Felix Salmon


Felix Salmon
Jan 18, 2011 05:40 UTC

Liz Alderman provides the news context for Paul Krugman’s big magazine piece on Europe’s fiscal situation — NYT

Monica Davey does something similar on the fiscal situation facing state governors in the US — NYT

Freddie deBoer with a sharp look at the dominance of the wonky technocrats in the lefty blogosphere — L’Hôte

Steve Waldman with a brilliant (and wonky) look at the dominance of technocrats on the left, and why they’re failing — Interfludity

Sarah Palin defends use of blood libel term — Reuters

Shipping rates in Pacific go negative for first time — Bloomberg


What on Earth happened to the Left indeed?

One of the most insightful looks I have seen is by the Pew forum:
http://pewforum.org/American-Grace–How-R eligion-Divides-and-Unites-Us.aspx

Over the last 20 or 30 years, the left became arrayed against its old allies in the religious community on abortion, and more recently, redefining marriage.

Methodists for example have historically been major social activists, setting out a strong abolitionist doctrine 100 years before the end of slavery. Catholics have been a major force in support of the poor. But these groups cannot support a radical redefinition of marriage. The Catholic Church in Washington, D.C. had to end many decades of working with the city as a leading provider of adoption services because the city tried to force them to go against their beliefs.

As long as the left vigorously pursues a redefinition of marriage, it will continue to alienate the very ones it counted on as supporters in its fight on the economic front.

Perhaps the left imagined that its losses among the religious would be made up for with gains among the non-religious, but these newcomers do not share the concern for the poor of the left’s former allies.

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Goldman’s Facebook plan falls apart

Felix Salmon
Jan 17, 2011 22:15 UTC

When the news came out that Goldman Sachs was orchestrating a private offering of Facebook shares at a $50 billion valuation, those shares overnight became an even hotter commodity than they had been up to that point. Check out the results of the periodic SecondMarket auctions: the three auctions in December, before the Goldman news was public, cleared at between $21.01 and $22.75 per share. The first auction after the Goldman news, by contrast, cleared at an all-time record of $28.26 per share — that’s a valuation of over $70 billion.

Clearly the Goldman news moved markets — a lot. And equally clearly, that’s very problematic in terms of securities law. Andrew Ross Sorkin explains why Goldman now feels forced to restrict its offering to non-US investors:

Federal and state regulations prohibit what is known as “general solicitation and advertising” in private offerings. Firms like Goldman seeking to raise money cannot take action that resembles public promoting of the offering, like buying advertisements or communicating with media outlets.

This is a point which was made before Goldman’s latest announcement, for example by Chris Whalen:

Look, for example, how the Facebook portal got a lot of ink last week because of the superlative public relations job by GS. In feeding their “private investment” hype to the Big Media, GS was effectively front-running their own private market, the little ghetto called Face Book that they created apparently to evade securities laws.

All of this serves to underline the difficulties inherent in trying to put together a private market in Facebook stock. In Goldman’s ideal world, and quite possibly in Facebook’s ideal world too, Goldman could broker private transactions in Facebook shares for years to come, obviating the need for Facebook ever to go public.

Received opinion has it that Facebook might as well go public once it exceeds 500 shareholders and starts making public large amounts of information about itself in 2012. And today’s news only serves to underline how difficult it is for a highly-visible company, and its advisers, to maintain a market in its securities while remaining private.

Selling the shares privately isn’t going to be a problem, reports the WSJ:

A total of about $7 billion in orders for Facebook shares has poured in, according to a person familiar with the matter. That means it is highly likely that Goldman still can pull off the offering at its original size without U.S. investors. Chinese demand is especially strong, said one person familiar with the offering.

“They’re still committed to doing the deal at the original size,” one Goldman client said.

But Facebook is a US company, and while it can surely raise lots of money from Russian and Chinese investors, that’s always going to look like a stopgap solution. This news definitely increases the chances of a Facebook IPO in 2012, while at the same time decreasing the probability that Goldman will lead it:

The struggles of the offering may also deal a blow to Goldman’s relationship to Facebook and the firm’s prospects of leading the social network’s long-awaited initial public offering, expected in 2012…

However, in the past two weeks, the relationship between Facebook and Goldman has grown increasingly tense, people involved in the offering said. Accusations about the news leak have flown back and forth, these people said.

The fact is that although remaining private is very attractive in theory, in practice it’s likely to come with a lot of unwanted attention from the SEC, and its own set of downsides. Still, an IPO is far from a foregone conclusion.

If Goldman Sachs feels left out of the running when it comes to the Facebook IPO, it’s going to be even less likely to be a model shareholder when it comes to its own $450 million stake in the company. Here’s TED, making an important point:

Do you realize how difficult it is for investment banks to put their own capital at risk to earn an underwriting or placement mandate? We hate, hate, hate it, Mr. Mallaby. It goes contrary to everything we aspire to do. Goldman only did it because it thought it could make great fees on Facebook’s eventual IPO.

