Felix Salmon


Nick Rizzo
Nov 23, 2011 03:09 UTC

Izzy Kaminska cleverly argues that Swiss bonds are now Giffen goods — FT Alphaville

“France isn’t trading like a AAA” — Bloomberg

Latvia and other European periphery countries are looking like coal mine canaries — FT

A European bank flaps it wings, a loan is denied in Australia — WSJ

Predicting the depressing future of economic policy decisions — Credit Writedowns

8 reasons extending unemployment benefits will boost the economy — Rortybomb

How “long-term unemployed” became synonymous with “unwanted” — National Journal

Problem with thinly traded companies: “eventually they’re no longer thinly traded” — Dealbook

And Errol Morris has a great little documentary about the “umbrella man” and JFK’s death — NYT


Groupon is now trading below its IPO… Buy a share quick as a souvenir!

Posted by TFF | Report as abusive

The Greece basis trade: What could go wrong?

Felix Salmon
Nov 22, 2011 16:03 UTC

Why did Gretchen Morgenson write that column on Sunday about Greek credit default swaps? The answer is that the irresistible lure of writing about CDS lured her into the very murky waters of the Greek basis trade — the trade where you own Greek bonds and then hedge them by buying credit protection on Greece. Now this trade is emphatically not a big deal even in the context of the Greek debt restructuring: it’s probably a couple of billion euros in total, and won’t make much difference either way. But the outcome of the trade is likely to set an important precedent for the sovereign CDS market more generally, so it’s worth looking in a bit of detail at exactly what’s going on here.

Basis trades belong to a set which is relatively common in financial markets: things which are meant to be very safe but which, in fact, aren’t. Merrill Lynch reportedly lost somewhere in the region of $15 billion on basis trades, and at the height of the crisis I proposed that the US government should step in and start buying bond-and-CDS packages as a way to make money and get a bit of price discovery and liquidity into the fixed-income markets.

In theory, basis trades are simple: you buy a bond, which either pays off in full or doesn’t. If it does, you’re golden. If it doesn’t, then any losses you make on the bond can be recouped by profits on the CDS. So long as you buy the bond at a higher spread than the cost of credit protection, you should be guaranteed a modest profit.

But the question is how do you get there from here. Because CDS are derivatives, they’re subject to margin calls, and if you can’t meet CDS margin calls, you might be forced to unwind your trade before maturity. And that can be very expensive, if the basis has widened and markets have moved against you. So while the US government can play the basis trade without worries, everybody else has to treat it with a certain amount of caution.

And all of that was true before various EU member governments started deciding, in a killing-the-messsenger kind of way, that there was something profoundly evil about the sovereign CDS market and that they wanted to start trying to ban it.

There are two main forces putting the Greek restructuring together: the Greeks, and the EU. The Greeks, frankly, don’t care about CDS; what they care about is their debt, and their debt-service payments, both now and in the future. The CDS market, like all derivatives markets, is a zero-sum game, and whether CDS get triggered or not makes little substantive difference as far as Greece is concerned. That’s why I was highly skeptical of the idea that BNP had a conflict of interest when it was working for the Greek government while sitting on a key CDS committee: the Greek government really doesn’t have a dog in this fight.

The EU, on the other hand, has quite a lot of politicians and technocrats who hate the sovereign CDS market and would love to see it die. Bonds can be illiquid; CDS are the market’s way of pricing sovereign debt as accurately as it can. And when sovereign spreads are spiking nastily, it’s easy to blame a relatively small number of CDS traders for scaring the market, exacerbating very real problems, and making it harder to persuade people that things aren’t actually all that bad.

So, if the EU wants to throw a wrench of some kind into the spokes of the CDS market, what could it do in Greece? One thing would be to simply encourage Greece to do a “voluntary” bond exchange which doesn’t trigger the CDS. If bondholders playing the basis trade end up taking a 50% haircut on their bonds but getting nothing from their CDS, then clearly the CDS hasn’t provided them with the protection they thought it would.

There’s been a significant drop in the net notional amount of Greek CDS outstanding, of late, and that might indeed be a function of people unwinding their CDS trades in the face of uncertainty as to how they’ll be treated. But here’s the good news, as far as the CDS market is concerned: as the unwind has been going on, Greek CDS have continued to trade at extremely elevated levels. On a mark-to-market basis, anybody in the basis trade is fine. If they bought protection quite cheaply, they can unwind that trade and sell it at a high price, which will give them profits to offset against any losses they are forced to take on their bonds. In that sense, it doesn’t really matter what happens after the exchange: the trade is over, and it’s done what it was designed to do. More or less.

