Felix Salmon

Many thanks to Van Tsui and Scott Barber for putting this chart together for me. We’re all used to seeing yield curves — charts which show the yield, for any given credit, at various points along the maturity spectrum. This chart is different: it’s a price curve. It just shows the price at which Greek bonds are trading, plotted according to their maturity.

And it’s really odd.

To understand just how odd this chart is, it’s important to realize that in the Greek bond exchange, there’s only one menu of options for anybody holding a Greek bond. It doesn’t matter if your bond is maturing in six months or if it’s maturing in 26 years, the instruments you’re given the choice of swapping into are all exactly the same.

The way that the bond exchange has been structured, the new Greek bonds are all going to trade at roughly the same price, at least in the first instance. If they didn’t, then everybody would simply pile into the most valuable instrument. We won’t know exactly what price they’ll be trading at until they start changing hands, of course, but I’ve marked a range between 62 and 75 cents on the dollar in the chart. At 62 cents on the dollar the bonds would be trading at an exit yield of 13%; at 75 cents on the dollar they would be trading at an exit yield of 9%. Chances are, when the bonds start trading, they’ll be somewhere in that range.

For the bonds which are trading at or near that range, the exchange makes sense. You swap one bond for another bond worth pretty much the same amount, and Greece gets a bailout at the same time. Net-net, you’re better off.

But for bonds trading significantly above 75 cents on the dollar, there’s a lot of reason to stay out of the exchange. We’re talking the bonds maturing in the next year or two here — for them, you’d be much better off holding them to maturity, or even just selling them on the secondary market.

Odder still are the bonds trading at very low prices, below 40 cents on the dollar, or, in some cases, below even 10 cents on the dollar. What on earth are they doing down there?

All of those bonds can be tendered into the exchange for new bonds which are likely to be worth at least 60 cents on the dollar: it’s free money. Just buy a long-dated low-coupon Greek bond, tender it into the exchange, sell your new bond, and double your money. Why hasn’t that price difference been arbitraged away? And, more generally, why aren’t the blue dots all arrayed in a nice straight line at roughly the level the market expects the new bonds to trade at?

I suspect that what’s going on here is that we’re seeing artifacts of an extremely illiquid market. Over the past year or so, as the Greek fiscal crisis got steadily worse, mark-to-market bond investors sold their bonds to banks, who were willing to pay a premium for them, partly because they were eligible to be used as collateral at the ECB. And the banks are holding on to their Greek bonds now, promising to tender them into the exchange. As a result, there’s no real liquid market in Greek bonds any more, and the prices seen in this chart aren’t available to any old bond investor looking for a quick flip.

Embedded in that mechanism is an implied quid pro quo. The banks will make a lot of money, at least on a mark-to-market basis, by tendering their long-dated Greek debt. In return for that profit, they will tender their short-dated Greek debt as well, even though doing so doesn’t make a lot of rational sense.

This helps explain why the official description of the bond exchange splits the par bond into two seemingly identical parts: a “Par Bond Exchange” where bondholders get a new 30-year bond with a step-up coupon rising from 4% to 5%; and a “Par Bond offered at par value as a Committed Financing Facility,” where bondholders roll maturing bonds into exactly the same thing.

Why make a distinction between the Par Bond Exchange and the Par Bond offered at par value, when both involve swapping your old bonds for the same new 30-year bond? Because the second one, the Committed Financing Facility, can be spun by the banks as them putting new money into the deal. And in a certain sense they are: they’re voluntarily giving up the extra money they could get by holding or selling their short-dated Greek debt.

All of this is in one sense much more complicated than it needs to be. Why construct a hidden and implicit quid pro quo, when you could do a normal bond exchange instead, and swap existing debt into new debt of similar or slightly higher value? Greek bonds, as the chart clearly shows, are worth anywhere from 10 cents on the dollar to 110 cents on the dollar: why should they all be swapped into the same thing?

On the other hand, this is at heart an old-fashioned London Club debt restructuring, as opposed to an Argentina- or Ecuador-style bond exchange. Bondholders look at their holdings on an instrument-by-instrument basis, while bankers are more prone to thinking about their exposure to any given credit as one big risk to be restructured.

So this exchange might well work, insofar as Greece’s debt is overwhelmingly held by banks. But don’t think of it as a template for future restructurings.

What does it mean, when a bank takes a 21% haircut on its Greek debt? With the release of Deutsche Bank’s results yesterday we have an interesting case in point: the bank took an impairment charge of €155 million on its Greek government bonds. That’s just under 10% of Deutsche Bank’s stated €1.6 billion in Greek sovereign exposure.

Deutsche Bank is well aware of the size of the haircut, of course — but not all of its Greek exposure comes in the form of securities classified as “financial assets available for sale.” Still, it would have been nice to have been told the size of the writedown in percentage terms, rather than just in cash terms.

Part of the problem here is that the exchange offer is rather opaque; Joseph Cotterill says that the structure of one of the discount bonds, in particular, is “still stumping analysts.” Here’s how the IIF describes it:

A Discount Bond Exchange offered at 80% of par value for a 15 year instrument. The principal is partially collateralized with 80% of losses being covered up to a maximum of 40% of the notional value of the new instrument. The collateral is provided by funds held in escrow. These funds are borrowed by Greece from the EFSF. The EFSF funding costs are covered by the interest earned on the funds in the escrow account so there is no funding cost to Greece of this collateral. The funds in escrow are returned to the EFSF on maturity, if not used, and the principal on the bond is repaid by Greece.

Let’s say you swap €1,000 face value of Greek debt into this new instrument. The first thing that happens is that you take a haircut: the new bond, which carries a coupon of 5.9%, will have a face value of only €800.

The second thing that happens is that Greece will borrow 40% of that sum — €320 — from the EFSF, the European bailout fund. It will put that money into an interest-bearing escrow account; the interest on the money will be enough to repay the interest that the EFSF is charging Greece.

