Opinion

Felix Salmon

How to funnel money to bankers and brokers, housing edition

Felix Salmon
Mar 9, 2011 16:55 UTC

Linda Stern has replied to my post about her dreadful advice to leverage up as much as you can to buy a house right now. And she’s not backing down:

My job is to write about what’s good for the consumer, not the bankers and brokers. And, for a young person who wants to own a house, the numbers say it’s better to squeeze together your 3.5 percent down payment and lock in a 30-year fixed rate loan now, at 4.87 percent (with deductible interest).

Got extra money? I’m guessing a nice balanced mutual fund will do better than 4.87 percent over 30 years…

And if you banked your cash instead of tying it up in your house, doesn’t that give you more leeway to pay your bills while you sort out your finances?

The line about “what’s good for the consumer, not the bankers and brokers” is truly astonishing. The argument here, if you don’t want to follow it back to the beginning, comes down to a simple choice: do you buy a house now with very little money down, or do you save up for a larger down payment? Linda recommends the former course of action, I think the latter is much more prudent. But what’s undeniable is that bankers and brokers will end up making much more money if you follow Linda’s advice than if you follow mine.

After all, the more that banks lend, the more money they make. If you maximize your borrowings, as Linda recommends, that’s extra profit for the banks. On top of that, Linda reckons it’s a good idea to use any excess cash not for your down payment (which would lower the amount you have to borrow and therefore lower the amount of money the bankers make) but rather for long-term investment in “a nice balanced mutual fund.” Which of course means profits for the fund managers and stockbrokers involved in selling you that fund. And we’re not done: the house you buy will probably be sold by a broker, who will profit 6% or so of the sale price. More money going to intermediaries.

And has Linda forgotten this bit, from her original post?

To get one of those 3.5 percent down payment loans, though, borrowers have to pay one percent up front and annual mortgage insurance premiums. Beginning on April 18, those premiums will rise 0.25 percentage points, to 1.1 percent for borrowers who put at least five percent down, and to 1.15 percent for borrowers who only put 3.5 percent down.

That’s 1.15% of the value of your mortgage every year for 30 years — all going directly to insurance premiums, which are a crucial part of the financial-services profit machine.

So if you want to do what’s best for the financial-services industry, and for bankers and brokers, you should definitely follow Linda’s advice.

Meanwhile, Linda does seem to be a bit fuzzy on what exactly you should do with the money you don’t put towards a down payment. On the one hand, she says it should be tied up in that mutual fund for the next 30 years, in the hope that it will return more than 4.87%. But on the other hand, she says that it should be “banked” so that you can “pay your bills.” Well, you can’t have it both ways. If you want the cash to be liquid and available for bill-paying, you shouldn’t invest it on a 30-year time horizon. (After all, as we saw during the crisis, people have a tendency to need cash at exactly the time their investments plunge in value.)

As for Linda’s “numbers,” I’m completely unconvinced that there’s any clear math showing that buying now makes lots of sense. Linda’s argument is based on speculation about the future — that interest rates and house prices are both going to go up over the next five years. That’s possible, of course. But it’s hardly an obvious mathematical truth. In recent years lots of people have lost lots of money by making exactly that bet. Which would seem to indicate that a bit of prudence, and saving up money for a decent down payment, makes a lot more sense than a speculative plunge into a highly-leveraged and extremely illiquid asset.

COMMENT

Speaking of which…

I count the mortgage as part of my net worth calculation. I don’t count the house. This may seem odd at first glance, but it gives me a more meaningful number than either alternative — it targets financial resources and obligations.

Posted by TFF | Report as abusive

Slugging in DC

Felix Salmon
Mar 9, 2011 15:23 UTC

Emily Badger’s article on slugging in DC is a really fantastic piece of reporting. She doesn’t just explain not only the interesting phenomenon of people giving lifts to strangers so that they can drive in HOV lanes, she also puts it in its proper broader context, complete with useful hyperlinks:

Americans drive cars everywhere because gas relatively cheap (half what it costs in Europe), because only 6 percent of the interstate highway system requires tolls, because insurance rates are unrelated to how many miles people drive. We pay for the land we live on, but we expect the parking spot out front to come free of charge. The federal government has lately encouraged drivers with tax breaks to buy, variously: a new car, a hybrid or clean-diesel vehicle, a truck or SUV weighing more than 6,000 pounds, or any upgrade from a “clunker.” Then, regardless of what we drive, the IRS invites lucrative tax deductions for work travel, now at 50 cents a mile.