And here’s Peter Gallagher, who notes that Goldman’s boilerplate talks about how the bank “may at any time further reduce its exposure to its investment in Facebook through hedging arrangements”.

Goldman could write options against its own Facebook shares and likely has discretion to do so against the fund’s holdings.

In other words, Facebook has a speculative shareholder for the first time, now that it’s made its decision to get into bed with Goldman. And Goldman will think nothing of buying puts or selling calls on Facebook shares — or even dumping its shares outright, if it’s allowed to do so — if that’s what it needs to do to protect its $450 million investment.

As the same time, however, one of the main unwritten rules of IPOs of young companies is that they always need to be priced at a level above their last funding round. If Facebook can’t IPO at a valuation significantly north of $50 billion, then it probably won’t come to market at all. (That probably explains why bidders on SecondMarket are happy to buy at a $70 billion valuation: they’re betting that when Facebook goes public, it’ll be worth more than that.)

A lot of stuff can happen to Facebook between now and a 2012 IPO. And if Goldman is shorting Facebook rather than massaging its valuation and orchestrating an IPO which values the company at $70 billion or more, then maybe Facebook won’t go public at all next year. Maybe, indeed, Facebook will learn from this whole episode that dealing with investment banks is an unpleasant and expensive exercise, and will try to avoid doing so in future as much as it possibly can.


Facebook loses face. It’s all about the money anyway, so who cares about the people.

http://www.wired.com/epicenter/2011/02/f acebook-dating/


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James Macdonald on US sovereign default

Felix Salmon
Jan 17, 2011 14:28 UTC

After I blogged Greg Ip’s post on the dangers of a US debt default if the debt ceiling isn’t raised, it became clear that we were very much lacking an expert take on the matter. So I asked James Macdonald, author of my favorite book about sovereign debt, if he might weigh in. Here’s what he replied:

Constitutional issues:

In the event of a refusal by Congress to raise the debt ceiling, would public debts have precedence over other government obligations? Some commentators have referred to the Fourteenth Amendment, passed in the aftermath of the Civil War, which states that “the validity of the public debt… shall not be questioned.” Is the public debt of the United States constitutionally sacrosanct in ways that its other obligations are not?

The Fourteenth Amendment was needed because, as the ex-Confederate states rejoined the Union after the Civil War, they were likely to hold a great deal of power in Congress, just as they had before 1860. In fact southern whites had been over-represented thanks to the extraordinary provision of the original Constitution that States could count 60% of their slave populations towards their seat allocations in Congress even though slaves had no rights. The main purpose of the amendment was to ensure that emancipated slaves could not be deprived of the right to vote, and as an additional weapon the amendment stated that States would only be entitled to seats in Congress in proportion to their voting populations.

The clause on public debt was the amendment’s final provision, and reads:

“The validity of the public debt of the United States, authorized by law, including debts incurred for payment of pensions and bounties for services in suppressing insurrection or rebellion, shall not be questioned. But neither the United States nor any State shall assume or pay any debt or obligation incurred in aid of insurrection or rebellion against the United States, or any claim for the loss or emancipation of any slave; but all such debts, obligations and claims shall be held illegal and void.”

There are a number of issues raised here. As the southern states regained power in Congress they might have refused to honour war pensions to Union veterans unless an equivalent provision was made for Confederate soldiers. Or they might have demanded equivalent treatment for the war debt of both sides. The amendment put exiting debts, agreed while the Confederate states were not in the Union, out of bounds of discussion. The most striking aspect of the clause may be the second sentence. It rode roughshod over States’ rights by prohibiting them from paying any Confederate war debts, even if they wanted to. It also set aside the protection of property rights enshrined in the Fifth Amendment (“nor shall private property be taken for public use without just compensation”) by making it illegal to compensate slave owners for the loss of their property, even those in States that had not joined the Confederacy. It is perfectly possible that without the Fourteenth Amendment, slave owners could have taken to government to the Supreme Court on the basis of the Fifth Amendment.

What implications are there for the present situation? Prior to the Fourteenth Amendment, the main constitutional protection for public creditors was the Fifth Amendment. It is not clear just how much the Fourteenth Amendment added to that protection in the case of debt securities, which, as a form of property, are protected by the Fifth Amendment anyway. Where the Fourteenth Amendment might have some implications is in the case of state pensions, and by extension Social Security benefits, which could be deemed to be protected in the same way as post-Civil War veterans’ pensions. The Amendment also has a bearing on any attempt by the government to default on some debts while honoring others. (What happens to Chinese holdings of US Treasuries if China invades Taiwan triggering economic war between the two superpowers?)

Neither the Fifth nor the Fourteenth Amendments protected creditors in 1934, when the US declared that, as part of removing gold from circulation, it would no longer honor the “gold clause” that required the government to pay its bonds in gold coin of a fixed standard. The matter went to the Supreme Court, which found for the government on the basis that section 8 of the Constitution allowed Congress to determine what constituted money; so if it wanted to demonetize gold, it could. This, of course, did not mean the the government had not defaulted, merely that the Constitution allowed it to default under certain circumstances.