And this is where things become unclear. In the event that there are “losses,” then 80% of your losses will be repaid out of that escrow account.

But what does that mean? My first thought was that it was something to do with a possible second haircut. Say bondholders were asked to take another 10% haircut on the new bond. That would be €80, and of that €80 the escrow account will repay you €64, which means your actual haircut would only be €16, or 2%. This continues up until the losses reach 50% of the value of the new bond, and the escrow account pays out in full. After that, there’s no money left and all further losses you suffer entirely.

That would be quite elegant, since it’s unlikely Greece would impose a second haircut of much more than 50%. But then I realized that coupon payments are just as important as the face value of any principal. If you reduce the principal by 10% and the coupon remains the same 5.9%, then you lose 10% of all your coupon payments, too. Let’s say there are 12 years left on the bond when the second restructuring happens — then a 10% haircut wouldn’t just knock €80 off your principal repayments, it would also knock €57 off your total coupon payments. Presumably 80% of that, or another €45, would also have to come out of the escrow account.

So now the escrow account is looking rather thin. Let’s say there’s another restructuring after 3 years with a more realistic 30% haircut, and the coupon staying at 5.9%. Then the escrow account loses €192 in principal and another €135 in interest, for a total of €327. We’ve already exceeded the amount of money in the account — it’s wiped out.

And the other question, of course, is when the money would be paid out of the escrow account. Would it pay out at the time of restructuring, even for payments which aren’t due for another decade or more? Or would it just sit there in escrow, paying out little €5.66 partial-replacement coupons every six months until it ran out of money? It’s a big difference, since €5.66 today is worth a hell of a lot more than €5.66 in ten years’ time.

I’m sure answers to these questions will slowly emerge — but for the time being, if you’re a bank tendering into the exchange, I think you can more or less write down your bonds by any vaguely plausible amount you like, and probably get away with it. If you’re marking to market, of course, it’s easy. But if you’re holding old Greek debt on your books at par, then — especially if you swap into another par bond — you probably have very wide latitude in where you mark the new debt. And if you swap into a discount bond, for the time being almost no one understands exactly what that’s reasonably going to be worth.

Update: Thanks to my commenters, especially Greycap, for pointing out that it’s just the principal, not the coupon payments, which are partially collateralized. But in a way this only makes things much worse. If Greece wants to restructure the bond, it will now have every incentive to push back maturities and reduce coupons to zero, rather than other options — because that wouldn’t trigger a payout of collateral. It seems very easy to game to me.

My favorite bit of the NYT’s latest Murdoch story: the byline saying “Tim Arango contributed reporting from Baghdad” — NYT

Judith Klausner is my new favorite artist — JG Klausner

R.I.P Steve Lacey — Geekwire

“For the first time ever, developing countries as a group have been growing faster than industrial countries” — Rodrik

Apple’s paying less than $35/sqft for its space in Grand Central Terminal — NYP

Susan Sontag: the kind of person who puts on a bear suit and looks utterly miserable — Tumblr

Would you live in the Nineties for a million dollars? — National Review

Back in April, I was very skeptical that the NYT would achieve its leaked goal of getting 300,000 paying digital subscribers, and I put my money where my mouth was, entering into a bet with John Gapper. John wouldn’t bet me that the NYT would get to 300,000 within a year, so we pushed it out to two years instead. But he needn’t have worried, as Seth Mnookin explains:

It will take years for the ultimate wisdom of the Times’ strategy to be apparent, but the company’s second-quarter-earnings report proves that its digital-subscription plan has thus far been an enormous success. The internal projections have been closely held, but several people have confirmed that the goal was to amass 300,000 online subscribers within a year of launch. On Thursday, the company announced that after just four months, 224,000 users were paying for access to the paper’s website. Combined with the 57,000 Kindle and Nook readers who were paying for subscriptions and the roughly 100,000 users whose digital access was sponsored by Ford’s Lincoln division, that meant the paper had monetized close to 400,000 online users. (Another 756,000 print subscribers have registered their accounts on the Times’ website.)

There seems little doubt that, barring something enormous and unexpected, I’m going to lose my bet; the only question is by how much. Total digital subscription revenues are still going to be a drop in the bucket — if the NYT gets 500,000 digital subscribers at say $200 a year each, that’s $100 million a year, which is a lot of money in absolute terms but still just a fraction of the more than $2 billion that the NYT sees in total annual revenues. Digital advertising revenues alone are running at about $700 $350 million a year. The subscription revenue is nice, but it’s not in and of itself going to allow the Sulzbergers to start paying themselves a dividend again.

Those paying digital subscribers, however, are much more valuable than their subscription streams alone would suggest. They’re hugely loyal, they read loads of stories, they’re well-heeled, and advertisers will pay a premium to reach them. Judging by the second-quarter results, which is admittedly early days, it seems as though total digital ad revenues are going up, not down, as subscriptions get introduced: the holy grail of paywalls.

Mnookin concludes:

As a profession, journalism of the kind the Times practices can be dangerous. And as a business, in a metaphorical sense, more so. You’re depending for your living on the seriousness and high purpose of a substantial segment of the American public. In that sense, the Sulzbergers have always been involved in a fool’s game. The current Sulzberger’s bets have at times seemed the most outlandish, as if he’s willfully refused to read the writing on the wall. But for the Sulzbergers, whatever their faults, even when the paper was making money, it has always been a calling rather than a business. Insisting that people would pay for their content when a consensus of media savants said that they would hemorrhage readership was the work of an eccentric family. Which the Sulzbergers are and always have been. And for now, cross your fingers, it seems to be working.