Go ahead, all the signs (and car ads) seem to suggest: Buy your own car — and ride in it alone!

You can embrace this or you can rail against it, but either way it’s a fact of life. And slugging is a Pareto-optimal way of improving it.

What if, instead of one bus with a capacity of 50 that came along every 30 minutes, five cars came along every few minutes, each with a capacity to carry five people? Looked at broadly, Oliphant says, slugging is a kind of public transit, because public subsidies pay to pave and restrict the HOV lanes on which slugging relies.

My favorite part of the piece is the way in which local government is trying to encourage slugging, but is doing so incredibly quietly, so that the sluggers themselves don’t notice.

Chris Hamilton, the Arlington County Commuter Services bureau chief, understands this better than anyone. Sitting in the 11th-floor office where he hosted Oliphant’s symposium two months earlier, he confesses that Arlington has been quietly funding LeBlanc’s website with an annual $10,000 grant. For 10 years. The site doesn’t disclose the connection, and Hamilton seldom does.

“It’s not public knowledge because we don’t want people to know; it works fine the way it is — that people think it’s just this little slugging community,” he says. “The slugging community has always had that idea about themselves, that this is their own thing, and they’ve created it, and they don’t need anybody else to muck it up.”

In terms of bang for the buck, quiet support of slugging initiatives is surely the cheapest and most effective way that government can improve its citizens’ commuting experience. And it still looks very cost-effective even if reasonably serious amounts of money start getting spent on building new HOV lanes. The big unanswered question though is whether it can be scaled or recreated elsewhere — it’s pretty much nonexistent outside the Bay Area and DC. Badger explains the social forces which make DC slugging work:

The homogeneity of Washington’s work force may play a role in this casual acceptance of strangers in cars. With so many federal employees and military personnel, people here even look alike, sporting uniform haircuts, black briefcases and government IDs. “If you’re a government employee or in the military, you’re taught ‘the group,’ not individualism,” suggests Donald Vankleeck, a civilian on his way to Bolling Air Force Base one morning in September at 80 miles an hour. “So it’s nothing to get in a stranger’s car. You may have been all over the world serving with people whose first names you never knew.”

I’m no expert on the cultural differences between various US metropolitan areas, but in principle I can’t see why this couldn’t work in, say, Charlotte. It clearly can’t work in a sprawling city like LA, since it relies on the existence of central hubs. But there are many US cities with poor public transportation and delineated office zones with parking spaces. It would be hard to get slugging up and running in any of them. But once it’s established, it can become a very popular and powerful force.

COMMENT

As a DC area resident, I think I can tell you the secret sauce.

We have severe traffic, arguably the worst in the nation. A crawl during rush hour is guaranteed on Rt 50, I-270, I-66, I-95 and others. Basically all highways toward/away from the city are like this. The HOV (high occupancy vehicle) lane meanwhile is fast and free.

I think even if every 10th slug was a felon, you’d just have to pack heat keep on slugging, the traffic is so bad.

Posted by DanHess | Report as abusive

John Cassidy vs bipeds

Felix Salmon
Mar 9, 2011 07:00 UTC

Aaron Naparstek has a masterful demolition of John Cassidy’s bizarre anti-bike-lane rant, but he somehow skips over the most wonderful bit of all:

I view the Bloomberg bike-lane policy as a classic case of regulatory capture by a small faddist minority intent on foisting its bipedalist views on a disinterested or actively reluctant populace.

Yes, you read that right: the New York populace, it seems, is basically comprised of cars, to the point at which bipeds are “a small faddist minority”.

Now it so happens that I’ve met Mr Cassidy a few times and he’s always looked perfectly bipedal to me. And for all that he enjoys parking his Jaguar XJ6 on Manhattan streets — he’s just written 1,250 words on the subject, after all — I’m quite sure that he always gets out and saunters happily among the other New York pedestrians as he makes his way to his dinner in the West Village.

