Felix Salmon smackdown watch

By Felix Salmon
July 20, 2011

Apologies to everybody here who would normally warrant a whole blog post of their own, but I’m way behind when it comes to catching up on the Felix Salmon smackdowns and so I’m going to clear them all out in one fell swoop, starting with:

Yves Smith, who hates my post on triple-A debt so much that she accuses me of “spending too much time with lobbyists from ISDA and SIFMA”. Her main beef is with my contention that an excess of overcaution was responsible for the enormous demand for triple-A debt. That can’t be true, she says:

If there was “overcaution” you would have seen a wide spread between AAA bonds and lesser-rated bonds.

The first thing to remember here is that there were so many triple-A bonds at the height of the bubble that all the other bonds in the world combined were in the minority. The supply of triple-A debt expanded to meet the demand for it; lesser-rated debt had its own supply-and-demand dynamics and spreads became tight as the Great Moderation thesis took hold.

On top of that, the bond bubble generally was indicative of overcaution: if cautious people buy triple-A-rated debt rather than other debt, they also buy bonds rather than stocks. An overcautious world has too many bonds relative to stocks and too many triple-A bonds relative to other bonds. That’s exactly what we saw.

Yves has her own explanations of the rise in triple-A-rated debt. One is the rise in the derivatives market, which meant a similar rise in the demand for triple-A-rated collateral; the other is regulatory arbitrage, in that under Basel II, banks could hold triple-A debt on their books with zero capital requirements.

Both of these explanations are entirely true, but they’re not really dispositive of my thesis; in fact, both are symptoms of the very overcaution I’m talking about. Collateral is designed to protect you in the event that your counterparty makes bad bets and can’t pay; by asking for triple-A-rated collateral, Wall Street essentially outsourced its diligence to the ratings agencies while being able to say that it had extremely high standards. And the Basel II rules, too, gave triple-A-rated debt a zero risk weighting because they wanted to encourage banks to stay cautious when it came to the quality of their assets.

Next up comes Richard Smith, also at Naked Capitalism, with a very long post taking issue with my very short dismissal of the idea of coin seignorage as a tool to get around the debt-ceiling problem. I should probably explain my position in slightly more detail: yes, there is an argument to be made that coin seignorage is legal and that it could be done without Congressional approval if the coins were made of platinum or maybe palladium. But just because something can be done doesn’t mean it should be done. We shouldn’t rule via loophole, and more importantly, we shouldn’t take monetary policy out of the hands of the Fed and put it into the hands of Treasury. Sometimes, in a crisis, loopholes are the only way to get things done. But we’re not in a real crisis right now — insofar as we’re in a crisis at all, we’re in an utterly fake one. So let’s deal with the root of the problem, which is Congress, rather than trying to ignore it with the use of dangerous loopholes.

Then there’s Brad DeLong, who isn’t impressed with my take on Larry Summers:

Let us parse this:

  1. Summers says that peripheral countries that cannot access the private market cannot repay their debts if the strong countries of Europe charge them high premium interest rates.
  2. Summers says that peripheral countries that cannot access the private market can repay their debts if the strong countries of Europe charge them the interest rates at which the strong countries can borrow.

Both of these statements by Summers seem to me to be true. It is often the case that debt loads that are unsustainable at high interest rates are very sustainable indeed at low interest rates.

But to take a very salient and obvious example, the debt load of Greece is clearly not sustainable, even if it were brought down to German-government interest rates.

Brad also has a clever way in which the ECB can take $10 billion of French and German money and turn it magically into $471 billion of liquidity which could be provided to Italy. But bringing the ECB into this doesn’t help matters: yes, of course the ECB can lend $471 billion to Italy and it could probably do so even without a French and German guarantee. But it won’t, because (a) doing so would be politically impossible and (b) doing so would violate Article 123 of the Lisbon Treaty, which bans monetary financing.

Finally, there’s John Hempton, with his novel thesis that “the last ethical newspaper company is News Corp”, on the grounds that it’s the one company where the proprietor doesn’t ask for journalists’ sources. I’ll leave the rebuttal of this one as an exercise for the reader, I think; I’ll simply note that Rupert Murdoch is perfectly happy dictating his newspaper’s front pages, sometimes with highly embarrassing consequences. Does that sound like a company where the proprietor is assiduously disinterested in his newspapers’ content to you?