My fingers are crossed: I was very much a skeptic with regard to the paywall experiment, but I’m extremely happy that it’s working, I’m a big fan of the NYT, and I sincerely hope it has found a predictable and dependable new revenue stream in the volatile and treacherous media business.

I’m particularly glad that the NYT has proven that a very porous paywall can work — one in which just about anybody online can read just about any NYT article for free very easily. The media business has never been about denying access to people who want to read your publication, but the paywalls at News Corp, as well as the one at the FT, are based around that model. The NYT, by contrast, has proven that people will pay even if the paywall is extremely porous.

And in today’s fractured online media environment, the tougher your paywall, the more annoying it is. The NYT paywall is done pretty well, and I still find myself being asked for a username and password on a distressingly regular basis when I’m reading it on the iPad, often when articles come up in an app like Twitter or Flipboard, and I try to use the embedded sharing tools. More distressingly still, entering the password doesn’t always work.

But compared to the FT, the NYT paywall is a dream: not only do I run into the paywall pretty much every time I try to read an FT article on my iPad, I even run into it pretty regularly when I’m on my desktop computer. I’m a paying subscriber, but a very unhappy one: repeatedly typing in a username and password on a touch-screen device is decidedly unpleasant. Overall the user experience at the FT in general seems to be taken straight from the TSA: the general principle seems to be that no amount of customer inconvenience is too much if it makes sure that no unauthorized person will ever be allowed through.

Oh, and one other thing: when I signed up I selected the $4.99 per week option, and the FT helpfully told me that over the course of a year, the total annual payment charged to my credit card would be $259.48. What they didn’t tell me was that I’d have to pay that all at once — and then some: they actually charged me $282.52, after slapping on 8.9% sales tax. (The NYT, by contrast, doesn’t do that: if they do charge sales tax, they don’t break it out, and instead bundle it into the total subscription charge.)

I’ve been getting the physical NYT delivered to my home for well over a decade, which means I pay a lot more for the NYT than for the FT. But I don’t do it in one huge annual chunk, and I don’t feel like I’ve been tricked when I see my credit card bill. As a result, I don’t begrudge the NYT the money I pay them, but I feel much less well-disposed towards the user-hostile FT. And I frankly don’t read the FT all that much, either. I get my news socially, and people simply don’t share FT stories in the way that they do with the NYT. The FT annoys its readers into taking out a subscription; the NYT, by contrast, has persuaded hundreds of thousands of people — it’s overtaken the FT already — to pay for digital-only subscriptions even when they don’t really need to. That’s a much more positive model.

Update: The sales tax question might have been answered! Ryan Chittum points me to the New York State sales tax rules:

If you sell publications that qualify as newspapers or periodicals for sales tax purposes, you don’t need to charge sales tax because they’re exempt. The exemption also applies to charges for electronic versions of newspapers or periodicals if you sell a hard-copy version, and both versions contain the exact same information (except for advertising).

The question here is what is meant by the phrase “if you sell a hard-copy version”. Clearly my subscription to the NYT is exempt from sales tax, because I’m subscribing to the paper version. But what about my digital-only subscription to the FT? The FT does sell a hard-copy version which contains the exact same information — but it just isn’t selling that hard-copy version to me. Is that why they feel they have to charge sales tax?

It’s looking increasingly likely that the US is going to lose its triple-A credit rating at some point in the next 12 months or so, whatever happens to the debt ceiling. And right now, nobody knows what the consequences of that would be: it’s never happened before. Paul Krugman is trying to put a brave face on things and point out that hey, sovereign borrowing costs didn’t rise in Japan. (Not, of course, that turning out like Japan is exactly desirable.)

But the fact is that Japan never got much benefit from having a triple-A rating in the first place. Japan borrows overwhelmingly from its own citizens, who have lots of savings — they don’t give two hoots about what Moody’s thinks of their country’s creditworthiness.

The US, by contrast, is very different. Treasury bonds are the ultimate global asset class: they’re the epitome of risk-free safety for investors all over the world. Look at what happened when the subprime bubble burst and the US economy was plunged into the greatest recession in living memory, causing a plunge in tax revenues, a spike in unemployment, and a surge in government debt: Treasury prices went up. That’s what happens when you’re the risk-free asset of choice: you’re the beneficiary of the flight-to-quality trade whenever markets get spooked.

Which brings me to the question of what exactly a triple-A credit rating means and does. To fully understand this, it’s important to realize just how lazy and/or overworked institutional fixed-income investors are. A lot of their time is spent drumming up new investments, holding existing clients’ hands, and the like — and when they do get time to do real analysis, the first thing they worry about is always interest-rate risk. If you’re managing a bond portfolio, you’re obsessed with the duration of your portfolio, where your maturities are, and the like: you’re constantly putting on steepeners or flatteners or otherwise trying to manage what’s happening with interest rates in whatever currency you’re investing in.

Only once they’ve got the rates situation worked out do fixed-income investors start thinking and worrying about credit risk. Credit is an overlay — a way of boosting returns over and above what you’d get from rates alone. Sometimes you want more credit risk, sometimes you want less; when you want more, you buy lower-rated bonds with higher yields, and when you want less you buy higher-rated bonds with lower yields.

But the triple-A credit rating is not a credit rating like any of the others. It’s basically a sign saying “no credit risk here” — a way of investing in fixed-income assets without taking credit risk. Triple-A bonds are in this sense a pure interest-rate play — while they can rise or fall in value, and they can get illiquid at times, the idea is that they’ll never default.

In their heart of hearts, fixed-income investors know that there’s no such thing as no credit risk — especially in a world where more than half of the bonds being issued are rated triple-A. But that’s a worry for academics and people with time on their hands. If there’s credit risk in triple-A bonds, it’s too small to price or to worry about, and so, by convention, it’s ignored.

