Opinion

Felix Salmon

Amex’s aggressive move into prepaid cards

Felix Salmon
Jun 15, 2011 23:11 UTC

The new Amex prepaid card is a huge improvement, from a consumer perspective, over any prepaid alternative. It’s free to buy, there’s no monthly fee, and there’s no fee for making purchases: compare the competition, things like RushCard’s $9.95 per month, or Walmart MoneyCard’s $3 per month, or BanXcard’s $2.95 per month. And that’s just the beginning of the charges you find with such cards — charges which are increasingly resulting in subpoenas and other attacks on opacity.

The Amex card is so attractive, indeed, that it’s even beginning to start being compared to checking accounts. A checking account is still a better bet than a prepaid card if you’re good at avoiding nasty fees, of course. But the Amex card is never going to surprise you with something nasty and unexpected in the way that checking accounts are prone to doing.

Amex isn’t doing this for love, of course — the idea is that it’ll be able to make enough money on interchange fees to make the product profitable. (For reasons which are a bit obscure, prepaid cards were exempted from the Durbin interchange-fee reduction.) But the fact is that no one has managed to come up with a product this attractive in the past, and none of the other prepaid-card merchants have been able to produce a card with no monthly fee. (Well, there’s the pay-as-you-go RushCard, but that costs $1 per transaction, plus $1.95 per ATM withdrawal.)

It can’t possibly be a coincidence that Amex is launching this product just as Durbin is slashing debit interchange fees. But there’s nothing in Durbin which makes this product any more profitable for Amex — the income that Amex gets will be the same now as it would have been if they launched this a year or two ago. So what’s going on here? Why is Amex launching this now?

My feeling is that Amex is looking at this as a game with an asymmetrical payoff. Amex has been pushing gift cards for a long time; this is basically a glorified reloadable gift card, and as it starts getting adopted by people who would never normally use an Amex card, it increases the pressure on merchants to accept Amex as payment. And there’s always a chance that this product could become hugely popular — if banks start making their current debit cards extremely unattractive in the wake of Durbin.

I don’t believe that banks will start charging for debit cards, or applying fees to debit-card transactions, or the various other horribles which they threatened during the big debate over debit interchange. But it’s possible. And if that happens, people with checking accounts are going to start looking for alternatives to their current debit card, and Amex will be right there waiting for them. The prepaid card is also safer than a debit card, in that it’s easier to contest fraudulent charges and have them refunded.

More generally, we’re entering a world where there’s going to be a lot of disruption in the payments space, with clearXchange going up against PayPal and many other dot-com startups, including Square. No one knows who’s going to win this war. It’s possible that no one will: payments might simply fracture into dozens of different systems with relatively small market share. Given the huge uncertainty in payments, it’s probably a good idea to have as many different products as possible and push them hard during this rare period of upheaval and change. You might not make a lot of money in the short term. But if you’re not aggressively in the game, you’ll never have a hope of winning.

COMMENT

I like the AmEx prepaid card. They have their own reasons, but the card is actually very good, especially for consumers with no access to credit cards and bank accounts. http://blog.unibulmerchantservices.com/a mexs-new-prepaid-card-shows-how-issuers- will-fight-debit-fee-limit.

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Dealbook’s Goldman debate

Felix Salmon
Jun 15, 2011 20:26 UTC

It’s the big Dealbook debate! In the red corner, there’s Andrew Ross Sorkin, defending Goldman Sachs from Senator Carl Levin’s accusations of egregious behavior during the financial crisis. Sorkin’s main point: that depending on how you measure it, Goldman might not have been quite as short mortgages as Levin suggests. And now, in the blue corner, we have Jesse Eisinger, saying that it really doesn’t matter how big or small Goldman’s short was: the real problem, as has been clear from the day the SEC filed charges against Goldman over a year ago, is that it lied to its clients.