Since the Constitution gives the government the power to redefine money at will, it could be argued that the government might find a way around the debt ceiling by some monetary sleight of hand. However, the Constitution would not help in this instance, since the power is vested in Congress, not the administration.

Historical precedents:

The power of the debt ceiling can be very effective. The closest historical analogy to the present situation – other than the shutdown of government under Clinton in 1995 – is the run-up to the French Revolution. The French government was running a chronic deficit, although nothing like so large as the present US deficit in relation to GDP. There was no elected assembly in France, but registration of government loans by the Parlement of Paris, an unelected body of lawyers, was required to give them the force of law. In 1788 the Parlement refused to register the loan needed to cover the annual deficit unless the Estates General was reconvened. The government responded by disbanding the Parlement and imprisoning its leaders, but its access to the credit markets was frozen. In the end it was forced to summon the Estates General in 1789, and the rest, as they say, is history.

Thoughts on the present situation:

Clearly the US does not have to default just because the debt ceiling is reached – for the reasons outlined in this blog and elsewhere. It can temporarily cut back, or delay, its expenses. There is very unlikely to be a problem covering interest on this basis, since the interest on the market debt is only running at $16bn per month and only represents 5% of spending.

The problems could occur for other reasons:

- Given a budget deficit of $1,500 billion per year, new debt has to be issued at a average rate of $130 billion per month. The government would therefore have to reduce/delay spending by $145 billion per month to cover interest and avoid increasing its debt. This is a far more serious problem than finding a mere $16 billion per month, and represents 44% of total spending.

- The market could take fright and refuse to refinance existing debt as it matures, leading to default. Since, quite apart from bond maturities, there are around $2 trillion of T-bills outstanding, the government is on a very short leash when it comes to its credit standing. However, I do not take this risk seriously, since the Fed will simply lend the government the money to roll over the debt if the market refuses to do so.

Given that the the prices of government bonds have not collapsed, the market clearly assumes that that Congress will blink first and there will be no crisis. Personally, I am pretty confident that the market is right. However, there is a risk that, precisely because the only thing that the government can do legally to avoid default is to reduce spending, which is what the Republican right wants, there is an incentive for the Republicans to continue with the game of chicken until it is arguably too late.

At that point, even if the government does avoid default, the battle may be such a “damn close run thing” that the markets may decide that American politics is in so parlous a state that the risk premium on government bonds needs to rise sharply.

PS. Diverting the Social Security surplus (as per your blog) is not an option. Because of the recession, the program is currently running at a deficit, although it is supposed to return to surplus as employment increases.


All very enlightening, Felix, but what we here in the peanut gallery are really hungry for, is your no-doubt prestidigitatious take on the Goldman-Facebook implosion.

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Felix Salmon
Jan 17, 2011 05:22 UTC

Goldman’s “principles would be no help in decision making: they are a mixture of untruths, platitudes and boasts” — FT

Food crisis solution: Reconsider how we farm — Good

A Filipino guy next to me freaked out: “In all of my 23 years, this is the first time I’ve ever met a celebrity!” — Gawker

Adam Levitin on trustee liability: “The trustees (USB & WFC) insist they have no possible liability. I’m not so sure.” — Credit Slips

Everything I know about Reince Priebus I learned from the Daily Show — TDS

Fantastic piece from Greg Spielberg on the importance of good illustrations on blogs — Nieman

Apple tells newspapers: no free iPad edition for print subscribers — Apple Insider

I wish my German was good enough to understand this: I like the jab at “internationalen Aufsichtsjargon” — BaFin

“A half-British former showgirl, Minetti became Berlusconi’s dental hygienist” — Guardian

Freakonomics Leaving NY Times to Start Own Venture — Forbes

Why is Seeking Alpha paying its contributors?

Felix Salmon
Jan 16, 2011 23:41 UTC

Seeking Alpha has finally started paying its contributors — but I’m not convinced that this is a welcome development.

CEO David Jackson announced “three new initiatives” this morning: revenue sharing, a new leaderboard system, and access to statistics. The big news is the first one, which goes by the name of the Premium Partnership Program:

We can now share meaningful revenue with contributors: You’ll earn $10 for every thousand page views to articles which are published by Seeking Alpha and given to us exclusively (i.e. they don’t appear for free elsewhere on the Web).

Elsewhere, in the FAQ, we’re told that “top articles garner 10s of thousands of pageviews, so if you’re writing compelling articles, the potential to earn significant income is very real”.

I don’t think this can really be taken at face value. Seeking Alpha’s contributors are sophisticated financial investors and professionals: their idea of “significant income” is likely to be at least a couple of thousand dollars a month or so. But the chances of them getting anywhere near that are very slim indeed.