That’s how the financial crisis happened: enormous quantities of triple-A-rated nuclear waste was issued and placed with fixed-income investors who were looking for a modest yield pickup over Treasuries with no real risk of default. They outsourced their due diligence to the ratings agencies: after all, these structured products were highly complex, and precious few bond investors had the ability to even try to work out the credit risk in them on their own.

Nowadays, people are a bit warier when it comes to structured products. But the triple-A mystique remains, and amazingly continues to adhere to Treasuries even as the current debt ceiling debate brings us closer and closer to default. More importantly, it adheres to municipal bonds: individual investors — people who certainly have no ability to gauge credit risk — demand triple-A ratings precisely because they don’t want to have to worry about credit risk. Similarly, people are happy keeping their money in the bank because it’s insured by the FDIC, which in turn is backed by the full faith and credit of the US government. Triple-A.

So what happens if the US loses its triple-A? The simple answer is that nobody knows. But it will certainly cause second thoughts among people who up until now have been very good at ignoring the question of credit risk in triple-A assets.

The problem is that the world of finance is built on mass suspensions of disbelief. Money itself has value only because we as a society all opt to believe that it does. When we deposit money in the bank, we happily leave it there and believe that it’s available to us on demand, despite the fact that the bank has taken that money and lent it out to someone else. Similarly, we believe that our investments are worth whatever they’re changing hands for today, even though we’re not selling them today, and any state of the world where lots of people wanted to sell those investments is a state of the world where they’d likely be worth much less than they are now.

The single biggest beneficiary of this suspension of disbelief is the USA. Because everybody believes Treasury bonds to be risk-free, they’re a risk-off asset, and they tend to rise in value whenever the world starts looking scary. They’re the place you put your money when you’re not thinking — they’re the default option, the safe end of the barbell. No one buys Treasury bonds because they want to go long US credit risk: they buy Treasury bonds because they don’t want any credit risk at all, and because they want the most liquid instrument in the world.

If the US were to lose its triple-A rating, all that would change. Treasuries would remain highly liquid, simply by dint of the sheer quantity of the things that there is outstanding. And they would continue to be used as collateral in repo operations and the like, just because there’s no alternative. But their fundamental nature would change forever. Look, for instance, at all the investors who are standing on the sidelines right now, ready to jump in and buy Treasuries if they sell off sharply. That’s a speculative, risk-on move: you try to catch the falling knife, and then ride the rebound.

A downgrade probably wouldn’t cause an immediate selloff in Treasury bonds, not least because there’s no other asset in the world which has nearly the same amount of size and liquidity. But the effect on non-Treasury triple-A debt, including municipal bonds, might well be larger. And the long-term effect is likely to be huge: when looking for a safe haven, investors will henceforth have to stop and think about which one of various options are the least risky. The knee-jerk flight-to-quality trade will be a thing of the past, because nobody will really know what “quality” is any more. Specifically, would triple-A debt be safer than Treasuries, if Treasuries aren’t triple-A?

Again, this is something it’s impossible to answer ex ante. My gut feeling is that triple-A issuers like Johnson & Johnson or the World Bank would still trade at higher yields than the US Treasury, even if the US was downgraded and they weren’t. But in the first instance, there would be bound to be a lot of volatility, with weird price action and very unexpected correlations.

There is one interesting alternative, however. What would happen if, instead of downgrading the US specifically, the ratings agencies simply decided to abolish the triple-A rating entirely? The rating is dangerous and impossible: a triple-A default is a much more significant event than a double-A default. Taking the entire fixed-income universe and capping it at double-A would send a message to the markets that, sorry, there’s no such thing as risk-free debt: you can worry about rates all you like, but everything you own has some element of credit risk built in.

Taking the triple-A out of the ratings universe would, at one level, be purely cosmetic. It would be like removing the pinstripes from the Yankees’ uniform, or changing the markings on Nigel Tufnel’s guitar amp so that they only go to 10 rather than 11.

But appearance matters, especially in something as fragile and important as the global confidence game that is the fixed-income market. And abolishing the triple-A rating would be an admission on the part of the ratings agencies that in creating it, they built a monster. It is a monster which has been very good to the US, over the years; its death throes would be extremely painful. But a world without triple-A debt is a world where investors are more alive to the risks that they’re running. And ultimately that’s probably a good thing.

For a clear, powerful, and erudite short take on the current debt debacle, there’s no better place to go than Jim Surowiecki. His main thesis is pretty much impossible to argue with: that the debt ceiling should be abolished. If Congress wants to cap the government’s borrowing, it can and should do that in the budgeting process, not with a saber-toothed ceiling which risks devastating the entire global economy.

The debt ceiling, it turns out, has been a dangerous anachronism for almost 40 years now:

Congress used to exercise only loose control over the government budget, and the President was able to borrow money and spend money with little legislative oversight. But this hasn’t been the case since 1974; Congress now passes comprehensive budget resolutions that detail exactly how the government will tax and spend, and the Treasury Department borrows only the money that Congress allows it to.

There’s an important lesson here. For 37 years, the debt ceiling has provided an easy way for the party which isn’t in the White House to posture politically against the party which is in the White House. Even Barack Obama voted against raising it, once. Every one of the dozens of times the debt ceiling was reached, there was a small but non-zero probability that something disastrous would happen. And each time, disaster was, predictably, averted. It’s a classic sign of how tail risks are treacherous and breed invidious complacency. We’ve reached the debt ceiling dozens of times; nothing’s ever happened; so there’s nothing to worry about; so there’s no point expending precious political capital doing the right thing and abolishing it.

And now we’re paying the price. It’s increasingly looking like the best-case scenario is that America simply loses its triple-A credit rating — something which in and of itself will be pointless, dangerous, unnecessarily expensive and potentially catastrophic. The worst-case scenario, of course, is an outright default.