There was the lie that Goldman peddled to potential buyers of Hudson Mezzanine, that “Goldman Sachs has aligned incentives with the Hudson program”. In fact, Goldman had a huge net short against Hudson. There was the lie that the Hudson assets had been “sourced from the Street,” when in fact they were sourced from the festering pile of nuclear waste that was stinking up Goldman’s own balance sheet. There was Lloyd Blankfein’s lie that Goldman was simply acting as a market-maker in these securities, when in fact it was aggressively trying to sell them and had no interest at all in buying them at any point. There was the lie seen by the Israeli bank which bought Timberwolf assets at 78.25 cents on the dollar, presumably on the understanding that Goldman was making markets in such assets and that their value was in that ballpark. (In fact, Goldman had marked those assets at just 55 cents.)

And then there was the way in which Goldman gratuitously maximized the total mortgage losses in the global financial system by creating new mortgage-backed assets out of thin air:

Goldman’s techniques harmed the capital markets. Goldman brought something into the world that didn’t exist before. Instead of selling something — thereby decreasing the price or supply of it — and giving the market a signal that it was less desirable, Goldman did the opposite. The firm created more mortgage investments and gave the world the signal that there was more demand, for C.D.O.’s and for the mortgages that backed them.

By shorting C.D.O.’s, Goldman also distorted the pricing of the underlying assets. The bank could have taken the securities it owned and sold them en masse in a fairly negotiated sale, though it likely would have gotten less for them than it was able to make by shorting the C.D.O.’s it created.

Because of Goldman’s actions, the financial system took greater losses than there otherwise would have been. Goldman’s form of shorting prolonged the boom and made the crisis that followed much worse.

Jesse concludes:

Goldman executives surely hope to change the subject from the firm’s specific actions to a more general discussion of how much and when it shorted. We shouldn’t let them.

One of the problems here is that it’s easy to get caught up in endless discussions about whether Goldman’s actions were illegal or not. Best to leave that to the prosecutors, I think. But Goldman’s actions were undoubtedly harmful: to its clients, to the financial markets generally, and to its reputation as an honest broker. Goldman’s trying to revisit those days and persuade us that it wasn’t that bad after all. Jesse’s right: if they’re raising the subject like this, it’s incumbent upon us all to remember exactly what they did, rather than letting them snow us with revisionism.

COMMENT

If their clients are going to the market making desk looking for investment advice then they need to go back to the switch board. Market makers have counterparties not “clients”. Again those clients of the market makers include high paid buyside professionals who do have a legal responsibility to their clients to check what they are buying and selling and clearly didn’t bother. Given those professionals – a not insignificant portion of whom would have been far far better renumerated than their counterparty at GS – failed in that responsibility surely rather than calling them “victims”, they should be the ones in court.

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Casey Mulligan’s weird defense of the mortgage-interest deduction

Felix Salmon
Jun 15, 2011 13:09 UTC

It’s not easy to find an economist who thinks the mortgage interest tax deduction is a good idea, but the NYT has managed it, with this column from Casey Mulligan. Unfortunately, it makes no sense. Here, for instance, is the first paragraph, in full:

The home-mortgage interest deduction does not by itself significantly distort housing markets. Too much owner-occupied housing has been built because housing is excluded from sales and other taxes owed by businesses.

That’s the last we hear about sales tax: the argument isn’t fleshed out anywhere else. But apparently if you’re an economics professor at the University of Chicago, then this is all the argument that’s needed: houses aren’t subject to sales tax, therefore the mortgage-interest tax deduction doesn’t distort housing markets. It’s a non sequitur, and the bit about sales taxes isn’t even true. In New York City, for instance, real property transfer taxes, plus the “mansion tax” on properties over $1 million, plus the mortgage tax, can amount to 4.75% of the purchase price between them.

But never mind that, because soon we’re getting to the meat of Mulligan’s argument:

One person’s mortgage interest payment produces interest income for another person or a business. The lender may well owe taxes on the interest income.

More home-mortgage borrowing means more home-mortgage lending, and the latter means more interest income that can be taxed. In theory, home-mortgage borrowing could even add revenue to the Treasury if the lender is in a higher tax bracket than the borrower (or if the borrower is not itemizing her tax deductions).