Thanks to the new stats, I can now see just how many pageviews I’m getting on Seeking Alpha: over the past year, I’ve ranged from a low of 30,589 in November to a high of 68,390 in May. On average, I’ve been getting just under 48,000 pageviews per month. Which means that if I gave every single one of my blog entries to Seeking Alpha exclusively, then I’d still be earning on average less than $500 a month. And I’m a full-time blogger, unlike most Seeking Alpha contributors.

If I contributed only some of articles for exclusive status, of course, my income would be much lower. Over the past year, exactly one of my posts — this one, on Warren Buffett — generated more than 10,000 pageviews. Put that single entry aside, and a very successful post for any given Seeking Alpha contributor looks as though it generates 4,000 pageviews or so — enough for a whopping $40 check.

And I’m near the very top of the Seeking Alpha contributor list. As part of the revamp they got rid of the “SA 100″, their list of Seeking Alpha contributors with the most followers. My 59,027 followers were enough to put me in tenth place on the list; top place went to Roger Nusbaum, with 84,758.

Jackson says that the revamped leaderboard is a function of the fact that “the number of followers a person has on Seeking Alpha doesn’t necessarily equate to reader engagement or influence”, and that “in contrast, the number of people who read your articles is a direct measure of reader engagement and thus your influence”. But the new leaderboard nowhere lists the top contributors by overall pageviews, instead listing only the most-read authors in narrow fields like “IPO Analysis” or “Dividend ETFs”. I doubt that many if any of those kind of posts result in over 10,000 pageviews.

Meanwhile, Jackson’s letter and the FAQ both leave out the most important part of the new system. To find that, you need to carefully read the terms and conditions:

By indicating an article is Premium when you submit it to the Seeking Alpha Premium Partner Program you agree to make Seeking Alpha Ltd your exclusive publisher for that article should it be accepted to the Premium Partners Program and you are granting a worldwide, irrevocable, perpetual, transferable, fully-paid up (subject to required payments hereunder), exclusive license to make any use of the articles and the derivative works of the article, to publish it and make it available it in any way it wishes, and to generate income from it.

In other words, Seeking Alpha here isn’t really paying per pageview at all. (If it were, it would pay contributors of all articles, not just exclusive articles.) What’s really happening is that Seeking Alpha is buying premium content, at zero up-front cost, which it can then resell in any way it likes and for as much money as it likes, with none of those revenues being shared with the author.

This is reminiscent of the evil goings-on at Forbes. I can easily imagine that Forbes magazine, or Forbes.com, or any number of other media outlets, might be interested in republishing the most popular content on Seeking Alpha. But up until now, Seeking Alpha hasn’t had the right to sell or license their content. With this new program, they can do just that, and keep all of the proceeds for themselves.

I don’t have access to Seeking Alpha’s internal metrics, but my guess is that on average they’re ultimately going to be paying roughly $10 per article for this premium content — that’s on a par with what content farms like Demand Media pay, but Seeking Alpha’s material, of course, is much higher quality.

I’m very suspicious, then, of what Seeking Alpha is doing here, and whether it’s really being transparent and honest. Jackson told Joseph Tartakoff that an average entry on Seeking Alpha gets between 3,000 and 4,000 page views, but I simply can’t believe that’s true:  Seeking Alpha published about 600 of my articles between February and December of 2010, which generated about 500,000 pageviews in total. That averages out to less than 1,000 pageviews per article, despite the fact that I have over 50,000 Seeking Alpha users following me. (It’ll be fascinating to see whether they publish this one, and if so how many pageviews it ends up getting.)

In any case, my advice to anybody thinking of taking part in this new Seeking Alpha program is to just say no. So long as you stay outside the program and retain the copyright to your material, you can sell it or repurpose it or do anything you like with it. The minute you contribute a piece under Seeking Alpha’s “premium” terms and conditions, however, you lose all rights to it whatsoever — note the word “exclusive” in the agreement. I’ve sold magazine pieces for thousands of dollars where I haven’t given up exclusive rights. You should never give up exclusive rights for a pathetic payment of $10 or so.

Update: Jackson responds in the comments, calling this “a bit of a crazy conspiracy theory”, saying that SA has “no content syndication business”, and adding that if such a business were to emerge, then “we’d share those income streams with the contributors”. He also implies that since my posts “typically aren’t actionable”, they’re likely to get fewer pageviews than most. I’ll believe that — and the idea that the program “will likely put some highly talented people in full-time business” — when I see anybody else’s figures, or when I see an overall pageview league table.

Jackson’s comment raises more questions than it answers, however. If SA isn’t in the content syndication business, then why is it insisting on being granted “a worldwide, irrevocable, perpetual, transferable, exclusive license” to the work before paying $10 per thousand pageviews? And why indeed is it insisting on exclusivity at all? By doing so, SA is forcing its contributors to make a hard decision: earn money from their posts, or have a full archive of their work available on their own site. If you want the latter, you can’t have the former.

