted by martin66 | Report as abusive

Is Obama endangering Social Security?

Felix Salmon
Dec 13, 2010 15:41 UTC

There’s a meme doing the rounds on the left, that giving employees a 2% break on their Social Security contributions for a year is, in Ryan Grim’s words, “a hidden threat to Social Security.”

At the heart of the logic is a quotation from FDR:

“We put those payroll contributions there so as to give the contributors a legal, moral, and political right to collect their pensions and their unemployment benefits. With those taxes in there, no damn politician can ever scrap my social security program.”

This logic is now being applied in reverse. It’s going to be politically difficult to increase employees’ payroll contributions by 50% in a year’s time — that’s a tax hike, and nobody likes tax hikes. So there’s a decent chance that they will remain at 4.2% rather than 6.2%, with the extra Social Security contributions being paid not by employers, and not by employees, but rather by the general fund.

Rep. Keith Ellison picks up the narrative, quoted in Grim’s story:

We’ll replace the loss of money from Social Security with general fund money, but in the past Social Security has been raided to help fund general fund programs. So how long will it be before somebody says Social Security is not sustainable and we need to cut the program?

This is where I lose the thread. As Ellison points out, it’s been uncontroversial for decades to use the Social Security surplus to help pay for non-Social Security programs. Why should it be more controversial to do things the other way around?

Kevin Drum had a fantastic explanation of how Social Security works back in August, along exactly these lines. The 1983 Social Security reform created a decades-long surplus, which could be used for other expenditure. Then, when Social Security fell into deficit, other taxes were always going to have to make up the difference.

People on the right who want to cut Social Security will always make a fiscal argument for doing so, talking about how it no longer pays for itself. They will do so no matter where the payroll contributions are set, and they would do so even if they remained untouched. Meanwhile, people on the left who want to save Social Security will scream bloody murder any time anybody suggests even something as small as raising the retirement age in 50 years’ time. Trying to get these two camps to come to agreement on anything will always be impossible. And I fail to see how adding the general fund to the payroll tax as a contributor to the Social Security trust fund is going to change that dynamic.

Mike Konczal reckons that we would be better off, politically, with a tax rebate out of the general fund rather than a reduction in payroll withholding. But that ignores the behavioral economics of the reduction in the withholding tax: people are more likely to spend a relatively invisible increase in their take-home pay, and they’re more likely to save, or deleverage, with a one-off rebate check from the government.

The debate, in a year’s time, about whether we should let the payroll-tax cut expire is going to be a fascinating one to watch. But I don’t think it’s going to have much if any effect on the future of Social Security.


“it’s been uncontroversial for decades to use the Social Security surplus to help pay for non-Social Security programs. Why should it be more controversial to do things the other way around?”

If you’re willing to go that far why not take another step towards the abyss of the truely absurd. Stop collecting the tax entirely and just print crisp new bills and mail them to seniors via the postal service… problem solved!

…why does a loaf of bread cost $35?

…oh ya problem not solved.

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