It can hardly have escaped Cassidy’s notice, on his regular peregrinations from car to restaurant and back, that New York’s streets are positively bustling with bipedal life. There’s good reason for this: New York is a very dense city, in which 8 million or so bipeds — birds not included — cram themselves into a rather small area. His Jaguar XJ6 takes up about 100 square feet of street space; if everybody in Manhattan was so greedy, we’d turn the city into something more akin to Manhattan, Kansas.

And so New Yorkers turn to other modes of transportation. Primarily, we walk, taking up very little space while doing so. When we don’t walk, we cram lots of people into efficient vehicles like subways or buses. And sometimes we bike, since doing so makes a great deal of sense in a pretty flat city where space is at a premium.

Driving a car, on the other hand, is an enormously expensive thing to do, with most of the costs being borne by people other than the driver. Yet here’s Cassidy, the economics correspondent of the New Yorker:

From an economic perspective I also question whether the blanketing of the city with bike lanes—more than two hundred miles in the past three years—meets an objective cost-benefit criterion. Beyond a certain point, given the limited number of bicyclists in the city, the benefits of extra bike lanes must run into diminishing returns, and the costs to motorists (and pedestrians) of implementing the policies must increase. Have we reached that point? I would say so.

Well yes. If indeed the limited number of bicyclists in the city was a given, then Cassidy might have a point here. But it’s not. Bike lanes attract bikes no less effectively than roads attract cars and the number of cyclists in New York has been growing just as fast as the city can create new lanes for them. See if you can follow Cassidy’s logic here, because I can’t:

From San Francisco to London, local governments are introducing bike lanes, bike parks, bike-rental schemes, and other policies designed to encourage two-wheel motion. Generally speaking, I don’t have a problem with this movement: indeed, I support it. But the way it has been implemented, particularly in New York, irks me to no end…

Thanks to these four-wheel friends, I have discovered virtually every neighborhood of the city and its environs, and I would put my knowledge of New York’s geography and topography up against most native residents…

Let us have some bike lanes on heavily used and clearly defined routes to and from the city—and on popular biking routes within the city and the boroughs. But until and unless there is a referendum on the subject—or a much more expansive public debate, at least—it is time to call a halt to Sadik-Khan and her faceless road swipers.

The message here is that cars can and should be able to go anywhere in the city they like — that’s part of what makes them so great. Bikes, on the other hand, should be confined to a few “heavily used and clearly defined routes”, which would probably run parallel to existing subway lines. If you want to use a bicycle to explore the city, then you’re just going to have to take your chances in traffic, like Cassidy did in the 1980s.

In those days, there were few cyclists on the roads, and part of the thrill was avoiding cabs and other vehicles that would suddenly swing into your lane, apparently oblivious to your presence. When I got back to my apartment on East 12th Street, I was sometimes shaking.

Sorry, John, but the purpose of biking is not to “thrill” you so much that you end up shaking. And you surely know, even if you’re loathe to admit it, that traffic expands to fill the roads available: if you build more road space, you don’t reduce congestion, you just increase the number of cars. And similarly, if you reduce the amount of road space, you don’t increase congestion so much as you reduce the number of private cars. Which is a feature, not a bug.

Cassidy is convinced that the addition of bike lanes has increased the time he spends stuck in traffic, or looking for his beloved free on-street parking. (As Naparstek notes, his argument can basically be boiled down to “Street space should not be set aside for bike lanes. It should be set aside for free parking for my Jaguar XJ6″.) But the fact is that impatient motorists will always want to blame someone else for traffic, when, clearly, they themselves are the main culprit in that regard.

Cassidy has no problem with the vast number of parked cars which take up precious road space in New York because he regularly aspires to transcending his bipedal nature and becoming one of them himself. But if you replace those parked cars with a healthy, efficient and effective means of getting New Yorkers safely around town, then watch him roar. Jaguars — whether they have four wheels or four paws — are good at that.

Update: Adam Sternbergh piles on too, and Cassidy responds to us all.

COMMENT

Love this! Can’t believe I haven’t read this till now…

Posted by sammydavisjrjr | Report as abusive

Housing: The leverage bulls return

Felix Salmon
Mar 8, 2011 22:12 UTC

I know that memories are short on Wall Street. But are they short on Main Street too? Reading Linda Stern’s latest paean to leverage and housing risk, it certainly seems that way. Saving for a down payment is hard, she says. It can take time!