Seeking Alpha is in the business of helping its contributors make financial decisions, which makes Jackson’s follow-up comment even odder: he says he didn’t publish this post on SA because it “isn’t in any way actionable”. Of course it is: it helps SA contributors decide whether or not to take Jackson up on his offer. It’s arguably the most actionable thing I’ve ever written for the SA audience. My guess is that Jackson just doesn’t want to give any publicity at all to the small print he inserted into the terms and conditions.

Update 2: Since posting this, I’ve heard from a few other Seeking Alpha publishers, all of whom have total pageview counts roughly in line with my own. One of them was Barry Graubart of Alacra Pulse Check, who posted his own analysis of the news here, and whose content is very much “actionable”. He got 186,654 pageviews from 58 posts over the past 90 days: if he gave all of his posts exclusively to SA, that would work out at a monthly income of $631. What’s more, just one of his posts — “10 High Dividend Stocks for 2011″ — accounted for 36,353 pageviews, or roughly 20% of the total. You can see why Josh Brown reckons that under SA’s new model, we should “expect a tidal wave of ’7 Stocks for an Election Year’-type schlock”.

More interestingly, Seeking Alpha has taken the meat of my criticism to heart, and have edited their terms and conditions. They now read as follows:

By indicating an article is Premium when you submit it to the Seeking Alpha Premium Partner Program you agree to make Seeking Alpha Ltd your exclusive publisher for that article should it be accepted to the Premium Partners Program and you are granting a worldwide, irrevocable, perpetual, transferable, fully-paid up (subject to required payments hereunder), exclusive license to make any use of the articles and the derivative works of the article, for free use on a website.

They’ve added the qualifier “for free use on a website”, and subtracted “to publish it and make it available it in any way it wishes, and to generate income from it”. Those are substantive changes, which address most of my ethical issues with the scheme. I still think it’s invidious to ask people to stop publishing their own material if they want to make money from Seeking Alpha; I would be much happier if they allowed that material to be published with some kind of time delay.

But I can see two reasons why they’ve gone down this route. The first is that most of their contributors — people like me and Barry, or successful fund managers — won’t take them up on their exclusivity offer, and therefore they won’t need to pay us. And the second is that this is an SEO play: they reckon that they’ll do better in Google searches if they have their content exclusively.

This is a dangerous path to take for Seeking Alpha. The “premium” contributors will learn fast to write listicles and other link-bait if they want to make decent money, the overall quality of the site will therefore decline, and the smart content will become harder to find. Is that a price worth paying, for added pageviews? I think not, but Jackson clearly thinks otherwise.

Update 3: Seeking Alpha’s Eli Hoffmann leaves a detailed comment below, saying much more than David Jackson has about the program and the thinking behind it. It’s well worth reading the whole thing, but here’s the bit where he tries to explain why SA is asking for exclusivity:

Why ask for exclusivity? None of us knows how all of this plays out, but we’ve put an offer out there for our contributors that we hope will resonate with many of them: Park your financial identity on SA. Help us make this the most awesome investing site on the free web, and we’ll make sure you share in our success.

I’m not sure that Seeking Alpha is the place that anybody would want to park their financial identity, given that it has layers of editing that people often dislike,  that the degree of information that people can give about themselves is limited, and that all SA pages will always promote SA first and contributors second. But we’ll see, I guess.


SA’s agreement may not be worthwhile for someone with their own blog and thousands of followers, but for someone who is just starting out and trying to write articles for fun, the monetary incentive is great. It allows me to share my ideas and get modest compensation while doing so. Sure, the compensation is roughly equal to or less than minimum wage, but since I’m doing it for fun, that’s not a huge issue. I certainly think that I get a lot more views on SA than I would by starting my own investment blog and trying to drum up followers that way.

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Why Yunus is right about for-profit microfinance

Felix Salmon
Jan 16, 2011 20:12 UTC

Muhammad Yunus has a heartfelt NYT op-ed railing against for-profit financiers. When he founded Grameen Bank in Bangladesh, he writes, “I never imagined that one day microcredit would give rise to its own breed of loan sharks. But it has.”

Yunus names the obvious names, such as Compartamos in Mexico and SKS in India, which have gone public, providing windfall profits for their founders with little if any benefit for their borrowers.

Yunus calls for stricter government regulation of microfinance entities, saying that their interest rate should be capped at 15 percentage points over their cost of funds. (Grameen manages on a spread of 10 percentage points.)

But Matthew Bishop, on his Philanthrocapitalism blog, pushes back hard against Yunus’s essay, with some rather peculiar arguments. (I’m assuming this is Bishop writing, and not his co-author Michael Green; the posts on the Philanthrocapitalism blog annoyingly don’t have bylines.)

It’s worth taking Bishop’s arguments in order:

For some microfinance providers, like Grameen, the way to keep down the interest rate is to take deposits from clients to fund loans. That is all well and good for Grameen but financial regulations in many countries stop microfinance providers taking deposits and the capital has to come from somewhere else. And, given the limited supply of the sort of philanthropic donations that helped Grameen get started, the only plentiful supply of capital is for-profit investors.

