Felix Salmon

One of the consequences of Joe Nocera’s move to the NYT op-ed page is that his column now appears on the same day as that of Andrew Ross Sorkin. Which can sometimes result in a great lesson on the difference between how Wall Street is viewed from the outside and how it is viewed from the inside.

Nocera devotes his column today to Basel III, which is of course fantastic — he’s quite right that the fight over capital standards is much more important than any wrangling over Dodd-Frank, or derivatives, or the Consumer Financial Protection Bureau. Capital is crucial, it’s insufficient at present, and Nocera’s right that asking too-big-to-fail banks to hold as much as 14% of their assets as equity is a very good idea.

(One point I’d add: these capital standards have to be progressive, a bit like income tax. The last thing we want is a situation where too-big-to-fail banks have an incentive to get even bigger, on the grounds that if they’re going to be socked with the highest capital surcharge anyway, they might as well just get as big as they possibly can. So my suggestion is for the SIFI surcharge to range between 3% and 7%, giving banks an incentive to shrink and thereby get a lower rate.)

Nocera also links to the smart analysis of Anat Admati, who explains that there’s no good reason for banks to minimize the amount of equity they hold:

JPM’s overall funding costs, averaging the required return on the various debt claims it issues (some of which might decline if JPM is better capitalized) and the required return on equity, need not change just because more equity is used.

In other words, it’s a really bad idea to encourage banks to minimize the amount of equity they have, or to look at banks’ profits solely as a percentage of their total equity, rather than in relation to their entire funding structure. If you want to look at profitability, then return on assets is a much smarter place to start than return on equity.

Which brings me to Sorkin:

Wall Street is facing a new reality that it has yet to come to grips with. “Return on equity,” perhaps the best metric for considering the health of the Wall Street, fell to 8.2 percent in 2010, according to Nomura. That is down from 17.5 percent in 2005, before the crisis.

By comparison, total compensation has hardly fallen at all. At Goldman Sachs, for example, compensation and benefit expenses fell 5 percent in the first quarter… And its annualized return on equity fell to 12.2 percent from 20.1 percent in the period a year earlier.

Andrew is, simply, wrong on this. Return on equity is not “the best metric for considering the health of the Wall Street”, precisely because it makes equity seem like a bad thing which should be minimized, rather than a good thing which should be maximized.

More generally, looking at total compensation as a percentage of total equity is rather silly. What direction does Sorkin want that ratio to move in? He seems to think it a bad thing that it’s going down — but isn’t a world where bankers are less overpaid and equity is more abundant exactly what we want?

Sorkin’s bigger point is that higher base salaries (to make up for lower bonuses) are “perverting Wall Street’s calculus during periods of weakness”. Which rather forgets that Wall Street’s calculus was pretty perverted before. The current system is definitely an improvement: it forces banks to hire people for the long-term value they create, rather than for the short-term quarterly profits they can generate before cashing their eight-digit bonus checks and quitting for a life of leisure.

And, since when is this a “period of weakness” for Wall Street? Hasn’t the banking sector been wallowing in cash dropped from Ben Bernanke’s helicopters for the past couple of years? This is a period of strength for Wall Street, and the biggest banks are making record profits. If they’re firing people, maybe that’s a good sign that they reckon they can get by without employing quite as many of America’s best and brightest. And that in turn is a development to be welcomed, rather than criticized for its perversity.

Foursquare reaches 10,000,000 members — 4sq

$250/mo for bike parking on E 12th St — Twitpic

Club Penguin Down After Disney Fails To Renew Domain Name — Mashable

Something still doesn’t smell right, here, on the Skype firings — Techcrunch

If you want a great example of the kind of mean things that people are saying about Groupon in the run-up to its IPO, you could do a lot worse than Rocky Agrawal’s TechCrunch essay entitled “Why Groupon Is Poised For Collapse”. It’s a great example of overstretch and dubious logic, with a couple of moments of brilliance and genuine insight thrown in at the same time. Groupon, of course, being in its quiet period, can’t react. Except, it just can’t help itself, and has put up a whiny post, supposedly authored by the company cat, about how unfair the whole situation is.

The fact is that when Groupon made the decision to go public, it invited exactly this kind of attention — both before the IPO and forever more. When Groupon was private, no one really knew anything about its financials, and CEO Andrew Mason could happily declare that he’d much rather talk about building miniature dollhouses. Once it’s public, however, he’ll have a fiduciary responsibility to his shareholders, and will have to answer such questions at length. Will that make him happier than answering such questions with a death-ray stare? I doubt it, to be honest. Revenues and business models and profits and forecasts are serious things, and you can’t kid around with shareholders in the same way you can with journalists.