This is quite possibly the silliest thing I’ve seen the Economix blog ever print. Confidential to Professor Mulligan: mortgages are made by banks, and the margins on mortgage lending are razor-thin: it’s simply impossible for the taxes on the profit a bank makes from a mortgage to exceed the amount of the tax deduction on that mortgage. Oh, and right now, most mortgage lending is done by the government, in one form or another. How much tax are Fannie and Freddie paying on the mortgages they write?

Mulligan’s not finished, though:

Landlords can also take out mortgages on their properties and deduct the interest payments from their taxable income (that benefit may, in turn, affect the rent they set). In that sense, the possibility of deducting mortgage-interest payments from income taxes does not by itself discourage renting rather owning.

It’s that “does not by itself” construction again! Which doesn’t make any more sense the second time it’s used. Of course the mortgage interest tax deduction discourages renting rather than owning, because it’s available only to owners rather than renters. And as any Chicago economist knows, rent is set by the market: landlords will look to maximize the amount of rental income they get on their properties, regardless of what their taxable income might be. Does Mulligan have any evidence that the deduction decreases rents? Of course not, because there is no such evidence.

Naturally, Mulligan completely ignores the host of excellent reasons why the deduction should be abolished, from the fact that it’s distributed incredibly unevenly, mainly going to rich people on the coasts, to the more salient fact, in these fiscally-conscious times, that it costs a whopping $100 billion a year. I can think of a lot of better uses for that kind of money — including simple deficit reduction — and few worse ones. Which is true no matter how many times someone comes up with a facile argument about how one man’s loan payment is another man’s income.

COMMENT

the mortgage write encourages home ownership but is also a safety valve for those who have not or are unable to provided for retirement. The safety net is the downsizing or sale of home that will likely release saved equity. If you think its wise to abolish the deduction consider that there will be no safefty net, that there are no pensions except for goverment workers. Then the tax payer will be picking up the tab-
bottom line its worth preserving this incentive

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Counterparties

Felix Salmon
Jun 15, 2011 07:19 UTC

THR rounds up the Spider-Man reviews. They’re bad. Very bad — THR

The 100 greatest non-fiction books — Guardian

How Businesses Fare with Daily Deals: A Multi-Site Analysis of Groupon, Livingsocial, and Opentable, Promotions — SSRN

Wall Street’s The Same as It Ever Was: my contribution to the Atlantic’s Big Ideas issue — Atlantic

Amex’s new no-fee prepaid card looks like it could & should be a game-changer — Bloomberg

COMMENT

Here’s a post that mirrors what I said way back when:

http://www.slate.com/id/2296521/

It’s amazing how many people contested this position.

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Philanthropy isn’t for profit

Felix Salmon
Jun 15, 2011 07:06 UTC

Dalberg is an international consultancy which explains, on its About page, that “we value social impact above profit but recognize that a sustainable business model is essential to our success”. Makes a certain amount of sense: if you want to do a lot of good in the world, it’s helpful not to be having to beg for money all the time. And of course that mission makes it much easier for Dalberg to charge huge sums of money and help its owners on their path to wealth and fortune.

Daniel Altman is an economist who glories in the title of Director of Thought Leadership at Dalberg, and he’s now written a paper which essentially seeks to eradicate the distinction between social impact and profit altogether. Social impact, he says, along with similar ideas like double bottom lines or corporate social responsibility (CSR) and creating shared value (CSV),

are inefficient workarounds or substitutes that should ultimately lead back to a single bottom line – profit – with a long time horizon and rational expectations. Executives targeting profitability with a sufficiently long time horizon will make investments that generate social benefits because these investments serve the interests of their companies. Moreover, companies that take this approach will generate social benefits more efficiently and sustainably than those using typical strategies for CSR or CSV.

Altman’s paper cites Philanthrocapitalism. That book’s author, Matthew Bishop, has a similar essay this week in the Economist, comparing IBM to the Carnegie Corporation and concluding that the former has done more for society than the latter.