Do keep the smackdowns coming. They’re the true essence of blogging.


We welcome comments that advance the story through relevant opinion, anecdotes, links and data. If you see a comment that you believe is irrelevant or inappropriate, you can flag it to our editors by using the report abuse links. Views expressed in the comments do not represent those of Reuters. For more information on our comment policy, see http://blogs.reuters.com/fulldisclosure/2010/09/27/toward-a-more-thoughtful-conversation-on-stories/

Right now, there is a huge demand for safe debt, which is why the government is able to sell so much of it at a very low interest rate. Why isn’t anyone manufacturing fraudulently labeled AAA debt any more?

There’s always a lot of demand for very safe places to put your money (I am avoiding the word “investment”), especially where it can return a high yield (I am avoiding the word “earn”). There is always a demand for higher quality at lower prices, or higher returns at lower risk. That doesn’t justify mislabeling your product (risk) to sell more of them. Should we blame the theft of luxury cars on the demand for more affordable luxury cars?

Posted by KenG_CA | Report as abusive

It’s a shame John Hempton’s post was so florid, because it contains a perfectly reasonable point to which you haven’t responded. If a newspaper has a dangerous/aggressive/sleazy/unethical approach to investigation, it’s considerably *less* likely that owners will want to know the details of how they’re investigating (plausible deniability, protecting reporters, blah). That’s a completely separate issue from editorial control. Why you think “assiduous disinterest” in one area would carry over into another is unclear.

Posted by absinthe | Report as abusive

@absinthe – I think in your scenario, the proprietor would want to know less of the “dangerous/aggressive/sleazy/unethical approach to investigation” only if they somehow feel shame about the approach with which their journalists apply. Rupert Murdoch comes from a very tabloid type background wherein he shares that sort of mindset, combined with his very hands on approach, I don’t think it was a stretch on the part of Felix (nor many others who share) in the belief that Murdoch knew at least the general parameters under which NoTW operated.

Felix – you missed this smackdown by Steve Waldman: http://www.interfluidity.com/v2/2039.htm l

Posted by GregHao | Report as abusive

@GregHao, I didn’t miss Steve’s post. I replied to it here:
http://blogs.reuters.com/felix-salmon/20 11/07/13/are-principal-writedowns-bad-fo r-bank-equity/

Posted by FelixSalmon | Report as abusive

KenG_CA, the major foreign buyers of US Debt are not doing it because it is “safe”, they are doing it to manage their currencies. Banks and pension funds are buying it for regulatory reasons.

Again you seem to be confused as to the difference between having very low credit risk and having no risk.

Finally, if demand is not what is driving the theft of luxury cars vs ones that no one wants then what do you claim is driving it? And if the government and regulators are fabricating false demand then maybe just maybe that should be something they should be looking at rather than trying to outlaw supply.

Posted by Danny_Black | Report as abusive

Danny, I don’t know, I constantly read about the “flight to safety” driving demand for US debt, maybe you should tell the financial writers and editors they got it all wrong, it’s not about safety.

Currency risk is a risk, and the response is to buy something people believe is less risky. I don’t see anybody manufacturing fraudulently labeled packaged products for this purpose just to meet demand for a stable currency (which the dollar isn’t).

Yes, demand for luxury cars provided incentives for people to steal them and sell them, but I don’t see anyone excusing the thieves because there was demand for their product. This meme that Felix is pushing is ammunition for people who say higher ratios will cause another credit crisis, and should be ignored. Regulators aren’t trying to outlaw supply, they’re just trying to protect depositors from having their money frittered away by people with no accountability.

The false demand that the government fabricated happened in 2002-07, when interest rates were driven artificially low. The low interest rares, combined with complete lack of regulation, allowed real estate prices to increase because monthly payments are as dependent on interest rates as they are on prices. Combine low interest rates with no rules on how banks lend money, or how much they lend out relative to their capital they hold, and you get what we got 3 years ago.