In other words, Mason will have to go from saying nothing, which can be fun, to saying something, which almost certainly won’t be. Rather than moan about his inability to say anything in the quiet period, he should enjoy it while it lasts. From now on in, the boring financial questions are going to be unavoidable — from analysts, from journalists, from shareholders, even probably from merchants and customers who wonder whether Groupon’s profitability is a sign that they’re being ripped off.

Which brings me to one of Agrawal’s smartest points:

Underlying Groupon’s success is an auction. It’s not explicit, like Google’s AdWords bidding platform, but the economic effects are similar. The fact that Groupon runs daily deals creates artificial scarcity and drives up pricing to absurd levels. Even with four deals a day in a given market, you’re talking about fewer than 1,500 deals a year.

The reason that Groupon can get away with retaining 50% of the proceeds of its offers is precisely because the supply of those offers is so constrained that demand will always exceed it. Groupon can then pick and choose among the various different merchants clamoring to do business with it, aiming to maximize its own revenues by selecting the offers which are most lucrative for Groupon.

In this, Groupon’s interests are not aligned with either merchants or consumers. With merchants, indeed, the interests are almost diametrically opposed: the greater the proportion of total revenues that Groupon takes, the less well the merchant does. And consumers will always prefer an offer with a low up-front cost, while Groupon wants to maximize the up-front spend, since that’s all that Groupon ever sees.

Up until now, there’s been one overriding narrative when it comes to Groupon: its astonishing, breakneck rate of growth. The secondary story was the quirkiness of the place, and its sense of humor. And I’m sure that from the company’s point of view there’s something frustrating about running into its first real barrage of negative press just when it can’t respond at all. But my guess is that it won’t take long before executives look back wistfully on these quiet days. Because the aggressive questions aren’t going away — and the questioners are never going to be satisfied with Groupon’s answers, either.

Is this jobless recovery a peculiarly American phenomenon? This chart, from a new paper seeking to unentangle cyclical from structural unemployment, would suggest that it possibly is:

I find these numbers quite shocking: after all, it’s hardly as though countries like the UK and Portugal have emerged from the recession unscathed. But the US increase in unemployment over the course of the recession was more than double the increase anywhere else.

That said, the US has historically has a much lower rate of structural unemployment than most of these other countries: the level of unemployment which is baked in to economic reality, before cyclical factors move it temporarily up and down. And what I fear is that the Great Recession has moved the US towards European levels of structural employment, without any kind of Euro-style social safety net.

Here are the charts for what’s happened to structural unemployment in the US. The red lines are the official employment rate; the blue lines are the structural employment rate. The first chart shows the unemployment rate overall; the next four break it down into people unemployed for less than five weeks; people unemployed for between five and 14 weeks; people unemployed for between 15 and 26 weeks; and the long-term unemployed who have been out of work for more than six months.

What’s going on here is pretty clear. For short-term unemployment, little has changed: the structural rate has been around 2% for decades. But look at any of these charts and they show structural unemployment at an all-time high, with the situation getting much worse the longer the duration of unemployment. Overall, the structural rate of unemployment is now more than 8%, which means that we’ll only dip below that level temporarily, during cyclical upturns.

Measuring structural unemployment is, of course, more of an art than a science, and I’d be astonished if any economist agreed with all of the figures in this paper. That said, it’s entirely intuitive to believe that structural unemployment rose significantly over the course of the recession, and that it’s now painfully high. And that the Obama Administration is, to a first approximation, doing absolutely nothing to address this crisis head-on.

You probably won’t be surprised to hear that Wells Fargo is sparring with the government on the subject of foreclosures. But you might be surprised to see who’s on which side:

Wells Fargo & Co. decided to exit reverse mortgages after federal officials insisted it foreclose on elderly customers who were behind on property tax and insurance payments, a Wells executive wrote in an email to business contacts Friday…

Reverse mortgage market participants generally agreed that the industry is enduring hard times…

One problem is that lenders are not allowed to set aside payments for property taxes and other such recurring costs, leading to trouble if the borrower cannot pay them. Contributing to the issue is a prohibition on underwriting loans based on borrowers’ credit rather than the equity they have in their home.

A third problem arises in the course of disposing of the property. If the borrower dies and the equity in the home does not cover the mortgage, the FHA is responsible for making up the difference. But it is often the lender’s duty to dispose of the house, a process that sometimes forces it to eat some of the costs. An FHA requirement that the lender not sell the house for less than 95% of its appraised value can make that process difficult, Lewis says. “Imagine 5% as your margin on this kind of housing market — it’s insane. If someone has a 375 bid for a 400 house, we can’t sell it.”