All of this is profoundly silly. Both Altman and Bishop are all in favor of companies engaging in philanthropic initiatives, although only Altman goes so far as to say that they have to be justifiable on a P&L basis. He writes:

If companies view social initiatives as cost centers rather than contributors to profitability, then these initiatives are likely to become procyclical, being cut in downturns and then reinstated when balance sheets are flush again. Their budgets will be arbitrary rather than being linked to a rate of return. As investments expected to be competitive and profitable, by contrast, social initiatives will enjoy more durable support from executives and become a core part of corporate operations.

The problem here is that Altman’s idea of profitability turns on the idea that “the time horizon for a company’s decision-making should be infinite” — and if he’d ever spent any time running a for-profit company, he’d know full well that in downturns, corporate time horizons are anything but. Even the most enlightened CEO will increase the discount rate with which she calculates distant profits when she runs into short-term trouble — and if you’re calculating philanthropic returns on an NPV basis over an infinite time horizon, a small tweak to the discount rate can easily mean the difference between profitability and being axed.

But the point in the paper at which Altman becomes a complete laughingstock to any genuine capitalist is in his third hypothetical of how corporate philanthropy can be profitable:

The chief executive of a major electronics manufacturer is deciding whether to develop a line of low-cost smart phones for sale at a small margin in poor countries. This investment would cost $100 million and generate an expected rate of return of only 2 percent. However, the chief executive is convinced that the investment is a moral one, and she would get substantial personal satisfaction from making it. Her salary is due to increase by $3 million during the period in which the investment would take place, but she will accept a raise of only $1 million if the investment goes forward. With this additional factor in mind, the expected rate of return on the investment doubles to 4 percent; it is now more competitive with the other investment opportunities in the company’s portfolio.

I had to read this a few times to be sure I understood it right: apparently the CEO of a major electronics manufacturer is going to take a $2 million pay cut just so that she can get “substantial personal satisfaction” from selling phones in poor countries. I can just imagine her presentation to the board: “we’ve created this wonderful line of phones which is profitable, but not very profitable, so in order to make it reach an adequate IRR, I’ve decided to ask you to pay me $2 million less.”

Bishop’s article doesn’t have anything quite that ridiculous, but it is based on an equally silly premise: that we can learn something useful from comparing IBM to the Carnegie Corporation, just because they were both founded 100 years ago:

Comparing the records of those giants of 20th-century American capitalism—or “philanthrocapitalism”—can shed light on a question that is keenly debated today: whether philanthropy or business is more effective at “Making the World Work Better”, to borrow the title of the book celebrating IBM’s centenary.

Well, no, actually, it can’t. Bishop’s conclusion is that Carnegie wins the first 50 years while IBM wins the second 50 years and the prize. But you’d want Carnegie to be front-loaded, since that’s how philanthropy works best. Bishop admits as much:

100 years is too old for a philanthropic foundation…

Many of today’s philanthropists aim, as Carnegie did, to give away all their money by the time they die, or at least put a time limit on the lifespan of their foundation after their death. The Gates Foundation will have to be wound down 50 years after the second of Bill and Melinda Gates dies.

On top of that, Bishop’s choice of IBM exhibits massive survivorship bias. The Carnegie Corporation was the only mega-philanthropy in the world in 1911: Bishop has chosen 100% of the big philanthropies of the day to see how they fared. But IBM was just one of thousands of companies founded that year, and it’s almost certainly the only one which could even come close to giving Carnegie a run for its money in this particularly weird competition. Carnegie never aspired, when he created his foundation, to outperform every single corporation ever to be founded. Instead, he simply aspired to make the world a much better place, which is exactly what he did.

The good news here is that these attempts by Altman and Bishop to elide the distinction between capitalism and philanthropy — to make rapacious executives feel good about being greedy — are such transparent failures that with any luck they’ll mark the turning point at which people do good to do good, rather than simply declaring that the best way they can do good is to chase profit as zealously as possible. You can’t just invest money in the stock market and declare it the best way to do good in the world, any more than you can start an arms or cigarette manufacturer and claim that your pursuit of profits is the best way to improve global welfare. And I must admit it’s a little depressing to find the likes of Altman and Bishop helping the global plutocracy think otherwise.