I basically said this in my comment on Felix’s original post: if the demand for food increases, and I package and sell dog $hit as food, will the culprit for people getting sick from it be the demand for food, or my fraudulent and deceptive marketing of “food”?

Posted by KenG_CA | Report as abusive

KenG_CA, I have to say i find this sort of faith in journalists kinda touching. Especially after NYT reporters turn out not to be able to tell the difference between assets and liabilities in Fannie, the FT gets Greece’s GDP wrong and claims the ECB is gonna let banks post **liabilities** as collateral etc etc. Again, rub the two brain cells together, if it is a “flight to safety” how come all these people have been holding so much Treasury and quasi-treasury debt for so long?

You know of course that by far the two largest OTC derivatives markets are FX and Rates right? Aka “products for this purpose just to meet demand for a stable currency”?

The false demand for AAA had nothing to do with “low interest rates”, it had to do with Basel 2 and the special place credit risk has above all other risks.

As for complete lack of regulation, you clearly think banks and other financial institutions hate trees because they are needless putting tons of boilerplate on everything they do. “how much they lend out relative to their capital they hold” – are you seriously saying this with a straight face or do you come from the hsvkitty school of dimwittedness? There is a ton of regulation about just this. Just because you are either too ignorant to know about it or too stupid to understand it doesn’t make it true.

Posted by Danny_Black | Report as abusive

Danny, those tons of regulations worked great last decade, didn’t they?

If you don’t think the artificially low interest rates of that decade drove demand for housing, then maybe it was just Bush’s #1 economic goal (at least judging by what they were bragging about), of increasing home ownership. That worked well, didn’t it?

The regulations that were missing were a) the Fed asking banks who were borrowing money from them who they were lending it to; and b) the FDIC actually paying attention to what they were insuring. Most insurance companies won’t provide liability insurance for people who want to put a diving board in their 2 foot deep pool, but that’s about the equivalent of what the FDIC was allowing. Don’t mistake having to fill out lots of forms for regulation.

And can’t you come up with a better argument than “too ignorant” or “too stupid”?

Posted by KenG_CA | Report as abusive

KenG_CA, if you are now stating there is a ton of crappy regulation then you will get zero argument from me. Note this is not the same as “no regulation” or “virtually no regulation” or “deregulated”.

Demand for housing was a side effect of investor demand for certain products which drove down the rates at which people could borrow for housing. The idea that these products were something that needed to be peddled by slick sellside salesman is yet another of the big lies of the crisis. The fact is that until 2006, banks had difficulty finding the raw materials. As for your poo vs food analogy, there is exactly one group who have a legal obligation to distinguish between the two and that is the investment manager. Not the rating agencies, not the originators and not the distributors.

Why should the Fed care? They care about being paid back which, without a single exception, they have been.

Finally, you were claiming things that were patently false. Either you didn’t know about it – aka too ignorant – or did know but didn’t understand – aka too stupid. Of course maybe you did know and did understand but made the false claim anyway – aka lying.

Posted by Danny_Black | Report as abusive

That post at NC about seignorage was actually a cross-post from Joe Firestone. But hello there, anyway.

Posted by RichardSmith | Report as abusive

Danny, I had said there was a lack of regulation, not a lack of regulations, meaning that the regulations weren’t enforced. A subtle difference, but one I expect you to understand.

The Fed was paid back, only after the $750 billion intervention prevented many of them from going under. Which is what a lot of people were upset about. If that action (which was widely called a bailout) didn’t happen, did you think the Fed would have been paid every cent?

I didn’t claim anything that was false. Please be specific.

Posted by KenG_CA | Report as abusive

KenG_CA, what makes you think the crappy regulations were not enforced?

TARP was 700bn not 750bn. Also the intervention for the banks was 245bn and occured well after the crisis had passed – the key period being the middle of Sept when GS and MS in particular were bleeding cash from their prime brokerages. GS raised capital form Buffet on 24th Sept. MS raised 9bn from Mitsubishi 13 Oct. The TARP injections were made suddenly on the 14th Oct by which time those banks were more secure. TARP is a red herring. The two key interventions were bailing out Freddie and Fannie and acting as repo lender of last resort when the CP market was freezing up. Specific enough?