All of this is, of course, a direct consequence of the fact that the government is now more lender than regulator when it comes to mortgage finance. Rather than standing up for beleaguered borrowers, it now has a huge financial interest in extracting as much money from them as it can, as quickly as possible.

It’s also completely insane that lenders can’t underwrite reverse mortgages: if we learned anything during the housing crisis, it’s that writing mortgages based on nothing but home value is a recipe for disaster. Tanta, of course, explained this better than anyone:

Three things have been the core of mortgage underwriting since roughly the dawn of time: the three Cs, or Credit, Capacity, and Collateral. Does the borrower’s history establish creditworthiness, or the willingness to repay debt? Does the borrower’s current income and expense situation (and likely future prospects) establish the capacity or ability to repay the debt? Does the house itself, the collateral for the loan, have sufficient value and marketability to protect the lender in the event that the debt is not repaid? …

“Traditional” subprime lending was about loans to people who had capacity but not creditworthiness or who had creditworthiness and capacity but not great collateral…

Given assumptions about the collateral—like, its value always goes up and its value always goes up—you could more or less forget about problems with the other two Cs. When the RE markets were hot enough, in fact, there weren’t “problems” with the other two Cs.

This was spectacularly boneheaded even during the height of the real-estate boom. But it’s even more boneheaded in an environment where homes are falling in value. You can’t underwrite a mortgage, reverse or otherwise, based only on collateral and not at all on creditworthiness. You just can’t. We’ve learned this a million times. And yet HUD is forcing lenders to do just that — and then forcing them to foreclose when the loans go sour, even if the only delinquency is on property tax and insurance payments.

The big problem here, of course, is that no regulator is going to tell HUD to shape up and get its act together. The private sector turned out to be very bad at writing mortgages, during the boom. But it looks increasingly as though the public sector will turn out to be just as bad, during the bust.

We’re now close enough to a Greek default that the likes of Daniel Gros are coming up with schemes for how to avoid such a thing:

The European rescue fund — European Financial Stability Facility, or E.F.S.F. — should offer holders of Greek paper an exchange into E.F.S.F. paper at the current market price. Banks could be “induced” by regulators to accept the offer.

The E.F.S.F. could then be the only remaining creditor of Greece and propose a bargain to the country: “We write down the nominal value of our claims (say, 280 billion euros) to the amount we paid (say, 150 billion euros) and extend all maturities (at unchanged interest rates) by five years provided you (Greece) agree to additional adjustment efforts (and asset sales).”

This should be too good of a bargain for Greece not to accept since it avoids default and saves the country 130 billion euros. While the E.F.S.F. exchanges the stock of Greek bonds, the International Monetary Fund could finance the remaining deficits in the usual way, with bridge financing until the fiscal adjustment is completed.

Greece would then be left with some I.M.F. debt and the 150 billion euros it owes to the Europeans. Together, this would be about 85 percent to 95 percent of its gross domestic product, which is not far from that of France. It would be high but manageable.

The losses that would be taken by Greece’s private-sector creditors — €130 billion or so — would be small enough to avoid large-scale bank insolvencies, at least outside Greece itself. (What would happen to Greek banks is far from clear.) But it’s not at all clear how this regulatory “inducement” could work.

One problem here is that unless they’re Goldman Sachs, banks don’t mark all their assets to market every day: the current secondary market price might be a more reliable guide to value than anything else, but that doesn’t make it infallible or even in the right ballpark. And of course the minute that the EFSF or anybody else starts treating the market price as some kind of holy benchmark, you can be sure that the market price will start rising dramatically.

A bigger problem is that the market price is a marginal price, being set between a relatively small group of speculative investors with pretty short-term time horizons. (That’s why it’s fine for Goldman to mark to market: when it holds securities it does so on a speculative basis and with a short-term time horizon.)

There’s an enormous group of investors who would never buy Greek debt for anything near the current price, and there’s an equally enormous group of investors who would never sell it at these levels. Those investors, obviously, don’t trade with each other: they simply don’t participate in the market for Greek debt. But Gros’s idea is to drag them into the market against their will, tell them that they’re wrong to stay out of it, and force them to sell at a price they would never normally agree to. Regulatory strong-arming can be effective, but this would be a very tough sell indeed — and indeed would violate the very spirit of markets, where trades are voluntary and done in the knowledge that most investors aren’t actually interested in trading at the current market price.

The point here is that Gros’s plan would never work if the EFSF simply bought up Greek debt in the secondary market — it could never buy enough to move the needle, and if it started buying extremely aggressively, then the price would necessarily rise sharply. So it’s the element of coercion here which is central to the Gros scheme.

And if banks are going to be strong-armed into swapping out their Greek bonds for about 54 cents on the dollar in cash, then it should probably be Greece making that offer, and probably putting a few other options on the table as well. There’s no obvious reason why the EFSF should be the central player in a Greek restructuring, rather than Greece itself.