And that doesn’t seem to pay. If you think about the cost of paying rent for five or more years, you may be better off jumping into a home with a low down payment now. That’s true even if you have to spend more money on fees and mortgage insurance to get one of those low down payment loans.

Well, yes, let’s think about the cost of paying rent for five or more years. In fact, let’s plug all our numbers into a rent-vs-buy calculator and see where we’re at after five years. The problem with Linda’s formulation here is that it helps to reinforce the common fallacy that 100% of rent payments are “wasted,” in a way that mortgage payments are not. But that’s simply not true. In both cases you’re paying money every month for your shelter; in the rental case that money goes to the landlord, while in the ownership case it goes to the bank.

Some small part of your monthly payment may or may not end up helping you build equity in your home, if house prices move up rather than down and depending on how much of your payment goes towards principal. But remember that the alternative here is saving up for a down payment — which is essentially the same thing as building up equity in a future home. If you save up $250 per month for five years and then put down $15,000 as a down payment, then you immediately start off with $15,000 of equity in your home. By contrast, if you buy today with no money down and start making mortgage payments, there’s a good chance your equity will be much less than $15,000 in five years’ time.

But Linda’s on a roll here, and manages to come out with one of the most astonishing pieces of personal-finance advice I’ve seen since the crisis hit:

Even if you have the money for a bigger down payment, there can be good reasons to save your cash. Mortgage rates continue to skirt all-time lows: Why not put your money to work for yourself and borrow as much as you can reasonably afford, on a monthly basis, at today’s rates? You can put the money you’re not paying into a down payment to work elsewhere. If home values rise, you will have done your best to leverage a small down payment into bigger equity. If they fall, you’ll have less skin in the game, and that could put more pressure on your banker to improve your loan terms lest you walk away.

This, in a nutshell, is everything that was wrong with the housing market before the crash — everything that we want to avoid going forward. Can’t Linda look around at the current devastated state of many people who bought with little or no money down, and see the dangers here? Evidently not. Instead, she seems to think it’s a bright idea to borrow more money than you need, to the point at which you’re pushing the envelope of what you can reasonably afford. And then take the cash you’re not using for a down payment, and “put your money to work for yourself.”

I barely know where to start on this. Here’s one way of thinking about it: banks are not charities, and that they expect to make money from their loans. They have a cost of funds which is lower than the mortgage rate that you’re paying; the difference between the two rates is their profit. You, however, if you follow Linda’s advice, have a cost of funds which is your mortgage rate: if you wind up getting a lower return on your savings than you’re paying on your mortgage, you would have been better off just using the money for a down payment. Needless to say, if there was an easy way of getting a higher return on capital than the mortgage rate, the banks would have done it already, rather than lending you the money. And it’s pretty delusional, frankly, to think that you can invest better than say JP Morgan. Yes, there are tax benefits to having lots of mortgage-interest payments. But they’re not sufficient to make the difference here.

Here’s another way: let’s say you own your home outright. Would you take out a mortgage against 95% of your home’s present market value, and then invest that money in the market somehow, trying to “put it to work for yourself “? Of course not: you don’t have remotely that kind of risk appetite. Borrowing money against your house to invest in the market is, always, stupid. But that’s exactly what Linda’s proposing you do.

And here’s one more: shit happens. Sometimes, you end up needing money, in an emergency. If you’re already borrowing as much as you can reasonably afford, that’s a big problem. If you have a bit of fiscal breathing room, you’re much better off. If you end up in a situation where you’re in a position to put pressure on your banker to improve your loan terms lest you walk away, that’s not a good situation to be in. It means you’re broke. It’s something you want to avoid, whereas in Linda World it seems to be something to actively court.

Linda’s also convinced that house prices are going to rise: if you buy now rather than later, she writes, that means you’re buying “while housing prices are low.” That’s debatable — they still seem quite expensive, on some measures: the price-to-rent ratio, for instance, is still well above its historical average. And more generally, buying low doesn’t help you in the slightest if prices just continue to grind lower.