Posted by Danny_Black | Report as abusive

Without government intervention, BofA, Citi, Goldman, and Morgan Stanley, to name a few, would have went under.

What makes me think the regulations were not enforced? if I’m the FDIC, I’m an insurance company. It’s my job to make sure that the firms I am insuring are not doing risky things. Lending money to people with no means to pay it back is risky. If I’m the Fed, and lend money to banks every night, I should know what they’re going to do with the money. Do they lend it to anybody who asks? No, only to banks that have met certain criteria, one of which is the ability to know who to lend money to, and they obviously did not ensure adherence to that requirement. One of the jobs of regulators is oversight, not just filling out the forms that you consider to be time wasting regulations.

Not only did GS get $5B from Buffet, but they also converted to a commercial bank so they could get more money from the Fed, and they got the treasury to make them whole on CDSs they bought from AIG. Without those two acts of government generousity, they were toast.

If you think that no large bank was on the verge of collapse by the time TARP was passed, then we should stop this discussion, as that’s not the version of history accepted by most people.

Posted by KenG_CA | Report as abusive

The government intervention that saved GS and MS in sept 2008 when the CP market froze was the repo lending of last resort by the Fed, not TARP. This is simply an undisputable fact. AIGFP made GS whole on the CDSes? Yeah at the very end of 2008, even further after the immediate crisis over – this is not to mention that GS had a neglible direct exposure to AIGFP when they were bought out. I am not entirely sure what you are arguing now. That TARP bailed out the banks is clearly false unless you are a believer in time travel. That the banks borrowed – and paid back in full – collateralised loans that the Fed extended whilst the CP market froze up and without that they would have failed? If the later then you are basically agreeing with me. Remember doing a back of the envelope calculation when the Fed published its loan details and coming up with a upper bound of the cost of this lending programme at a couple of billion. Also bit weird to be lectured on history by someone who can’t even get the easily available figures or datetimes right. Guess we are going to have to go with too stupid.

Lending to anyone is risky. Are you advocating no credit then? Cash only economy? Care to name some actual regulations you claim were not being enforced, not your mickey mouse version?

Posted by Danny_Black | Report as abusive

The government intervention that saved GS and MS in sept 2008 when the CP market froze was the repo lending of last resort by the Fed, not TARP”

OK, you agree that GS and MS were saved by outsiders. As for whether it was done by the Fed or the Treasury, they worked together. Paulson was just as involved in the deal as anyone at the Fed. The cash may have came from te Fed, but that’s only because that’s how it had to be structured.

When the govt took over AIG, it was because they were in technical default on the swaps they sold to GS and fove other banks. These firms insisted that AIG put up collateral for the insurance they were selling. If the collateral lost value, AIG would be in default, and because of the mark-to-market rules, their collateral lost value. GS went to the government and said if you don’t give us 100 cents on the dollar for all the swaps we bought from AIG, we’re going under and the financial system will collapse. Given that Bernanke and Geithner were academics who couldn’t play poker with the GS sharks, they caved, instead of backing up the collateral or forcing GS to take a haircut on the swaps they bought.

So the government gave GS about $9 billion to cover their “negligible” exposure to AIG, and combined with another $4 billion they borrowed from the Fed (because they changed to a commercial bank, the process for which was reduced to a day), they had enough cash to stay afloat (without the cash, they would have been technically broke, as the swaps that they were using to back up the junk they had on their books would have to be marked down).

Yes, the eventual cost was not that much, but when the TARP program was implemented, the government was on the hook for up to $245B (that’s your #). If we had a crystal ball and knew there wasn’t going to be any significant loss, then loaning the money wasn’t a big deal, But that’s not how loans are viewed, are they? You can’t say just because they paid back loans, there was no cost. If that’s the case, then why are so many people whining about the deficit?

I didn’t say lending was bad, only that lending money to people with no means to pay it back (zero down, no docs, ARMs that people could only qualify for at teaser rates) is not prudent lending. If you think it’s ok for somebody to lend your money out like that, then I guess you got the financial system and economy you want. Get that time travel machine and go back to September 2008 and have a ball.