It’s true that it’s much easier to become a lender than to become a fully-fledged deposit-taking bank. If a lender goes bust, only its owners are hurt; if a bank goes bust, either its depositors stand to lose all their money, or else some kind of government insurance scheme takes the hit.

But that’s kinda Yunus’s point: microlenders should be more regulated, and the world of microcredit should not be open to any old loan shark wanting to hide behind a flimsy veil of ostensible social responsibility.

As for those for-profit investors, they come in many forms, and there’s no reason why they need to invest equity. There are lots of people out there willing and able to make relatively low-interest loans to microfinance institutions; those people don’t require an ownership stake or the chance to make millions of dollars when the bank goes public. Microfinance institutions should be owned and run for the benefit of their borrowers and depositors, not by foreign (or even domestic) millionaires.

Banks do need capital as well as loans, but equity isn’t the only form of capital, and philanthrocapitalists looking to support microfinance institutions should be perfectly happy to provide a combination of grants and subordinated debt.

More generally, I’m not at all convinced that for-profit microfinance shops are a consequence of a lack of philanthropic donations: in fact I suspect that it might be the other way around. Given the millions to be made in the microfinance space, entrepreneurs wanting to lend money to the poor are more likely to want investments from the for-profit sector than they are to want grants from philanthropists who will insist that the bank be owned not by its founders but rather by its borrowers. If the world of for-profit microfinance institutions dried up, then maybe all those philanthrocapitalists might be more inclined to simply donate startup capital to non-profit institutions instead.

Bishop continues:

Of the billion people living in poverty about 150 million currently have access to microfinance, so there is still plenty of unmet pent-up demand. Providers like Compartamos and SKS have grown quickly and therefore helped more people because they have engaged the for-profit capital markets (and as they have grown, they have passed some of the savings from scale efficiencies back to borrowers in lower interest rates). If Mr Yunus has his way, this supply of growth capital will be choked off and hundreds of millions of people will be left waiting for financial inclusion.

This is highly disingenuous, partly for the reasons explained above: we simply don’t know how many people would have access to microfinance in an alternative world where non-profit organizations were the norm.

On top of that, for-profit lenders tend to congregate in dense cities where most of the population already has access to some kind of microfinance institution. In order to provide small loans to the billion people living in poverty, new lenders are going to have to venture out into much more rural areas, where banks can’t easily scale and where the limiting factor is finding qualified loan officers rather than finding sufficient capital. Yes, there’s pent-up demand for small loans. But most of that pent-up demand will not be met by for-profit lenders who can grow much more quickly in banked urban areas.

I’d also like to see some evidence that Compartamos and SKS “have passed some of the savings from scale efficiencies back to borrowers in lower interest rates”. Indeed, according to the CGAP report on Compartamos, the bank grew to its present size partly because of a deliberate decision not to lower interest rates:

When Mexico was hit by heavy devaluation and inflation in 1995, Compartamos, still in a pilot phase of operations, responded by raising its effective annual interest rate above 100 percent, in order to provide real (inflation-adjusted) yields that were sufficient to cover its lending costs. When inflation dropped back to normal levels, the founders and managers deliberated about whether to lower the rates. They had a choice about the matter because they faced little direct competition and were in a near-monopoly position with respect to their clients.

They decided to leave the high charges in place…

Looking at the facts available to us, it is hard to avoid serious questions about whether Compartamos’ interest rate policy and funding decisions gave appropriate weight to its clients’ interests when they conflicted with the financial and other interests of the shareholders.

CGAP’s report makes it clear that Compartamos never reduced its interest rates as a result of scale efficiencies; the only thing which would ever prompt it to lower its rates seems to be competition. Similarly, when SKS reduced its interest rates in October, it was clearly in response to political pressures, rather than a result of any scale efficiencies.

And this, from Bishop’s post, is just plain weird:

Mr Yunus supports the idea that governments should impose caps on the interest rate charged by microlenders. He says this should be no more than 15 percentage points above the cost of raising the funds to lend. In the case of Grameen, he says, that would be an interest rate of 25% – a number that, it would be easy to conclude, is not far off what he thinks would be the right cap on interest rates elsewhere. Yet in countries such as India and Mexico, where interest rates are significantly higher, the consequence of a rate cap of anything close to 25% would be a dramatic decline in the number of poor people able to get access to credit.

The proposal that banks’ lending rate be limited to 15 percentage points over their cost of funds is surely simple enough for the US business editor of the Economist to understand. At no point does Yunus ever say or imply that the lending rate be limited to 15 percentage points over Grameen’s cost of funds. Yet somehow that’s what Bishop contrives to understand him to mean.

And in what bizarro world are interest rates in India and Mexico “significantly higher” than they are in Bangladesh? The benchmark central bank interest rate in India is 6.25%; in Mexico it’s 4.5%. In Bangladesh, by contrast, the interbank rate is 15%. Poor borrowers in India and Mexico pay much more in interest than their counterparts in Bangladesh not because interest rates are higher in those countries, but because microlenders in those countries charge much higher spreads over their cost of funds.