Linda’s conclusion is that “the less you put down, the better off you are.” Which is true so long as you keep on making all your mortgage payments without any problem, and nothing goes very wrong either with your personal economic situation or with the US economy as a whole. That’s the way that leverage works: it makes everything sunny, so long as things go right. And then it plunges you into misery when things go wrong.

The scariest part of Linda’s post, for me, is when she talks about how it’s a good idea to “do your best to leverage a small down payment into bigger equity.” It’s not the dollar amount of the equity she’s talking about here, it’s the leverage used to get there, and the higher the leverage the better off you are. Following that advice got us into our current mess. And taking it now is a recipe for disaster.

COMMENT

MikeURL, I doubt your portfolio is yielding over 7% based on the present market value. You are almost certainly measuring the yield relative to the price you paid in 2009. While that is an instructive number to consider, it isn’t the relevant comparison today to your mortgage rate.

Back in the fourth quarter of 2008 and first quarter of 2009, I was grabbing every scrap of cash I could get my hands on and dumping it into the stock market. Didn’t quite get to the point of taking out a home equity line of credit on the house (or tapping my margin line), but if the market had dropped another 20% I would have been seriously tempted!

But today? Could make a case either way — that 4.5% rate is very low and you ought to be able to beat that with high-quality dividend stocks, very little risk. I paid down enough to eliminate a balloon payment that was coming due in less than ten years but haven’t been motivated to do more than that.

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Reporting the debit interchange debate

Felix Salmon
Mar 8, 2011 15:41 UTC

Edward Wyatt has a big piece in the NYT on the banks’ last-ditch attempts to weaken the rules reducing debit-card fees — attempts which might be working, especially given Barney Frank’s long-standing opposition to the rule.

I’m not a fan, though, of the way that Wyatt presents the banks’ side of the argument without trying to work out whether it makes sense. For instance:

Banks contend the proposed cut in fees — to 12 cents per transaction from an average of 44 cents — will leave many of them unable to afford to issue debit cards to customers or will force them to raise other consumer banking charges to cover the costs. They also claim retailers will reap unfair profits.

This is ludicrous on its face: there’s no chance that banks will be “unable to afford to issue debit cards to customers”. In most cases, your debit card is your ATM card, are they really suggesting they can’t afford to give out ATM cards?

As for the costs of debit cards, they’re largely the banks’ own fault, for constantly exhorting people to use the insane abomination that is signature debit, and even implying that signature debit is safer than using a PIN. If you tell your customers to use an unsafe method of payment, it’s a bit rich to then turn around and complain of high fraud costs.

It seems to me that Wyatt should have stopped and asked what the people he was quoting were talking about:

“I am appalled that our members will shoulder tremendous financial burden and still be on the hook for fraud loss while large retailers receive a giant windfall at the hands of the government,” John P. Buckley Jr., the president of Gerber Federal Credit Union of Fremont, Mich., told a House of Representatives subcommittee last week.

In what possible sense will credit union members “shoulder tremendous financial burden” if this rule is enacted? I’m having difficulty thinking of one. The cost they pay for goods bought — the amount of money that leaves their account — will be unchanged. The only question is how much of that money goes to the merchant, and how much gets kicked back to the credit union. Technically, it’s true, credit unions are owned by their members. But I’m not seeing any tremendous financial burden here.

And that’s not the only part of the story which doesn’t make sense:

Lawmakers tried to soften the blow by exempting smaller banks from the fee cap. But now even those institutions with less than $10 billion in assets oppose the law. They say that if they continue to levy the current, higher fees, their debit cards will not be able to compete against the big banks, which will charge lower fees because they have no choice.

This just stumps me: I’m open to any conceivable interpretation, if you want to help out here. Compete on what front? For customers? Why on earth would consumers care how much the debit interchange fee is? A lower interchange fee doesn’t save them any money. For merchants? No: the cards are all going to be either Visa or Mastercard, and merchants have to accept them. They can’t accept low-fee cards and reject high-fee cards.

In general, it seems to me, banks compete on how high their debit interchange fees are, not how low. The higher the fee, the more perks they can kick back to their depositors, in the form of reward points or cash back or the like. I simply can’t for the life of me work out how banks with high debit interchange fees “will not be able to compete against” big banks with low fees.