Posted by KenG_CA | Report as abusive

What is it with people who cannot read. “acting as repo lender of last resort when the CP market was freezing up” was what i wrote right at the very beginning. This by the way is exactly WHY the Fed was created after the 1907 panic. The Fed made overnight collateralised loans. If you consider a bank giving you mortgage as an “outsider saving you” then yes by the same logic the major banks were saved.

When the government took over AIG, AIG was not in default – these words have meaning by the way, I know you and hsvkitty seem not to care about that – it was running out of cash. It wasn’t running out of cash because of the swaps, which would be manageable but because the geniuses in the AIG Treasury decided to lend securities they owned and “invest” it in AAA tranches of structured products which then became illiquid causing a cash crunch.

You also seem hopelessly confused about how the swaps worked. Fundamentally, the swaps were a promise that the tranches insured would be worth 100. When the went down to around 60, AIG forked over 40. So at the time of closing out GS had tranches with a market value of around 60 and some collateral worth about 38 and 1.5 of protection on AIG. What the government got for it’s 100 was the collateral worth 38 and the tranches worth 60 and a tearup of the protection or around 99.5. The tranches then jumped back up in value which is why the Fed is making a handsome profit on those transactions. The only thing i can think of your rather muddled recollection is you are conflating what happened to the treasury dept of AIG “investments” and the collateral AIG was giving TO Gs.

245bn is not “my figure”, it is the figure and it was a prefered equity investment in banks. Not only did they get their money back relatively sharpish but they made a massive profit on it. Again, loaning the money wasn’t a “big deal” because it was collateralised and the loans were well above market rates which is why the gov had to threaten the banks to make them take it.

Ah the magic crystal ball…. So lending to people with good credit ratings is good lending but ARMs are bad? Funny you would write this a couple of days after a post here about how people with ARMs are unexpectedly making payments – because of the unusually low interest rates – and when a significant number of prime mortgages are defaulting.

Thanks for confirming that it is definitely “too stupid”. At least you don’t post links that say the opposite of what you claim and as such are one step up on that other f**kwit.

Posted by Danny_Black | Report as abusive

Maybe a bit unclear… The bit that AIG is forking over is collateral that is insurance that they will actually be able to pay. If the insured tranches go back up to 100 then GS would have to give that collateral back. As far as i am aware there was never a default on those tranches.

Posted by Danny_Black | Report as abusive

I wouldn’t call a bank giving me a mortgage “an outsider saving me”. And I certainly don’t think the Fed was designed to give money to any back that asked for it, regardless of what they wanted to do with it.

AIG wasn’t running out of cash, they had breached their collateral requirements, so excuse me for using the word “default” instead of “breached”, but I thought you would understand. THey didn’t owe more than they had at the time, but because they no longer had enough collateral to cover the swaps they sold to GS and others, they had technically breached the contract (coincidentally, the value of the collateral was partly determined by, you guessed it, GS).

I understand how the swaps worked. I know the government made out ok on its hostile takeover of AIG, but that wasn’t the point. At the time, if AIG had breeched its agreement with GS, GS would have been forced to write down the value of the swaps it held, and it would have been in trouble. It wasn’t a question of them running out of money, but what their assets were allegedly worth. They wanted to swap their swaps for cash, and they got the government to make that happen. I would think a right-minded guy like you would be furious with the government confiscating assets from one company to give to another.

I said $245B was your figure because I got it from you, not from looking it up, so don’t be defensive. The point isn’t that the government made money on its equity investments (I thought you guys don’t like the government getting into businesses like that), but that they shouldn’t have put all that money at risk.

You also obviously did not understand my point about the mortgages. I didn’t say ARMs were bad. I said making ARMS to people, with no money down, with no documentation of income, at interest rates that they could only afford for a few months, was a bad idea, and not one that an insurance company or the Fed should approve. In no textbook will you find anybody suggesting that kind of loan is a good idea. And the comment you made about people making payments on ARMs is laughable – the only reason the rates are low is because the Fed is forcing them to be low.