Any Greek restructuring is going to have a menu of options. If the EFSF wants to be helpful and provide a pool of cash which it will use to fund one or more of those options, great. But that’s just the beginning of the process — it’s not a fully-fledged scheme in and of itself.

Bill Clinton has 14 very good ideas about how to increase employment — Newsweek

Debbie Reynolds sells Marilyn Monroe’s frock for $4.6m — Guardian

New York Post Blocks iPad Access Via Safari — PaidContent

The bitcoin fiasco continues. Watch anarcho-libertarian techno-utopians get their comeuppance — Ars Technica

The Globe and Mail investigates Sino-Forest. Findings consistent with Muddy Waters — G&M

Hitchens squirts venom at David Mamet — NYT

Oaktree Capital Files to Go Public — NYT

The one good thing about “Green Lantern”: this review from Chris Orr — Atlantic

My birthday present, from William Powhida and Michelle Vaughan — Powhida

Hans Werner Sinn replies – On and off target — VoxEU

“House Minority Leader Nancy Pelosi is a Democrat. An article Thursday incorrectly called her a Republican.” — WSJ

Tensions between owners and managers are nothing new; you might remember, for instance, the way in which Sequoia Capital forced Zappos to sell itself to Amazon over its founders’ wishes. But at least when the sale took place the executives got their full share of the proceeds — in contrast to what seems to be going on at Skype.

Skype Technologies SA, the Internet- calling service being bought by Microsoft Corp, is firing senior executives before the deal closes, a move that reduces the value of their payout…

Silver Lake, based in Menlo Park, California, led a $2 billion buyout of a 70 percent stake in Skype from EBay Inc in 2009. The private equity firm and several Skype directors have actively voiced their opinions on who should be fired…

“As part of a recent internal shift, Skype has made some management changes,” said Brian O’Shaughnessy, a Skype spokesman.

When there’s a change of control, it’s standard for all options to vest in full. In this case Silver Lake is firing a slew of executives — at least eight, according to Bloomberg’s Joseph Galante — just before the change of control happens. Silver Lake’s partners and investors get to cash out at the $8.5 billion valuation; a large swathe of Skype’s own management, by contrast, does not.

This does seem pretty evil. I’m sure it makes financial sense for Silver Lake, which will be less diluted by the immediate vesting of lots of options. But when you’ve just scored one of the biggest home runs in the history of private-equity investing, it’s generally considered polite to share the spoils with the people who actually run the company. Rather than summarily firing them for no obvious reason but sheer greed.

The Guardian has UBS data on the exposure that European banks have to Greek sovereign debt; the grand total, of €93 billion, seems low to me, especially when you back out the €46 billion owned by Greek banks. Add up all the French banks combined and you get to €9.3 billion; Germany’s even lower, at €7.9 billion. All of these sums are entirely manageable and imply that the impact of a Greek default on European bank solvency would be de minimis.

But those aren’t the only numbers out there. Kash has found data from the BIS which shows much larger exposures: $65 billion in France, $40 billion in Germany. (And another $40 billion in the US, which I’ll come to in a minute.)

But it’s worth looking at the raw data here — which is found on pages 102 and 103 of the PDF. The French $65 billion is made up of $57 billion in direct exposure, and $8 billion in potential derivatives exposure. And of that $57 billion, just $2 billion is held by banks: most is held by the public sector and the non-bank private sector. In Germany, too, direct exposure of banks to Greece is a mere $2 billion — and total derivatives exposure is even lower than in France.

The main conclusion I draw from all this is that no one really knows what the effects of a Greek default would be — but that non-Greek banks are unlikely to be the main vector of any contagion. And while Kash is worried about US banks’ derivatives exposure, I’m pretty sanguine on that front, too.

For one thing, $40 billion is not huge in terms of derivatives exposure — especially when we don’t know how much is held by banks and how much by deep-pocketed insurance companies and unleveraged fixed-income investors.

More conceptually, crises occur when banks suddenly find that debt they thought very safe is in fact very risky. That’s what happened during the financial crisis with structured products carrying triple-A credit ratings, and that’s what could happen again with European sovereign debt which carried a zero risk weighting under many bank-capital regimes. It’s emphatically not what’s happening with US investors who are writing credit protection on Greece, in full knowledge that a default is a real possibility.

That credit protection is an expensive hedge for European investors who got exposed to sovereign debt when it seemed much less risky than it does now. For the people selling the protection, it’s a speculative play that there won’t be a formal event of default — and when banks make speculative plays, they can generally cope fine if and when those bets go bad.