And Wyatt’s article as a whole is greatly tilted towards the bank lobby. By my count, he gives the banks’ side of the story eight different times, by quoting bankers directly or just recounting what “banks contend”. By contrast, the merchants get cited only twice, and their argument doesn’t really get parsed at all. And Wyatt makes no attempt at all to reach any consumer representatives to see what might be best for us.

Debit interchange is a complicated subject: it should be treated analytically, instead of as a political horse-race issue where lobbyists get to say anything they like without being fact-checked. I hope that the Fed’s rule stays in place. But if the banking lobby wins this one, stories like this will be part of the reason why.

COMMENT

Ya know…

You have some interesting comments on your blog – both good, bad, and some just completely wrong –

Please allow me to give you some free information:

You claim that the idea of banks being able to not afford debit cards is ludicrous because of a huge drop in fees.

A debit card can function as an ATM card but they are completely different beasts. An ATM card can NOT be used at a POS terminal it can only be used to get cash. A debit card can be cloned, used over the internet, or just stolen and then the sky can the limit to the amount of fraud transacted with that stolen card. If the card was stolen or couterfeited, the bank/credit union will lose 99% of the fraud cases and will have to eat those losses. Yes – the ugly fraud case again. Don’t beleive me – review TJMax and Heartland in the news and the hundreds of millions of dollars banks lost on those cases.

Merchants pay a fee for debit card transactions and they are helping to pay for that fraud loss risk – as they bear very little as opposed to fraudulent checks.

As a small bank, 12 cents is max interchange that we could receive as it can vary from 7-12 cents. That would knock us out of the ballpark as it costs us 0.12 cents per transaction and that doesn’t include fraud loss.

You claim that costs are the fault of the banks – and that it is insane to say that signature debit is more secure than pin debit. Well, from my standpoint in the bank… I don’t want consumers exposing their pin numbers at merchants. Pin numbers are exposed at merchants that are compromised and then the bad guys have the pin number and can extract cash at the ATM. We have 0 chargeback rights on ATM transactions. If I have a one percent chance of recovering some of my loss, that is better than 0 percent. So, NO – signature is better than pin.

Banks and Credit Unions will shoulder a huge burden if you knock out this income. Neither of us operates for free, we all have employees, members, stockholders that want a return on their investment. If you knock out interchange income, the money will have to be recouped with other fees.

You state that merchants can’t reject high and accept low fee cards. Merchants already discriminate on the cost of the transaction – it’s in the rules – but never enforced. All they have to do is say sorry, the transaction is being declined. Visa and Mastercard are required to identify debit cards with either the word debit or check on the front of the card. It is required. So, YES – they will discriminate.

On the point to which you don’t understand small banks and not competing. Merchants now have the ability to choose the routing of how they want the transaction to go. If one network offers lower interchange fees it will force smaller banks to have a lower interchange fee in order to compete to have their transactions accepted. So, really the two tier mechanism meant to exempt small banks is worthless. Small banks will have lower interchange fees forced on them.

In total: this is a very complex issue for banks and credit unions and it will really affect the bottom line.

Merchants do benefit from the system as well, and yes they pay a large fee for participating in the network for which they receive the biggest benefit of having almost 0 chargebacks.

Some points over the whole debate that gets skipped over:

Merchants can already offer a discount to the consumer to pay with cash or check – how many times have you gone to a big merchant and have been asked that?

If banks lose and we raise fees, restrict debit card usage, lower limits on debit cards to reduce our losses and make up lost income – no one seems to consider services that verify checks. So, if a consumer loses the ability to use a debit card and doesn’t qualify for a credit card, they are limited to cash and checks. If by chance they have an error and have a check returned to a merchant. They could lose out on using checks at most merchants that do check verification – we have tried to help consumers get off those lists and have been forced to give them debit cards so they can go shopping again. Otherwise, the only payment option which is left is to go back to cash.

Sincerely,

A small banker

Posted by bradrose90 | Report as abusive

Why isn’t Rajat Gupta facing criminal charges?