There are good reasons to believe that Yunus’s 15% rule of thumb is overly simplistic: Richard Rosenberg points out that many of Grameen’s own favored microfinance institutions lend at much higher spreads than that. But once an institution becomes huge, like Compartamos or SKS, it’s pretty hard to make a case that it needs to charge vastly higher spreads than Grameen.

Grameen bank showed that the poor could be very good credits, and would repay loans even when they carried an enormous interest rate. Bishop himself concedes that Compartamos has a non-performing loan rate below 2%, which means that it clearly doesn’t need to charge enormous interest rates to cover the credit risk on its loans. And there’s no reason to believe that Grameen is vastly more efficient than Compartamos in the way that it does business, or that its all-in cost of funds is significantly lower. Which means that the excess lending rates charged by Compartamos over Grameen are entirely a function of profiteering, and that Yunus is right to criticize them.

Going forwards, I’m hopeful that a lot of the unbanked in poor countries will be reached by m-banking using mobile phones rather than through traditional microfinance institutions. Which is all the more reason to try to ensure that people lending to the poor do so at reasonable interest rates, rather than dividending monster profits back to international financiers who don’t need the money. I’m definitely on Yunus’s side of this debate: it’s pretty hard to be an apologist for millionaires and billionaires seeking to delude themselves that the best way to help the poor is to extract lots of money from them.

Update: David Roodman has a sophisticated, nuanced, and highly-informed view, which — like all his stuff — is well worth reading.


The huge profits made by MFI institutes in India and lead to crisis in India. And further has broken credit discipline.

http://devinder-sharma.blogspot.com/2010  /11/mfis-profiteering-from-poverty.html

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JP Morgan threatens small depositors

Felix Salmon
Jan 14, 2011 23:26 UTC

Well done to Ron Lieber for calling bullshit on Chase’s PR spin:

Chase sure doesn’t sound happy. In a remarkable display of staying on message, it gave the same comment last week when The Wall Street Journal, CNN Money and the trade publication US Banker asked it to explain the reasoning for the new monthly fees.

“We don’t want to raise fees on our customers,” a company spokesman said. “But unfortunately, regulation is forcing us to do it. And as a result, some customers may end up unbanked.”

This statement is striking for a number of reasons, and the eye-popping earnings the bank announced on Friday don’t exactly make the company more worthy of sympathy. So I’ve spent the last week trying to figure out why I was so sure I did not believe it the instant I read it.

As Ron says, the Chase statement is trivially false: of course Chase wants to raise fees on its customers. That’s what it always wants. It already has the maximum amount of US retail bank accounts that it’s allowed — which means that it can’t increase earnings by becoming so attractive that more and more people flock to it. Instead, it would rather increase earnings by steadily culling the least profitable parts of its customer base, and replacing them with richer and more profitable depositors.

JP Morgan Chase CEO Jamie Dimon and CFO Doug Braunstein said on their earnings call today that roughly 5% of bank customers “may be pushed out of the banking system” as a result of the Durbin Amendment on debit interchange. Ron says he “sincerely doubts” that’ll happen — but I take it more as a threat than a forecast. Banks can kick out any customers they like — even embassies. The not-so-subtle implication here is that if the Consumer Financial Protection Bureau starts getting all bleeding-heart on America’s biggest banks by asking them not to gouge their poorest customers, then just maybe those poorest customers might find themselves with no bank at all.

This is pretty evil, and I hope that the government doesn’t stand for it — especially when JP Morgan earned $17.4 billion this year. Is it fair to ask JP Morgan to use some tiny part of the profits from its investment banking, wealth management, and other businesses to cross-subsidise the cost of providing free banking for poorer customers? Frankly, yes, it is. It’s the least that they can do, given the billions they’re making from the Fed’s loose monetary policy and Treasury’s implicit backstop on the debts of too-big-to-fail institutions. But instead they’re pushing back, grubbing for every dollar they can extract from those who can least afford it. Shameful.


Actually, the prevailing environment should be a good time for capital formation into new financial services companies. Experienced managemenet will most certainly help. Short-term, it’s certaily a high hurdle.

Customers, retail & business, want options that may well be opposite to the whims of these TBTF organizations. Not every business is going to need a global network and/or team of I-bankers at the ready.

Talent is abundant, and on the cheap. Capital costs, and regulatory costs, are certainly higher. But any true start-up will not cover operating costs for the front 2-4 years anyway.

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The observer effect on muni ETFs

Felix Salmon
Jan 14, 2011 20:00 UTC

How much are municipal bonds worth? There are lots of indices purporting to follow the market, but these days all the attention is on exchange-traded funds, which are plunging alarmingly. The volatility in municipal ETFs has already caused Vanguard to pull its plans to issue three more such funds, and the total amount of money in them seems to be falling fast:

Individual investors, who represent two-thirds of the market, withdrew more than $13bn from muni bond mutual and exchange traded funds in the last two months of 2010, an outflow that exceeded the sums they cashed out at the height of the financial crisis in 2008, Thomson Reuters data show.