None of which is to say that a Greek default would be easily manageable. There’s those Greek banks, for one, which could act as contagion vectors — and of course there’s Spanish and Portugese debt, too, and a whole slew of other highly-correlated assets we can only guess at ex ante. What we do know, though, is that Greece has been a very, very slow trainwreck — even more than Argentina was. And when debt crises come slowly, they’re generally more manageable than when they come fast (think Russia in 1998).

So although no one is going to enjoy a Greek default, I suspect that in and of itself it won’t prove catastrophic. But I could be very, very wrong about that. And that’s a risk no one in Europe really wants to take.

A Map and Simple Heuristic to Detect Fragility, Antifragility, and Model Error — Taleb/SSRN

Capital One to buy ING’s U.S. online bank for $9 billion — Reuters

Why it’s important to evaluate the Millennium Villages — Boston Review

AARP dropping its longstanding opposition to cutting Social Security benefits — WSJ

Spam books clog Amazon’s Kindle self-publishing — Reuters

How much does it cost to purchase the U.S. Web video rights to a hit Japanese TV show? Not very much — All Things D

Chris Matthews only reads online content insofar as it’s printed out on paper by his producers? — Atlantic Wire

Back on May 26, I was skeptical that Greek bonds were pricing in a massive default, despite the fact that the likes of Martin Feldstein were saying that they were. But even if they weren’t back then, we’re getting closer now. The numbers, courtesy of Peter Rudegair: Greek CDS spreads were 1,400bp on May 26; now they’re more like 1,900bp. Greek 10-year bonds were yielding 16.4% back then; they closed today at 18.3%, with prices at about 50 cents on the dollar. European stocks have lost 5% of their collective value since May 26, and the Thomson Reuters default-probability calculation is now over 90% for Greece.

Which means it’s time for an article saying that default is not priced in yet at all:

Today’s rising bond yields, stratospheric insurance costs and heavily pressured stock prices may only be a taste of what could come if euro zone leaders fail to halt Greece’s decline and ring-fence it from others.

In short, a lot of markets and bond holders have not priced in some of the worst outcomes…

“The main case that people are assuming is that when push comes to shove Europe and the IMF will step up,” said John Stopford, head of fixed income at Investec Asset Management…

Stopford says asset price moves actually only reflect caution.

“The market is taking risk off rather than necessarily pricing in catastrophe,” he said.

There are three factors at work here. The first is that no one has any idea what would actually happen in the event of a Greek default. In order for markets to be pricing in a default, traders would have to be buying debt now on the expectation that if Greece defaults the price of its debt would not fall further. I don’t think anybody’s doing that yet — as Stopford says, they might be taking risk off, but they’re not expecting catastrophe. If Greece were actually to default, I’m pretty sure that markets would fall further.

The second factor is the short-termism of market reporting. Journalists have a tendency to look at moves rather than levels when it comes to markets, since it’s the move which is the news of the day, rather than the level at which assets are trading. The conceit of market reports is that if an asset price moves, then it’s likely to have done so for a reason, probably related to some news or other. Meanwhile, if an asset price doesn’t move, then there’s a good chance that there was no news of interest at all. Neither of these things are true. But the result is that pundits are much more likely to think that the market is pricing in catastrophe after a big fall in bond prices from say 90 cents to 70 cents on the dollar than they are after a rise from 45 cents to 55 cents.

Finally, the markets are bad at pricing in catastrophic events even after they happen. Lehman collapsed in September 2008; it was another six months before the market reached its bottom. If Greece defaulted tomorrow and the bonds didn’t move very much, that wouldn’t mean a default was priced in, so much as that the market was paralyzed and didn’t yet know what the consequences of Greece’s actions were going to be. Look at Greek bond prices three or four months after a default: that will give you a much better indication of what the effects of the default were on markets.

In general, the market is much better at pricing in small events from Mediocristan than it is big events from Extremistan. A company releases quarterly earnings of 17 cents per share, or the monthly payrolls number comes in at 210,000 — these things can be priced in. Lehman goes bankrupt, Russia defaults, the House fails to pass the TARP bill — these things you just need to live through in order to know how markets will react. So long as the Eurocrats are all still unanimous that a Greek default is unthinkable, you can be sure that markets will fall if and when such a thing happens.

Is there something fishy about the bonds used to finance the parking lots at Yankee Stadium? Of course there is. And you don’t need to look far before you see two big reasons why. The first is that the bonds were issued by the Empire State Development Corporation. That’s Empire State as in New York State, one of the most corrupt and dysfunctional states in the union. The second is that these are conduit bonds — an asset class which, as Nathaniel Popper explains, is only for the very brave:

Conduits have grown roughly three times faster than the general municipal market over the last five years, according to data from Thomson Reuters, a New York data firm; $84 billion of these bonds were issued last year alone…

Although conduits account for roughly 20% of all municipal bonds, they have been responsible for about 70% of all defaults in the municipal bond market in recent years, according to Income Securities Advisors, a Florida research firm. Over the last two years, the five municipal bond issuers with the most troubled bonds have all been conduit bond issuers.