Posted by KenG_CA | Report as abusive

KenG_CA, when did AIGFP breach their collateral agreements? They WOULD have, had the government not stepped in but they never did.

Yes, the Fed was designed expressly to be lender of last resort to banks, that was its entire point. The other stuff came later:

http://www.law.cornell.edu/uscode/12/usc _sup_01_12_10_3_20_IX.html

Sorry but you clearly don’t have a clue how the swaps work. You also clearly don’t have a clue how mortgage rates are determined. Furthermore you seem determined NOT to understand how they work because it will burst your little bubbble….

Posted by Danny_Black | Report as abusive

do a google search for AIG collateral, and you will see many results like this one:

http://zerohedge.blogspot.com/2009/06/fi lings-disclose-goldman-sachs-aig.html

whose headline is “Filings Disclose Goldman Sachs’ AIG Collateral Demands Were Reason For AIG Implosion”

I understand how swaps work, and haven’t even said anything about that subject, but yet you keep saying I don’t understand how they work. I have repeatedly said the issue was the collateral requirements placed by a handful of CDS customers of AIG, which had nothing to do with the mechanism of the swap, but you obviously cannot comprehend what I’m saying.

Posted by KenG_CA | Report as abusive

Ah zerohedge… home of the f**kwit. Guess you feel right at home there.

“If the collateral lost value, AIG would be in default” – er no. The collateral in a swap agreement is a margin payment made to ensure that in the event of AIG not being able to pay up then GS is covered. The collateral is cash and near cash equivalents, they most certainly did not go down in value. Dimwit that you are you are confusing collateral with the tranches that the swaps were referencing. That is just one case of where you simply don’t know what you are talking about. This is remedial primary school finance 101 so I don’t actually need to do a google search for some wanker to also spout BS about subject they also clearly don’t have the first clue about. I am happy to leave with your head firmly shoved up your backside, convinced you are making an intelligent comment on topics that despite being rather straight forward are apparently far too complex for your midget mind.

Posted by Danny_Black | Report as abusive

Zerohedge? Ah the dimwitted are leading the mentally defective.

You clearly are confusing collateral – which is a margin payment of cash or near cash and most certainly was not “going down in value” – with the underlying tranches of the swap. You have now done that on more than one occasion, which if you can’t even get the names of the different bits right pretty much determines that the mechanics of a swap are well beyond you. Pretty much like having a conversation about computers with someone who can’t tell the difference between a keyboard and a power supply. Even worse with someone who apparently is not aware that he is talking about computers.

Whilst linking to what other shaved chimps have written is apparently definitive for the “special” readers of this blog, the fact is that this stuff is remedial primary school finance 101 and apparently still far far far to complex for you.

I am afraid i am not fluent in dimwitese so yes i guess i do not understand the deep and subtle points you are trying to make. As such i will have to leave with your head shoved well up your bum, absolutely certain you made some sort of “argument”.

Posted by Danny_Black | Report as abusive

it wasn’t just zerohedge:

http://www.businessinsider.com/2008/11/t he-aig-collateral-call-domino-effect
http://www.ritholtz.com/blog/2010/01/why -aig-fp-counter-parties-recieved-100-on- derivatives/
and countless others.

Only six CDS customers got this deal, as it wasn’t part of every swap that AIG sold, so stop lecturing me on swaps. I’m not confusing anything here. When GS and these five other firms bought swaps from AIG, they knew there was a chance that AIG might not have the cash to pay off the swaps, so they insisted on a separate collateral agreement. AIG had to put up collateral to ensure that their counterparties (Goldman, et al) would get paid in the event AIG ran out of cash to cover the swaps. The swaps never reached the point where AIG owed any money on them to Goldman, but the value of the collateral that AIG had posted declined, so Goldman and the others made collateral calls that AIG couldn’t meet.

I guess when you can’t comprehend subjects, you just resort to name calling, which works in a school yard when you outweigh the other kids. So goodbye, Danny Black, and enjoy your life of trolling.

Posted by KenG_CA | Report as abusive

Yeah I guess I am not clever enough to work out how cash goes down in value. Have you considered a job in financial journalism?

Posted by Danny_Black | Report as abusive