Felix Salmon
Mar 8, 2011 14:29 UTC

Andrew Ross Sorkin examines the weirdnesses surrounding the Rajat Gupta case today, and comes to the conclusion that the government “appears” not to have recorded any of Gupta’s phone calls after all. That’s a reversal from what things looked like on Friday, but the one thing we can be sure of in this case is that the whole thing is very murky.

Sorkin also raises the question of criminal charges:

Given the seriousness of the claims — insider trading by an executive who had reached the upper echelons of corporate America — why not bring criminal charges against Mr. Gupta? …

Not only has the Justice Department not brought a criminal case, at least not yet, but the S.E.C. decided to bring its case in front of an administrative law judge instead of in a Federal District Court, where a defendant has full discovery rights. The S.E.C. is using a new provision in the Dodd-Frank Act to bring the case this way…

Statistically, it is notable: of the 26 Galleon-related cases the S.E.C. has brought, all have been brought in federal court. None have been brought in front of an administrative judge.

I think the question of discovery rights is a bit of a red herring here: I doubt they’re all that important to Gupta’s defense. And personally I like the fact that the SEC is making use of new provisions in Dodd-Frank. Fully-fledged lawsuits are time-consuming and expensive things to put together, and if it’s easier to bring something in front of an administrative law judge instead, let’s see more of that. I mean, no one has suggested that Gupta will get anything other than a fair trial.

Of course there’s a question as to why Gupta in particular got this treatment, rather than anybody or everybody else. It’s a good question, and I look forward to getting the answer. But someone needs to be first.

More generally, if Gupta is guilty, it’s in the public interest that we be able to convict him. One of the problems with insider trading is that it’s so hard to prove, people do it with impunity. Maybe a few more cases like Gupta’s will help on that front.

Where I disagree with Sorkin is when he says that the SEC case doesn’t make Gupta look “much like a sinner.” Actually, that’s exactly what it makes him look like. It’s true that Gupta might not have made money personally on these trades. But that’s clearly not the only reason he’d pass on information to Rajaratnam. It might, on the other hand, be the reason the SEC is going to an administrative law judge. Maybe they reckon that insider dealing for purposes of showing off is somehow a lesser crime than insider dealing for personal profit. After all, if Gupta had just shown off to Sorkin instead of Rajaratnam, he probably wouldn’t have committed a crime at all.

Update: John Carney reckons that there are tapes, but that the SEC wasn’t entitled to have access to them.

COMMENT

Worth looking back at Texas Gulf Sulphur case in 1964. Circumstances almost identical: a director of TG (Thomas Lamont, retired Vice-Chairman of Morgan Guaranty) left a TG board meeting and called Longstreet Hinton, then head of MG’s pension investment to tip him off that rumors of a huge multi-mineral strike by TG in Ontario were true. Hinton then bought stock for various accounts (including his own). SEC did not bring criminal charges, and the issue bled away in a dispute, largely terminological, over what news about itself TG had made public when. Regarding motive in the Gupta matter, Naftalis, G’s lawyer, pointed out that his client had lost $10 million with Raj. Might there have been an agreement involving a make-whole? $10 million was probably real money to Gupta.

Posted by midasw | Report as abusive

Counterparties

Felix Salmon
Mar 8, 2011 06:17 UTC

Measuring teacher performance is really hard. But who cares about getting tenure if you’re thinking of leaving anyway? — NYT

With Sir Michael Gambon, as Blenheim Palace, and a brief but scene-stealing turn from Dame Judi Dench, as a wingback chair with cabriole legs — TNY

Kinsley on movie math — LAT, see also me in 2008

Open City, Closed: Acclaimed Literary Journal Says Goodbye — NYO

The TechCrunch experience with Facebook Comments — TC

The best part of Newsweek’s interview with Larry Summers is the photo caption — Newsweek

SCOTUS eliminates a FOIA exemption — HuffPo

Emily Badger’s great article on Slugging, the People’s Transit in DC — Miller-McCune

Since when does the WSJ consider a 4-digit sum a “Big Payday”? When it’s “for Some Hill Staffers” of course — WSJ

COMMENT

hsvkitty, most politics these days revolves around “sound bites”. People believe what they want to believe and don’t bother to see whether or not the emperor has any clothes.

This is the biggest reason to depoliticize education funding to the greatest extent possible.