Conduits constitute a brilliant boondoggle for everybody except the taxpayers who end up out of pocket. You want to build a parking lot next to Yankee Stadium? That’s probably not a great idea, as is evidenced by the fact that this season the lots are only 31% full on game days. Clearly Yankees fans are more than capable of attending games without needing to use anything like the 9,000 parking spots that Yankees management pushed for when they negotiated their new stadium. And parking lots are inherently ugly and unhappy things; Bronx borough president Ruben Diaz’s idea to build a hotel on some of that land instead is clearly a good one.

There’s no public interest in having all that space taken up with empty parking spots. So why on earth did New York State subsidize the construction of the lots by issuing $237 million of bonds whose interest payments are exempt from all state and federal income taxes? The people who bought those bonds financed a commercial venture and hoped to make a profit by doing so. If they did make a profit, there’s no reason at all for them not to pay income tax on that income.

Popper’s concerns about conduits in general go in spades for these parking-lot bonds:

“A lot of these are corporate bonds disguised as municipal bonds,” said Michael Lissack, a former municipal investment banker at Smith Barney who is now a critic of the industry. “How is this a good use of our tax expenditures? I would prefer to use that money seeing that kids get vaccinated or learn to read.”…

Frank Hoadley, who is in charge of selling traditional municipal bonds for the state of Wisconsin, said that the riskiness of conduit bonds has driven up borrowing costs for cities and states. He said Wisconsin paid $4 million more in annual interest than it would otherwise have had to on new bonds issued in January because of investor fears about the municipal market.

“Government issuers like Wisconsin are swept up in the smear that is tarnishing the whole municipal market because of conduit borrower problems,” said Hoadley, Wisconsin’s capital finance director.

The parking-lot project was particularly risky because it was structured with no equity. (Much like Goldman Sachs’s notorious Abacus deal, come to think.) All the money to build the lots came from tax-free bond investors, rather than the owner of the project, a tiny mom-and-pop nonprofit 100 miles from the Bronx which has a history of defaulting on tax-exempt bonds. Parking projections are notoriously error-prone at the best of times, but in this case the project was financed with a debt service ratio of just 1.2: the projections didn’t need to be far off before the lots ran into serious financial trouble.

The biggest winners in this story are the Yankees. They are luxuriating in the presence of endless parking infrastructure, they didn’t need to pay a penny for it, and they can offset the blame for misuse of public land by saying that it’s not their project and they don’t own the land. Even the bondholders will probably come out alright in the end. The losers are the general public, twice: first by dint of having to live with far too much parking provision, which serves no useful purpose in this urban environment, and second because of the tax break we gave the buyers of the bonds.

As a general rule, conduit bonds are always a bad idea. I’m no great fan of the tax exemption on muni bonds at the best of times — if the federal government wants to subsidize the states, there are much easier and more direct ways of doing that. But giving the tax exemption out for boondoggles like this is, well, mind-boggling. Let’s hope the latest wave of defaults helps speed their demise.

Give him points for chutzpah, at least. Matthew Bishop has responded to my post about profits and philanthropy with an astonishing assertion: that his ideas, and those of Daniel Altman, are so fresh and new that I’m scorning them out of sheer unfamiliarity. I’m a “traditionalist,” says Matthew, a “John Bull turning up his nose at ‘foreign muck.’” It seems I’m stuck 20 years or so in the past: since then, says, Matthew, there’s been a “growing realisation that business does have the capacity to create as well as destroy social value.”

The realization that business has the capacity to create as well as destroy social value is known as “economics,” and goes back at least as far as Adam Smith. There’s nothing new about it, and nor is there anything new about economists using this insight to assuage the guilt of the rich. Here’s Joan Robinson writing in 1936, and talking about someone who more or less fits the self-image of a Davos CEO: a person with intelligence, conscience, and wealth.

He cannot keep all three – integrity of mind, a quiet conscience, and the privileges of wealth. One must be sacrificed. If he is a saint he sacrifices the wealth – but we will suppose that he is not. If he is a man of no definite religious creed he can keep his mental honesty and his income by sacrificing his conscience. He can say “I am a selfish individual. I don’t pretend to have any better right than anyone else to a comfortable life, but I propose to enjoy it if I can.” …

Now, it is here that the economist is a godsend to him. The economist is a self-appointed expert. It is his business to know about these things. A man may have an honest and independent mind and yet take on trust the opinion of experts on a subject that he has not time to master for himself. If the economist tells him it is all right, then he can keep his integrity, his income and his conscience all intact.