COMMENT

Does it really have to be so Black & White?

I feel many of the arguments Daniel conveys are in line with a very inspiring philanthropist who I’m sure has made some money too – Dan Pallotta… the man behind: http://www.ted.com/talks/dan_pallotta_th e_way_we_think_about_charity_is_dead_wro ng

Anyone who proposes to do good for society – whether for their ego or for money etc. – should be encouraged.

I have founded an organisation that encourages volunteering: http://www.Power-of-You.org. People will volunteer for all sorts of reasons and even if it is in order to boost their CV, as long as people in Africa are benefitting from their time then I feel it is a win win situation.

My ‘competition’ so to speak are other organisations who often charge grossly inflated prices for people to volunteer. If people are willing to pay this money and they help the underprivileged, it is again a win win situation. The agency prospers, the volunteer settles their moral compass and boosts their CV and most importantly, there is hopefully some positive social impact from there volunteering.

I propose that all forms of Philanthropy are to society’s profit… if companies or individuals can prosper from it then good on them. There are many easier forms of making money without giving back to society.

And yes… using laughing stock is a little too much.

Best,

Tom
Founder of http://www.Power-of-You.org

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How the UK wants to deal with its biggest banks

Felix Salmon
Jun 14, 2011 21:59 UTC

In the Republican presidential debate last night, there was unanimity on most issues, including the new orthodoxy on the right that bank regulation — like any other regulation, for that matter — is a Bad Thing, and a sign of the government overreaching. It’s important to remember that this is not the way that right-wing parties behave elsewhere in the world. Consider for instance the UK, which seems to be cracking down on banks in a manner which would make even Barney Frank blush:

Britain’s biggest banks will be forced to put a firewall around their retail operations, the chancellor will announce on Wednesday at the Mansion House…

This was the central proposal made by the Independent Commission on Banking (ICB) in its April interim report…

By putting retail banking into a separate legal subsidiary, ring-fenced from the trading and investment banking activities of a big bank, the vital parts of our giant banks will be less exposed to danger in a crisis.

The idea is that the retail banking bits of Barclays, HSBC and Royal Bank of Scotland will have more capital to absorb possible losses…

The ICB’s interim report suggested a minimum capital ratio for retail banks of 10%, which Mr Osborne is understood to support, although he won’t quote any precise number for the new minimum capital ratio.

A source close to the chancellor said there was “nothing sinister” in Mr Osborne’s reluctance to quote a particular number for how much capital above the international floor should be held by British retail banks. “Ten per cent is certainly the right ballpark”, he said.

This is bold and welcome thinking. From a regulatory perspective, banks have good profits and bad profits. Bad profits are the ones coming from risky structured products and leveraged trading desks; good profits are the ones which come from the lending investment capital to individuals, small businesses, and large companies. State-insured deposits should be use to fund good businesses, not risky and speculative businesses — as should any access to central bank liquidity windows.

So if you’re not going to break the big banks up, then the next best thing is to force their riskier arms to operate outside the protective walls of their too-big-to-fail retail operations. And the retail operations should be as bankruptcy-remote as possible, with extremely stringent capital requirements on the order of 10% of total assets.

Now the 10% figure, although it sounds tough, might not be quite as harsh as it seems at first glance: I’m sure that it’s based on risk-weighted assets, for one thing, and so the details of the risk weighting will be very important. And I suspect that banks might be able to put all manner of capital into that 10% bucket, beyond tangible core equity: the UK is likely to allow them to use their beloved CoCos, for starters.

All the same, Britain’s politicians are thinking constructively about how to rein in the more dangerous tendencies of its biggest banks. The same can’t be said, sadly, of their U.S. counterparts. There are bank regulators at the Federal Reserve and elsewhere who are trying to put in place higher capital requirements for systemically important financial institutions — but those will be negotiated on the international stage, in Basel, and will phase in very slowly. The UK policy, by contrast, could simply be implemented unilaterally, and would make that country significantly less prone to systemically-dangerous bank crises. Just don’t think for a minute that it’s likely to be replicated here.