The lion’s share of the blame here belongs with the Republicans in general, the House Republicans in particular, and the Tea Party caucus within the House Republicans most of all. But it’s not like these people’s existence or intransigence was any great secret. And so the White House tactics over the course of the past few months look dangerously naive.

Bear with me on a short digression here. Back when George W Bush enacted his first big round of tax cuts, Paul Krugman wrote a column (I can’t find it right now, Google’s new algorithm hates pulling up old content) saying that, in effect, Bush had made Clinton look like an utter chump. There’s no point in Democratic presidents practicing fiscal responsibility and balancing the budget, he said, if their Republican successors are just going to come along and squander all that hard-earned fiscal rectitude on dangerously large tax cuts for the rich.

That kind of thinking helped to set up a vicious dynamic — Republicans would increase spending and slash taxes, while Democrats would increase spending and leave taxes untouched. It’s something which is certain to end in tears sooner or later — something the responsible people at Treasury know full well.

Which brings us to the current debt-ceiling debate. The budget debate, of course, sets near-term taxation and spending. So seeking to make a virtue out of necessity, Treasury entered negotiations over the debt ceiling to do something longer-term: to put in place a decade-long “fiscal straitjacket” which would constrain future Democratic and Republican administrations alike. That would address the Krugman point, and help to cement — rather than weaken — America’s triple-A credit rating.

As things turned out, of course, Treasury’s bright idea backfired catastrophically. Far from putting the US on a course of long-term fiscal prudence, it put the country on a log raft with no paddle, careening straight towards a deathly waterfall. In hindsight, attempting to engage the House Republicans on long-term fiscal issues was a silly idea — these are people who think you can raise revenues by cutting taxes. A fiscal straitjacket, necessarily, involves some mechanism for raising taxes; since that was always going to be anathema to the Republicans, there was no point even trying to construct one.

The cost of Treasury’s tactical mistake is going to be enormous. I don’t know how much choice Treasury had in the matter, of course: it’s possible that this particular debt-ceiling debate was going to come to tears no matter how the White House decided to approach it. But I can’t help but draw some kind of causal connection between Treasury’s oversized ambitions and the current mess. In any case, it’s a sunk cost at this point. And we’re all going to pay for it, dearly, in the years and decades to come.

Update: Many thanks to yonran, in the comments, for finding that column.

DSK Maid Tells of Her Alleged Rape by Strauss-Kahn — Newsweek

The Norwegian shooter’s 1500-page manifesto — Scribd

All Gawker content is Creative Commons — Gawker

Hacking was endemic at Piers Morgan’s ‘Mirror’, says former reporter — Independent

Only 52% of Americans Approve of God’s Job Performance — Atlantic Wire

Give Directly. I like this a lot — MR

Wayne Barrett on the “display of raw political power” exercised by the Murdoch/Giuliani nexus — Daily Beast

Phone Hacking: emails next scandal, says Tom Watson — Telegraph

Many thanks to commenter buysidemetrics for finding this very smart quote from Bill Gates, which actually comes from a discussion he had with Warren Buffett in 1998:

BUFFETT: The technological revolution will change the world in dramatic ways, and quickly. Ironically, however, our approach to dealing with that is just the opposite of Bill’s. I look for businesses in which I think I can predict what they’re going to look like in ten or 15 or 20 years. That means businesses that will look more or less as they do today, except that they’ll be larger and doing more business internationally.

So I focus on an absence of change. When I look at the Internet, for example, I try and figure out how an industry or a company can be hurt or changed by it, and then I avoid it. That doesn’t mean I don’t think there’s a lot of money to be made from that change, I just don’t think I’m the one to make a lot of money out of it.

Take Wrigley’s chewing gum. I don’t think the Internet is going to change how people are going to chew gum. Bill probably does. I don’t think it’s going to change the fact that Coke will be the drink of preference and will gain in per capita consumption around the world; I don’t think it will change whether people shave or how they shave. So we are looking for the very predictable, and you won’t find the very predictable in what Bill does. As a member of society, I applaud what he is doing, but as an investor, I keep a wary eye on it.

GATES: This is an area where I agree strongly with Warren. I think the multiples of technology stocks should be quite a bit lower than the multiples of stocks like Coke and Gillette, because we are subject to complete changes in the rules.

This I think is the heart of the reason why technology stocks are trading at lower multiples than industrials. There’s no doubt that in an era of massive change, there will be a handful of tech companies which are huge winners. On the other hand, there will be some giant tech companies which are big losers, too. (Just see the fate of Apple since 1998, and compare it to the fate of Microsoft.) In general, if the number of losers exceeds the number of winners, or if the winners start out small and the losers start out big, then that’s a sector you’d be smart to buy only at relatively low multiples.

Meanwhile, in an area where change is unlikely to massively disrupt your business, income streams are more predictable and therefore more valuable.

Another way to look at this is to take the simple but powerful heuristic that the expected lifespan of any company is twice its current age. Wrigley’s and Coke and Gillette have been around a lot longer than Microsoft or Apple or Facebook, and there’s a very good chance that they’ll still be here when the current tech stars are distant memories. If I had to buy one asset for the ultra-long term — something on the order of a few hundred years — then I’d probably end up buying a timber forest: those things last forever, with growth that is so steady and predictable that it’s literally a science, and yields which can easily be stored up during periods of market weakness (just by cutting down fewer trees).

So then the next question arises: why are tech companies trading lower than industrials now, when they’ve never done so in the past? Has the market suddenly become uncharacteristically rational?

That’s a harder question to answer, but I think that it’s fundamentally based on the fact that the giants of the dot-com era are still big and entering a long-term decline — think Microsoft, or Intel, or HP, or Yahoo. Meanwhile, the exciting smaller companies, insofar as they exist, simply aren’t public.