Meanwhile, as the unwind has been going on, the size of the Greek CDS market has been shrinking, so the number of people affected by the final decision as to whether or not the CDS is triggered has also been shrinking. That could be seen as good news for the EU and for people wanting to kill off the CDS market — but there’s a case to be made that the basis traders have simply moved on to Italy instead, which isn’t really a net improvement.

And the EU doesn’t just want to shrink the sovereign CDS market, it would ideally like to harm it in some way, in the hope that, once burned, the CDS traders stay away altogether next time.

Which brings me to the threats that BNP’s Belle Yang reportedly made in conversations with bondholders. Gretchen Morgenson didn’t explain them very well, partly because — I’m told — Yang herself was a little bit incoherent in what she was saying. But one bondholder did explain to me what he took away from the meeting.

The thing to remember here is that if the CDS isn’t triggered in the bond exchange, it doesn’t just disappear in a puff of uselessness. It still exists, and it still protects bondholders from a payment default. If you hold the old bonds — if you haven’t tendered into the exchange — then in many ways your basis trade hasn’t changed. Either Greece continues to make the coupon payments on the old bonds, or else it doesn’t, at which point the CDS really should trigger and make you whole.

But there are two ways that the sovereign CDS market really could be damaged in the aftermath of an exchange. The first is if the untendered old bonds got impaired significantly while the CDS remained untriggered. For instance, let’s say that Greece, using its own domestic law as the instrument, changed the payment terms on the old bonds so that they were paying out only a fraction of what they were paying before the exchange. That would almost certainly be a credit event under the ISDA definitions, and would trigger the CDS. But under one reading of what Yang was saying, Greece and/or the EU might attempt to impair the old bonds and pressure ISDA to declare that the impairment doesn’t count as an event of default. I very much doubt that ISDA would ever make such a determination. But if it did, then that would be a serious blow to the sovereign CDS market.

The second possibility is that Greece continues paying the old bond coupons in full, alongside its new bond coupons. And the Greek CDS market continues trading without any credit event. Until, one day, Greece being Greece, the country defaults again — on both its old bonds and its new ones. At that point, the CDS triggers. And to collect your payment on your CDS, you need to give up your bonds. But here’s the cunning bit: Yang has been hinting, I’m told, in her meetings with bondholders, that the EU and/or Greece will find some kind of way to change the law so that the old bonds aren’t eligible to be deliverable into the CDS exchange — to get paid out on your CDS, you’ll need to pay for new bonds, and your old bonds will be worthless.

If this were a credible threat, it would certainly be a good reason, at the margin, to tender into the current exchange rather than hold out. I don’t think it is a credible threat, but it’s easy to see how some investors might not want to take the risk.

The thing is, CDS is a young market, which hasn’t been tested in lots of different circumstances. No one can know for sure how it’s going to play out in future. So far, the CDS market has held up pretty well — everybody prophesying doom in the wake of the Lehman bankruptcy, for instance, was proved wrong. And when CDS were triggered on Fannie and Freddie despite the fact that there was never any payment default, the market coped with that well, too. My guess is that CDS will do what they’re meant to do, in Greece. But BNP is trying to spread a certain amount of fear, uncertainty and doubt over whether that’s necessarily the case.

As a result, anybody in the Greece basis trade needs to have a good degree of self-confidence that they know what they’re doing. Which, frankly, they should have had all along. Using derivatives to arbitrage securities is always a little bit messy and fraught with legal risks. If you don’t have confidence in what you’re doing, you shouldn’t be doing it in the first place.


@Publius, remember that bit about “modest profit”? Most basis trades need to be levered to be worthwhile, so you will be posting collateral on the long bond position. Collateral transfers on the CDS leg may be mtm settlement, but on the bond leg will be based on a haircut which may be reset based on perceived risk and not just mtm. Anyway, it’s entirely possible to lose on both legs of a trade; it’s so common that there is a special name for it: Texas hedge. Also, that volatile quanto adjustment that alea mentioned makes a big difference because it means that it would be expensive (in trading costs) to stay hedged. I’ll bet anyone who actually puts on this trade is punting some part of the currency exposure.

@klhoughton, sure alea has it right, but he’s not saying the same thing you are.

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Nick Rizzo
Nov 21, 2011 23:22 UTC

Some fresh links selected today from Counterparties.com:

Credit Suisse: The “last days” of the Euro are here — FT Alphaville


FMCN’s stock dropped 40% on this Muddy Waters report calling them lying liars — Zero Hedge

MF Global trustee: Actually, we think we’re missing $1.2 billion — Market Watch

“Mr. Nocera – You have destroyed everything and everyone related to Steven J. Baum PC” — Dealbook

A really big visualization of money — xkcd

Fresh off its pension overhaul, Rhode Island experiments with “work sharing” — WSJ

The continuing hunt for Anyone But Romney, illustrated graphically — National Post

And The Atlantic is now making more from digital than print advertising — NYT



“MF Global trustee: Actually, we think we’re missing $1.2 billion”

Let’s be accurate: after the “collateral” was taken to cover 100% of financial institutions–ignoring whether the collateral was client or firm money–the clients are short.