COMMENT

I don’t pretend to understand much of US politics, but the least understandable of all US political bodies has to be the US Senate.

What has given the UK government a dose of common sense is the presence of a Third Party, the Liberal Democrats, now in coalition with the right wing Conservatives. The origin of much of the common sense from the Lib Dems comes from their chief financial politician who has a PhD in Economics and was CFO of a multi-national oil company before entering politics.

It seems the US Senate could do with rather more real experts, and rather less partisan politics.

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The new normal is kicking the can

Felix Salmon
Jun 14, 2011 20:31 UTC

Michael McDonough has this wonderful chart:

321586003.jpg

Clearly the “new normal” meme is on the decline, and equally clearly “kicking the can” is developing a life of its own, having won the battle of minds against the cutesy rhyming phrases (“extend and pretend,” “delay and pray,” “fake it till you make it”).

I prefer “kicking the can” to “new normal,” on the grounds that it actually contains the tiniest morsel of actual meaning. But still, the cliché has definitely reached the annoying stage at this point. Any suggestions for what is going to supplant it, once it begins its inevitable decline?

Update: Jim Ledbetter informs me that Kick the Can is a popular US children’s game, which has nothing to do with its economic meaning. If it’s not the game which is the source of the phrase, where and when and how did people start talking about “kicking the can down the road”? Is that something people do? And what’s in the can?

COMMENT

Kicking a can as you walked was also practised by kids in my suburban Philadelphia neighborhood. I think it is a fairly universal bored-kids game.

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How Facebook could stay private after all

Felix Salmon
Jun 14, 2011 20:11 UTC

Dan Primack has some huge news today: new legislation being put forward is likely to radically change the calculus which currently forces companies to go public after they have more than 500 shareholders. If the bill being proposed by David Schweikert and Jim Himes becomes law, most VC-backed companies would never run into a shareholder limit: not only would the number be raised from 500 to 1,000, but employees and venture capitalists and other accredited investors wouldn’t count towards that total.

Schweikert tells Primack that the bill could get enacted by year-end, and that it’s likely to “move substantially on its own” rather than being subject to horse-trading. Certainly it doesn’t seem to be particularly right-wing or left-wing, and Schweikert says he’s got support even from the exchanges. There’s no natural constituency to oppose the bill, or lobby against it, which certainly helps its chances.

The bill would certainly be very popular in Silicon Valley, which is an important source of campaign donations in a presidential election year. And conceptually it makes sense. There’s no reason to force companies to go public just because of anachronistic rules, not when going public is such a drastic and irreversible move.

On the other hand, I do worry that if this bill goes through, the number of companies going public will fall even more, and the investing public will have access to even less of the investable universe than it does at present. Is it a good idea that only VCs and plutocrats have access to asset classes like fast-growing VC-backed companies? Probably not. But I’m also not sure that’s in and of itself reason to oppose this bill. The key constituency here is the SEC: if they’re OK with this, it’ll go through. And maybe Facebook won’t go public after all.

COMMENT

On the other other hand, being a public company isn’t necessarily all that great either–they tend to be managed in a very short-sighted way, to maximize the next quarter’s share price. And let’s face it–most investors are plutocrats already, or institutional investors. Individual “retail” investors don’t make the market. A well-managed private company is better off not subjecting itself to the whims and pressures of Wall Street vultures.

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Counterparties

Felix Salmon
Jun 14, 2011 04:47 UTC

Hitchens feels a tap on the shoulder — Ebert

The American propensity to fawn over mediocre British pundits — Tumblr

IMF boots Fischer from race for top job — Reuters

SoCal home prices take steepest dive since 2009 — HW

Rights to Ben Stein’s Dreadful Documentary for Sale — WSJ

University of Alberta dean of medicine Philip Baker, egregious plagiarist — CBC

COMMENT

I can’t access Tumblr links at work either.

Hitchens is on fire — god bless him. His rap reminds me a little of Richard Rorty, who after being diagnosed with inoperable pancreatic cancer said this about the consolations of religion vs. poetry:

http://www.poetryfoundation.org/poetryma gazine/article/180185

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