And it turns out that even Warren Buffett’s boring and predictable companies like Coca-Cola can benefit from huge and unpredictable trends. Mark Bittman has a good piece in this weekend’s NYT which included this chart:

I don’t think that anybody — not even Warren Buffett — could have predicted 30 years ago that soda price inflation would so massively lag both consumer prices generally and food prices in particular. Healthy food is now twice as expensive, relative to soda, as it was in the early 80s. Which obviously does wonders for Coca-Cola’s brand franchise, even if it causes billions of dollars a year in damage elsewhere in the economy. If I’m a long-term buy-and-hold investor, that’s the kind of trend I want to jump on. Rather than, say, Farmville. To make money in Zynga stock you need to know when to sell. To make money in Coca-Cola stock, you don’t.

I love This American Life’s investigation into patent troll Nathan Myhrvold and his company Intellectual Ventures. You should go read — or listen to — the whole thing, but in a nutshell, they explored what happened if they took Intellectual Ventures at its word.

IV pointed TAL to an inventor called Chris Crawford — a man with a patent which he sold to IV. Inventors! Getting paid! For inventing! Except when TAL tried to talk to Crawford, he wouldn’t answer their calls. And it turns out that IV had sold his patent to Oasis Research, a Texas company with a nameplate address and no employees, for some up-front consideration and a percentage of all litigation proceeds.

TAL goes into clear detail about the idiocies of the patent system — how even software engineers with patents don’t believe that software processes should be patentable; how patents are regularly awarded for ideas which have been around for years; how multiple patents are often awarded for much the same idea; how IV is essentially running an intellectual-property protection racket; and how big companies are amassing patent portfolios not so that they own the intellectual property behind their products, but rather so that they can threaten to sue any company which sues them.

The end result is a highly dysfunctional situation where virtually any startup is at risk of being shut down by a patent suit; and where nameplate companies with no business and no revenues, like Oasis Research, are the perfect vehicles to launch patent suits, since they’re not susceptible to countersuits. Essentially, if you’re small, you have to hope to fly below the radar; if you’re big, you have to pay billions of dollars on patents you have no particular interest in. Here’s how TAL describes the $4.5 billion that Apple, Microsoft, Nokia and others paid for Nortel’s patent portfolio:

That’s $4.5 billion on patents that these companies almost certainly don’t want for their technical secrets. That $4.5 billion won’t build anything new, won’t bring new products to the shelves, won’t open up new factories that can hire people who need jobs. That’s $4.5 billion dollars that adds to the price of every product these companies sell you. That’s $4.5 billion dollars buying arms for an ongoing patent war.

The big companies — Google, Apple, Microsoft — will probably survive. The likely casualties are the companies out there now that no one’s ever heard of that could one day take their place.

The US is in desperate need of patent overhaul. We need to make it easier and quicker to get good patents, and much harder or impossible to get bad patents. We need to abolish the abomination that is the business-method patent entirely. And most crucially we need to allow defendants in patent suits to argue that the patent is invalid because it was awarded in error, with lots of prior art at the time the patent was awarded. Right now, patents can be appealed — but not in the court where they’re being enforced, with the result that trolls with invalid patents can still get paid out to the tune of billions of dollars.

Chuck Schumer’s bill taking aim at business-method patents in the financial industry is a good start; if the sun continues to rise in the east after it passes, that might embolden legislators to start taking aim at business-method patents more generally.

But this is a Congress which is clearly incapable of doing the most obviously right things: given the choice, they’ll always and predictably pick demagoguery coupled with devastation over simple common sense every time. The incoherent and anachronistic patent system is, sadly, with us for the foreseeable future. And the cost of that will be huge, in terms of seven-figure lawyers’ fees, rents extracted by trolls, and, most importantly, lost innovation and entrepreneurialism.

I still haven’t been able to get an updated version of the triple-A bond chart, but I did manage to blow it up to six feet tall and do my best weatherman impression in front of it at the Nasdaq Marketsite in Times Square.

Thanks to Larry Summers for suggesting that I take a look at this chart. It wasn’t particularly easy to find, but it’s quite striking all the same. (And thanks very much to Roy Strom and Van Tsui, here at Thomson Reuters for putting it together.)

What we’re looking at here is a ratio of ratios: it’s the price/earnings ratio of the companies in the MSCI USA IT index, which covers technology companies, divided by the price/earnings ratio of the companies in the MSCI USA Industrials index. (For earnings, we’re using 12-month forward earnings — but we’re not really looking at the p/e ratios themselves here, just the ratio between the two ratios.)

Summers is absolutely right: this ratio is currently at an all-time low. The TR data goes back to 1994, so this chart encompasses 17 years, but I suspect you’d need to go back a lot further to find the last time this ratio was trading this low.

Importantly, the ratio is trading at less than 1: the market is saying that earnings at technology companies, which historically exhibit high growth, are worth less than earnings at established industrial companies.

Now this might be an artifact of the specific indices I’m using here: according to another chart sent to me by John Coogan, the ratio is still at an all-time low, but is above 1. Still, the fact is that the market clearly isn’t giving technology earnings the premium they’ve historically commanded.

Why might that be? Frankly I don’t really know. Maybe it’s a function of industrial earnings rebounding less quickly than earnings in the tech sector more generally. Maybe it’s largely an Apple thing. But there’s definitely an indication here that either industrial earnings are too expensive, or technology earnings are too cheap right now. Or both.

ISDA has made the right decision: the Greek bond default does not and should not count as a “credit event” for the purposes of whether Greek credit default swaps will get triggered.

This is the right decision for two reasons. Firstly, the swap is voluntary. If you don’t want to suffer a haircut, or see your six-month maturity suddenly become a 30-year maturity, then all you have to do is nothing. If the CDS paid out, that would be tantamount to giving free money to anybody who wanted it: just buy short-dated Greek debt and also credit protection on that debt. The bonds will pay out in full, and the CDS would pay out as well.*

Secondly, this should be a large nail in the coffin of the CDS market generally. Credit default swaps were designed primarily for banks: it took many years before they became widely-traded speculative instruments in their own right. The idea behind them was that banks could keep loans on their balance sheets while at the same time hedging the risk that they would default. That was easier and cheaper than selling the loans outright, and also helped banks maintain good relations with their borrowers.