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The well-intentioned but doomed mortgage settlement

Felix Salmon
Mar 8, 2011 06:05 UTC

No wonder the proposed settlement with mortgage servicers is proving too hard to write about: it’s really hard to read. There might be a lot of Elizabeth Warren in its substance, but there’s none of her in its style.

For those who can wade through it, however, it really is a code of best practices for servicers and it’s sorely needed. There’s much to love here, but it all basically comes down to the golden rule: treat your borrowers with honesty and humanity and common sense and you’ll be fine. Do servicers really need to be told that if they make more money from a loan mod than from a foreclosure, they should do the loan mod? Or that “sworn statements shall not contain information that is false”? Evidently, yes, they do.

I do have my doubts about whether all of this is feasible in the real world. Consider II.C.4:

Servicer shall create a Single Electronic Record for each account, the contents of which shall be accessible throughout the servicer, including to the Single Point of Contact, all mitigation staff, all foreclosure staff, and all bankruptcy staff.

Or II.F.1:

portal.tiff

There’s even a bit later on (see page 19), where the servicer is asked to “consider”, whatever that means, partnering with Kinko’s or Wal-Mart to allow borrowers to scan and email documents for free.

All of this is reasonable, on one level — but at the same time it’s also setting the servicers up to fail, since few if any of them have the ability to implement all of these changes. Some of the settlement is easy: if you’re currently doing force-placed insurance, stop doing it. But the parts of it which involve massive IT overhauls will certainly break and go over budget and not play well with various legacy systems and generally be incredibly difficult to get working.

As a result, the big question here isn’t whether the settlement is reasonable — yes, it’s entirely reasonable. Instead, we should ask what the penalties for non-compliance are, since just about every servicer will be non-compliant for the foreseeable future.

Those penalties come at the end of the document and they’re extremely vague: there’s talk of “monetary penalties and additional remedial actions”, but there’s also talk of “failure to meet timelines”, which implies that much of this stuff could be pushed off far into the future and of “a special master or referee to resolve violations”, with no indication of how such a person might be chosen.

I’m reminded of the tale of the scorpion and the frog. In this case, the servicers are the scorpion and the frog is a legal settlement which can get them some kind of protection in law. The two will get, uncomfortably, halfway across the river and then the servicers, unable to go against their nature, will doom them both.

Ultimately I still feel the same way I did in November, when I said that only a radical restructuring of the entire securitization architecture—and especially the broken relationships between investors and trustees and between trustees and servicers—has any chance of actually working. The settlement’s heart is in the right place. But I have no faith in the ability of the servicers to implement it successfully.

COMMENT

“Lots of middle class seniors use to rely on a few hundred bucks a month from CD interest those people have been eating principal or not eating at all the last few years.”

That’s what they get for investing in such risky assets…

I’m being sarcastic, of course, but the conventional view of “risk” is seriously lacking. There are many forms of risk, and CDs are not immune to all of them.

There is also an artificial distinction between “eating your interest” and “eating principal”. Back in 2006-2008 we were seeing CD interest rates between 4% and 4.5%, but inflation around 3%. Now we have CD interest rates around 2% and (over the last two years) inflation under 1%. The spread of CD interest to inflation hasn’t changed THAT much. I suspect the value of their principal was getting chewed away even with the higher rates.

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The attorney generals’ proposed bank settlement

Felix Salmon
Mar 7, 2011 22:31 UTC

Cheyenne Hopkins, of American Banker, has a great coup today: she’s found the famous 27-page term sheet laying out exactly how the state attorneys general are trying to force mortgage servicers to “change a dysfunctional system”, in the words of Iowa AG Tom Miller. There’s a lot of material in here, and unfortunately I’m a bit pushed for time right now and can’t give it a full go-through until later tonight.

So have at it, and let me know what you find — do you think this will actually result in a lot more principal reductions, as outlined on pages 18-19? I do hope so, but that bit about being “reserved for further discussion” does give me pause. It’s certainly the part which would cause the greatest immediate harm to banks’ balance sheets — much more than any fine the AGs might come up with.

27 Page Settlement

COMMENT

@Felix Even weirder is that when an attorney general is arguing a case, the Court refers to him/her as “General” So-and-so.

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