One of the main effects (I will not say purposes) of orthodox traditional economics was to fill this want. It was a plan for explaining to the privileged class that their position was morally right and was necessary for the welfare of society. Even the poor were better off under the existing system than they would be under any other.

Daniel Altman’s “single bottom line” idea — that by maximizing profits companies also maximize social welfare — falls squarely into this tradition. Far from being new, it was old even in the 1930s.

Here’s Robinson 41 years later, making the same point in a different way:

Freedom is the great ideal. Along with the concept of freedom goes freedom of the market, and the philosophy of orthodox economics is that the pursuit of self-interest will lead to the benefit of society. By this means the moral problem is abolished. The moral problem is concerned with the conflict between individual interest and the interest of society. And since this doctrine tells us that there is no conflict, we can all pursue our self-interest with a good conscience.

Robinson makes a strong case that Adam Smith himself did not actually believe this — but certainly many of the orthodox economists who followed him did.

Bishop himself criticizes Altman on the grounds that he treats “the chronic short-termism of today’s stock market capitalism only as an afterthought” — but that implicitly agrees with Altman that if businesses could just see their way clear to concentrating on the very long term, then the profit motive would automagically align with maximizing social welfare. This is dangerous, because Davos Man always thinks of himself as concentrating on the very long term. And I defy you to find a corporate leader who will ever say that chasing short-term profits is a better idea than maximizing value over the long term. When corporate leaders listen to Altman and Bishop, then, they get the message that if they just do what they claim to be doing already, then they’re already doing all they can in terms of their corporate social function.

Bishop cites anonymous “critics” as saying he’s being “too idealistic”; I’d love to know who these critics are. The truth is that Altman, and to some degree Bishop too, is being too ideological, with their article of faith that long-term profitability means long-term social welfare. Tell that to the companies removing mountaintops.

Of course it’s possible that a company — even a profit-maximizing company — can have positive social impact. Matthew’s example of IBM is a good one, although given the scale of IBM’s philanthropy I don’t think it’s actually profit-maximizing, at the margin. Altman would I’m sure have some convoluted explanation of how IBM’s philanthropy makes it a more desirable place to work and thereby helps to maximize long-term profits, but those kind of arguments are unfalsifiable and therefore meaningless.

Matthew also says I’m wrong when I say that his Economist article favors IBM over the Carnegie Corporation. I’ll quote, you decide:

In the first 50 years, the impact of the Carnegie Corporation on society dwarfed that of IBM…

Judged on the past 50 years, there is a strong case for saying IBM has had more impact than Carnegie…

The achievements of IBM and the Carnegie Corporation are impossible to quantify mathematically. What seems clear, though, is that as it enters its second century, IBM can plausibly hope that its best years lie ahead. Alas, that seems most unlikely for Carnegie.

If I was a corporate leader reading this, I’d happily take away the message that successful corporate leadership is the best way of improving the state of the world — even better than pure philanthropy. And I’d be greatly encouraged by Altman, who says this, in a comment on my post:

We think that using the single bottom line with a long (not infinite) time horizon will actually encourage profit-maximizing companies to invest in more social initiatives, since they’ll see how those initiatives can help their profitability in the long term.

I find it very hard to see how this is meant to work in practice. After all, the base case for any public company is to have a single bottom line with a long time horizon. Simply being funded by permanent capital won’t in and of itself make executives invest more in social initiatives, or open their eyes to the long-term value thereof — especially when any such investment carries an opportunity cost and means that there’s some other project which would have to be abandoned as a result.

I suspect that a weak form of Altman’s thesis might well be true. If a company’s equity capital comes from investors with a medium-term time horizon and one eye on the exit — VCs or private-equity shops — then that company is probably less likely to invest in social initiatives than if it’s a public company with permanent equity capital.

But that doesn’t mean that simply having a single bottom line and a focus on maximizing profit is the best possible way to maximize social impact. Public companies might look better, from a social perspective, than those run by corporate raiders and buyout chieftains. But that’s a pretty low bar to set.

Benjamin Edelman and Paul Kominers have a fantastic post up about the various legal pitfalls facing Groupon and other coupon sites: there are more of them than you might think. In many states, for instance, it’s illegal to offer discounts on alcohol, yet Groupon merchants do so anyway. In others, coupons need to have a 5-year expiration, rather than the much shorter ones found on most Groupons; it’s not enough just to offer the consumer’s money back for that long. Elsewhere, people redeeming coupons for less than the face value are required to get the difference back in cash. And it’s also quite common for merchants to need to hand over to the state any money they got from expired coupons.