In the case of Greece, however, banks are going to take a 21% haircut on their loans to the country — and if they hedged themselves in the CDS market, too bad. Whatever they paid for their CDS protection — and if they bought it recently, it could be quite a lot of money — will not help them one bit. If buying CDS doesn’t help you in the event of a default, then there’s really no point in buying CDS.

So even though there isn’t going to be a formal credit event in Greece, have no doubt that this is a default — or, at least, that it will be a default if the banks are correct in anticipating a participation rate of 90%. But I have to say I’m surprised they’re so bullish, and I will be extremely impressed if Greece wakes up one morning to find that 90% of its private-sector debt has been tendered into the exchange.

For one thing, the exchange is structured in a pretty unsophisticated way. No matter whether you have a bond maturing tomorrow or a bond maturing in a decade, you’re swapping it into exactly the same 30-year instrument. Banks with short-dated Greek debt aren’t going to be happy about this, and will have a strong incentive to quietly sell that debt on the secondary market to someone willing to just hold it to maturity.

And more generally, it’s almost impossible to see why anybody who isn’t a bank would tender into this exchange. If you’re an individual holding Greek bonds, or a big bond investor like Pimco, the obvious thing to do is to hold on to your debt for the time being, since the exchange includes no carrots and no sticks. The only incentive for you to tender into the exchange is that the new bonds will be partially collateralized with zero-coupon 30-year bonds. Triple-A-rated 30-year bonds in euros currently yield 4%, which means that the collateral in the new Greek instruments will be worth less than 31 cents on the dollar. And so far, there’s been zero indication that holdouts will get anything less than all their money back, in full and on time; they might have a bit less liquidity, but bond investors are used to illiquid instruments.

Is it really the case that over 90% of Greek bonds are held by banks which will tender all of their Greek debt into the exchange? Maybe so; non-bank investors looking to go long Greek credit might well have found it easier and cheaper to do so by writing credit protection in the CDS market rather than buying cash bonds. In which case they’re smiling broadly today.

If that’s the case, then maybe this deal is one of those rare occasions where the CDS market was genuinely useful. Back in the 1980s, when sovereign debt was held overwhelmingly by banks, negotiations about restructuring that debt could be held with the London Club of bank creditors. Non-bank investors didn’t really matter. But then the loan market became a bond market, and investors in sovereign debt were mainly non-banks; no longer were negotiations even really possible.

Now, however, we seem to have come full circle: banks are able to put together bond-restructuring deals on their own, without worrying much about non-bank bond investors. And one reason would seem to be that the non-bank investors have largely moved from the bond market to the CDS market.

Is this scheme going to work? There’s a big collective-action problem at the banks, and an even bigger problem with the non-banks. So the 90% target is ambitious. But so far I haven’t seen much doubt. I will say this: if the 90% target is achieved, then the Institute for International Finance will deserve a lot of credit. I’m no fan of the organization — I’ve been very rude about it for many years. But if it manages to pull this off, it will finally and genuinely have justified its existence.

*Update: Kid Dynamite asks a good question in the comments: if the bonds paid out in full, wouldn’t the CDS auction clear at par, with the CDS paying out nothing? No. To a first approximation, the CDS auction clears at the price of the cheapest-to-deliver Greek bond, and Greek bonds are trading at a substantial discount. The cheapest-to-deliver bond will probably have a very long maturity, and if there was a credit event for CDS purposes, then holders of credit default swaps would get a nice check in the mail.

Are the Winklevii the whiniest multi-millionaires in the world? Yes, they are — WSJ

The best thing about the release of OS X 10.7 Lion? It means there’s a new John Siracusa review — Ars Technica

Grover Norquist Contradicts Grover Norquist — NPR

It’s almost impossible to read this and believe James Murdoch didn’t know why he was paying off Graham Taylor — NYT, see also

Lucian Freud, Adept Portraiture Artist, Dies at 88 — NYT

Jay Walder, M.T.A. Chief, Resigns Suddenly — NYT

Can you pick Wendi Deng out from her middle-school volleyball team photo? — Reuters

Ryan Chittum on Murdoch’s press defenders — CJR

How Superman saved the planet — SMBC Comics

The latest Greek bailout is done — the official statement is here — and it involves Greece going into “selective default,” which is, yes, a kind of default.

I can’t remember a major financial story which has been covered so inadequately by the financial press. All the incomprehensible eurospeak seems to have worked, along with the fact that the deal was announced in Brussels, where the general level of journalistic financial literacy is substantially lower than it is in London or New York or Frankfurt. On top of that, statements are coming from so many different directions — Eurocrats, heads of state, the Institute of International Finance, Greek officials, Portuguese and Irish officials, you name it — that it’s extremely hard to put it all together into one coherent whole.

Oh, and to complicate things even further, most of the day’s discussion was based on various widely-disseminated draft documents which differed substantially from the final statement.

This is a bail-in as well as a bail-out: while Greece is getting the €109 billion it needs to cover its fiscal deficit, both the official sector and the private sector are going to take losses on their loans to the country.

As such, it sets at least two hugely important precedents. Firstly, eurozone countries will be allowed to default on their debt. Secondly, a whole new financing architecture is being built for Greece; French president Nicolas Sarkozy called it “the beginnings of a European Monetary Fund.”