When individual investors only owned specific bonds or muni mutual funds, outflows in the muni market were much less visible than they are today. With ETFs, outflows cause immediate and significant price drops, and that kind of volatility can in turn prompt even more selling from muni investors—who are, after all, risk-averse by their nature. Aaron Pressman writes:

Amid the turmoil, ETF investors have complained that some muni ETFs are not properly tracking their underlying market indexes. During the fourth quarter, for example, the share price of the $2 billion iShares S&P National AMT-Free Municipal Bond Fund, closed as much as 2.4 percent below the value of its assets, according to the iShares web site. The fund closed on Wednesday at a 0.5 percent discount.

Tracking problems arise because muni ETFs own only a portion of the thousands of bonds included in their underlying indexes. Fund managers try to create a representative sample of bonds but the technique sometimes goes astray when the market moves sharply.

But Dan Seymour has a different take, in a fascinating article about the increasing disconnect between municipal bond indices and the ETFs which try to track them, and comes to the conclusion that the ETFs actually do a much better job of price discovery than indices do—given that the indices, by their nature, comprise thousands of bonds which simply aren’t trading at all.

In other words, it’s not the fact that ETFs don’t own all bonds in the index which is the problem here, so much as the fact that the price of the index is a largely arbitrary measure, determined by implausible pricing services with the impossible job of evaluating the value of bonds that aren’t trading.

Financial markets often operate on the basis of a deliberate refusal to mark to market. In a crisis, all banks are insolvent on a mark-to-market basis, since there’s no real bid for that kind of quantity of loans. But they keep on servicing the loans, mark down the really bad ones, and often manage to come out the other side.

Similarly, in the municipal-bond market, in times of turmoil issuers simply stop issuing, and investors just keep hold of their bonds. Eventually, the market reopens, and things get back to normal; the official indices need not have moved very much at all in the interim. Many individual investors need be none the wiser; and as far as institutional investors are concerned, their best course of action is to simply sit tight, rather than try to sell into a bidless market.

The rise of the muni ETF changes all that. ETFs trade every day, and everybody knows their price. If bids dry up, as they’re doing right now, the price falls, in a very visible manner, to whatever the market-clearing level might be. In turn, that fall in price only serves to exacerbate the problem and the panic.

The observer effect, in physics, refers to the way in which a phenomenon is changed by the act of observing it. ETFs would love to be neutral reflections of the state of the muni market, but they’re not: they change the dynamics of the market dramatically, and not necessarily in a good way. Munis aren’t as safe, now, as they used to be, and the existence of ETFs is one reason why.


It’s marginal price setting via a tiny fraction of beneficial owners.

The price accuracy of another $1.X trillion in bonds might arguably “suffer” from a lack of instantaneous MTM, but then again, it’s arguably that a huge swath of their owners aren’t interested in selling, either. The muni market’s unusual heterogeneity means that massive selling of “benchmark” bonds used in ETF proxies may not have nearly as much a relationship to the actual bonds and their holders of much small bond deals from completely different municipalities in other regions.

We reject such thinking when looking at Treasuries or other very-like corporate issues because they are sufficiently comparable that, notwithstanding a major credit difference, they “should” trade the same based on interest-rate discounting. The same doesn’t always apply with municipals.

Put another way, relatively small volume + marginal price setting may not deliver any more “accurate” a price than matrix/comparative + evaluative price setting when it all comes out in the wash.

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The global risk that is Davos

Felix Salmon
Jan 14, 2011 16:38 UTC

Jim Ledbetter reads the 50-page Davos global risks report so you don’t have to, and comes away with three and a half questions, all of which boil down to more or less the same thing: what if Davos is itself a global risk?

Reading the report, you get the strong sense of a circular argument along these lines: “My tools are broken. How will I fix them? I will use my tools!” About as close as the WEF gets to a solution for broken global governance is “a well-informed and well-mobilized public opinion sharing norms and values of global citizenship.” Yes, well … good luck with that.

The one thing that a Davos risks report can never say is that there’s some non-negligible chance that the World Economic Forum itself will make things worse. Last year, when I went looking for contrition in Davos, I sought but did not find “an indication that much if not all of the crisis was caused by the arrogance of Davos Man and by his unshakeable belief that the combined efforts of the world’s richest and most powerful individuals would surely make the world a better, rather than a worse, place.”

That belief remains intact and inviolate, and it severely constrains the ability of the WEF to change its ways for the better: you can’t learn from your mistakes if you never admit that you ever made a mistake in the first place.

Whether we like it or not, there’s no doubt that the delegates at Davos are important and powerful; what’s more, many if not most of them have genuinely good intentions. They also love to talk about quantifiable deliverables, both in business and in philanthropy, which allow people to measure whether what they’re doing is working. But they never apply that mindset to the WEF itself. Because they know that if they did, they would risk finding out that the value it adds is negative.


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