And then there’s the question of sales tax. Let’s say I spend $20 for a $40-face-value Groupon at a restaurant. I rack up a $60 bill, before tax and tip, and the check arrives, charging me $65.32 after adding 8.875% sales tax. I hand over a Groupon and a credit card, and my card gets charged the difference, of $25.32; I then add a tip on the $60 amount. So far so normal.

But in fact, once I hand over the Groupon, the sales tax should be recalculated — this according to unanimous advice from various state authorities. Rather than charging tax on $60, the tax should be calculated only on the post-coupon amount of $20, and the check total should be $21.77.

This is in fact the amount of tax the restaurant pays — when doing its taxes, the restaurant adds up its cash receipts and calculates the total tax due. It doesn’t include coupons. So the extra tax — in this case $3.55, or 8.875% of $40 — is essentially a hidden gift which goes directly to the restaurant. (But not to the server! So don’t use this as an excuse to tip less!)

(Update: This gets complicated, I think I got this wrong. The restaurant should actually charge sales tax on the post-coupon amount plus the amount that the customer paid for the coupon. So in this case that would be $20 plus $20 makes $40. The restaurant is still charging too much sales tax, but only $1.77, or 8.875% of $20.)

Those sales-tax amounts quickly add up:

We value the principles of consumer protection law, and we hesitate to discard rights consumers have fought for years to obtain. Furthermore, the amounts at issue are substantial: Groupon’s S-1 anticipates selling $2 billion of vouchers in 2011. An extra 7% tax on that amount would be $140 million taken from consumers, and 15% nonredemption would cost a further $300 million.

The big picture here is that Groupon and other coupon sites are being unreasonably aggressive in trying to slough off legal responsibility for these issues onto their merchants. This bit is worth quoting at length:

Voucher services typically seek to cast themselves as mere marketing vendors that are not responsible for the conduct of the corresponding merchants. For example, Groupon’s Terms of Sale claim that “The Merchant, not Groupon, is the seller of the Voucher and the goods and services and is solely responsible for redeeming any Voucher you purchase.” On this view, a voucher service avoids liability for merchants’ shortfalls.

But a voucher service is the merchant of record for the charge to the customer’s credit card. As the entity officially responsible for charging the consumer, the voucher service thus faces increased responsibility to see that the consumer receives what was promised. Furthermore, the voucher service, not the merchant, writes the promotional text touting the merchant’s offering. As Rakesh Agrawal points out, Groupon’s financial disclosures even count the entirety of the consumer’s purchase price as revenue to Groupon. In this context, a consumer naturally looks to a voucher service for assistance if a merchant fails to perform. We think it is probably an unfair and deceptive practice, under the FTC Act and state equivalents, for voucher vendors to attempt to disclaim liability in such circumstances.

More generally, we are struck by Groupon’s attempts to push all responsibility to merchants. On every relevant question — discounting alcohol, honoring expiration dates, providing cashback — Groupon’s historic contract and current Merchant Terms of Service claim merchants are responsible. In our view, this approach invites confusion and non-compliance. Voucher services are far better positioned than merchants to determine what the legal system requires: Voucher services can research regulations centrally, once for each state in which they operate, then notify affiliated merchants of applicable requirements. In contrast, Groupon’s current approach asks each individual merchant to conduct its own research. If merchants actually conducted such research, it would be duplicative and potentially wasteful — thousands of small businesses re-researching the same questions. But in fact merchants typically ignore the questions, rationally concluding that these questions are too difficult for them to address on their own. Thus, by pushing merchants do to the work individually, voucher services virtually assure that the work is not done at all.

Importantly, the legal and regulatory questions flagged in this article are questions that arise distinctively in the context of discount vouchers: a merchant would never confront such questions were it not for discount vouchers. Having created the transactions giving rise to this regulatory complexity, we think discount voucher services should be expected to achieve compliance.

Andrew Mason, Groupon’s CEO, is the smiling face of customer service which exceeds expectations and keeps everybody — customers and merchants alike — happy. So it’s worrying to me that he’s set up his company in such a manner as to make it seem that these important legal issues are not his problem. Groupon is swimming in money these days: it should spend some of its millions on some decent lawyers and set a high standard in such areas for copycat sites to match. Otherwise its much-vaunted customer service looks as though it’s entirely cosmetic, and serves to disguise the fact that Groupon is helping merchants flout consumer-protection laws across the country.

Laser-made bike symbol could save lives — SMH

Demographics and destiny, US immigration edition — Alphaville

Ernest Hemingway kicks a can — Sutpen

The Economist gets suckered by Patrick Byrne — Weiss