The nature of massive precedent-setting international financing deals is that they never happen only once. There’s lots of talk today that this deal is for Greece and for Greece only, but some of the more explicit language to that effect was excised from the final statement. On thing is for sure: these tools will be used again, in future. They will be used again in Greece, since this deal is not enough on its own to bring Greece into solvency; and they will be used in other countries on Europe’s periphery too, with Portugal and/or Ireland probably coming next.

As far as the public sector is concerned, the European Union will do four main things. First, it will extend the maturities on Greece’s debt from the current 7.5 years to somewhere between 15 years and 30 years: the loans that the EU is currently giving Greece aren’t designed to be repaid, in some instances, until 2041.

Second, the interest rate on those loans will be extremely low — essentially, Greece is getting those EU funds at cost, currently about 3.5%. The EU is also extending these ultra-low financing rates to Portugal and Ireland, so as not to implicitly punish countries which don’t default.

Third, the EU will put together its own stimulus plan for Greece. The phrase “Marshall Plan” was taken out of the final statement, but there’s still talk of “mobilizing EU funds” and building “a comprehensive strategy for growth and investment.” This is vague, of course, but it does at least constitute an attempt to help Greece through a period of very painful austerity.

Fourth, the Maastricht treaty will get resuscitated, with all eurozone countries except Greece, Ireland and Portugal committing to bring their deficit down to less than 3% of GDP by 2013. Paul Krugman is screaming about this, but this was a central part of the eurozone project from the get-go, and clearly the eurozone needs some kind of fiscal straitjacket for its constituent members to prevent the rest of them from running up enormous deficits and then getting bailed out by Germany.

Finally, the EU will provide “credit enhancement” for Greece’s private-sector bonds. This is a central part of the default plan, and it looks a lot like the Brady plan of the late 1980s. The official statement from the IIF, which is representing private-sector creditors in this matter, is a little vague, but essentially if you’re a holder of Greek bonds right now, you have three choices.

1. You can do nothing, and hope that Greece pays you in full and on time.
2. You can extend your maturities out to 30 years, and accept a modest coupon of 4.5%; in return, your principal will be guaranteed with an embedded zero-coupon bond from an impeccable triple-A-rated EU institution, probably the EFSF.
3. You can extend your maturities out to 30 years, take a 20% haircut, and get a higher coupon of 6.42%; again, the principal is guaranteed with zero-coupon collateral.
4. You can extend your maturities out to 15 years, take a 20% haircut, get a coupon of 5.9%, and have only a partial principal guarantee through funds held in an escrow account.

The first option is by far the most interesting. No one has come out and said that Greece is going to default on bondholders who don’t exchange their bonds; instead, there’s just a lot of arm-twisting of big banks to do all this “voluntarily.” But that won’t stop the credit rating agencies giving Greece’s bonds a default rating — this is a coercive deal, which clearly reduces the value of banks’ Greek debt. (After all, just look at those haircuts.)

Is it possible for other bondholders — those who haven’t had their arms twisted — to free-ride on the back of this deal and continue to get paid in full? I suspect that it probably is. Which is one reason why this Greek restructuring won’t be the last.

Overall, this looks like a deal which can quite easily be scaled up and used as a framework for future default/restructurings. I don’t know if that’s the intent. But there’s nothing here to reassure holders of Portuguese and Irish bonds — or even Spanish and Italian bonds, for that matter — that they’re home safe. Greece will be the first EU country to default on its debt. But I doubt it’ll be the last.

Paul Krugman has been railing against what he calls “the false government-family equivalence” for a while: what’s true at the family level — if your income goes down, for instance, you need to spend less money — is not necessarily true at the government level.

But the metaphor is back, in a new form. And this time it’s coming from the left. Here’s Larry Summers:

The idea that adults who have some agenda, whatever the merits of their agenda, are really prepared to threaten sending the United States into default, to pursue their agenda, is beyond belief.

You know, I have had arguments with my college-aged children about spending, and sometimes we discuss whether they should spend less, whether they should pay, whether I should pay. We don’t entertain the option that because we can’t resolve our argument, Visa should get stiffed.

Nemo has extended the metaphor to full-on allegory length, talking about a woman who orders a $40 pizza when she only has $20 to spend. And Michael Kinsley has a whole column driving home the equivalencies:

What does Michele Bachmann teach all those kids about the importance of living up to your obligations?

Say, for example, that one of them owed some people, oh, about $14.3 trillion dollars. Would Bachmann tell her children that a debt is a moral obligation that an honorable person will go to great lengths to pay if at all possible? Or would she tell them, Well, it all depends. Whether you pay back money that’s been loaned to you is a practical question. And if you calculate that you’d be better off reneging, then by all means do so. It’s perfectly O.K.

Does Bachmann teach her kids that it doesn’t matter why you owe the money or what you spent it on—that if you owe it, you have a duty to repay it? Or does she tell them that your obligation to repay depends on whether—in your own opinion—you spent the money wisely or wasted it? Does she say it’s a matter of principle, or does she say it’s a matter of what you can get away with?

It’s all well and good to say that the government is like a household and should always honor its debts. But households don’t always honor their debts — this is why very few people have perfect credit ratings — and if they’re a few days or weeks late on a payment, the world doesn’t come to some calamitous end. So as an argument, this is not a very strong one.

And tactically, wheeling out the household-finance metaphor plays right into the hands of those who, like Barack Obama, are prone to talking about how “government has to start living within its means, just like families do.”

I’m beginning to think that the most politically corrosive movie of the past 20 years was Ivan Reitman’s Dave, from 1993, where the president, armed with nothing but his neighborhood accountant and a couple of bratwursts, manages to fix the budget over dinner.

It’s an attractive and romantic notion, which is why it plays so well in congressional races; it’s almost an article of faith, at this point, among Tea Party types. All we need is some common sense, and the problem’s solved. And that’s also why the personal-finance metaphor is so toxic and dangerous. I can see why people reach for it, at times like these. But they should maybe think twice before doing so.