Welcome to BidenVille, MF Global investors. Those of you who thought the 2005 R&P Act wouldn’t affect you because you would never have to declare bankruptcy are reaping the whirlwind.

Posted by klhoughton | Report as abusive

Why you can’t always trust auction results

Felix Salmon
Nov 21, 2011 20:15 UTC

Back in May, Sarah Thornton started worrying about the system of third-party guarantees and irrevocable bids at high-profile auction houses. I struggled to see what the fuss was about:

What’s Thornton’s beef with private sales, especially when the final price is public? A $50 million Warhol is a $50 million Warhol, whether the sale takes place in public, in private, or somewhere in between — and whether the sale is deliberate and orchestrated or whether it’s chaotic and unpredictable.

Now, however, Thornton has answered my question, in a new post. It turns out, according to her, that a $50 million Warhol — or, more to the point, a $43,202,500 Lichtenstein — might not be quite what it seems after all.

It is strongly believed, for example, that Guy Bennett, an art advisor acting on behalf of the Qataris, negotiated third-party guarantees on the top lots at both Christie’s and Sotheby’s recent contemporary auctions in New York. During the prestigious evening sale at Christie’s on November 8th, Mr Bennett was seen to make the winning bid of $38.5m for Roy Lichtenstein’s 1961 painting, “I can see the whole room!… and There’s Nobody in it!”. Christie’s normal buyer’s premium (or commission) on this would bring the final price up to $43.2m, which was the price reported by Christie’s. However, high-powered guarantors often negotiate a 50-50 split with the auction house of as much as 30% of the overage (the amount generated above the guaranteed price) and an additional 50% of the buyer’s premium. The market believes the Lichtenstein was guaranteed at $35m. If Mr Bennett, who bought the picture, had negotiated such a deal, the real price he paid would have been $40.3m.

This is more complicated than it needs to be, and of course it’s all based on what “the market believes”, which might not be fully accurate. But in principle, there’s definitely the possibility that something fishy might be going on whenever a guarantor buys a painting at auction for more than its low estimate.

There’s a lot of opacity when it comes to fine-art auctions, but the one thing which is always fully transparent is the final sale price. Sellers can negotiate deals when it comes to the commission they pay the auction house; buyers can’t. The buyer’s premium is set, and is public, and can always be used to find out the total amount of money which was spent by the buyer on the work of art in question. That’s why art-price databases use auction results: they know exactly how much was spent, even if they don’t know who the buyer was.

But now, with the system of third-party guarantees, we no longer know for sure that the reported price was in fact the price actually paid by the buyer.

The reason is this: in return for providing an irrevocable bid for a certain artwork (normally, but not always, at the low estimate), the auction house agrees to split some of the upside with the guarantor. Take that Lichtenstein. Its low estimate was $35 million; let’s say that someone called Guy Guarantor provides an irrevocable bid at that price. In return, he gets a deal from Christie’s. If the painting sells for more than $35 million, he’ll get 15% of the increase in the hammer price over and above $35 million, and he’ll also get 50% of the total buyer’s premium.

As it happened, the Lichtenstein was hammered down for $38.5 million — that’s $3.5 million more than the low estimate at which Guy Guarantor was providing the irrevocable bid. The total reported price for the painting was $43,202,500, including a buyer’s premium of $4,702,500. So Christie’s takes 15% of $3.5 million, or $525,000, and adds it to 50% of $4,702,500, which is $2,351,250. The total — $2,876,250 — is the amount that’s owed to Guy Guarantor under the terms of their deal.

That’s all fine, as far as I’m concerned. The buyer pays a total of $43,202,500, and that money gets divvied up between various parties. Christie’s gets some, Guy Guarantor gets some, and the seller, of course, gets most of it. As long as we know the amount the buyer is willing to spend on the painting, the auction market remains as transparent as it’s ever been.

But what happens if Guy Guarantor is the buyer? According to Thornton, the agreement is still in effect — which means that as he’s handing over a check for $43,202,500 with one hand, he’s simultaneously receiving a check for $2,876,250 with the other. The total amount the buyer pays, in this instance, is not $43,202,500, but rather $40,326,250.

That makes a difference. For one thing, if the work actually sold for $40,326,250 rather than $43,202,500, it would no longer be an auction record for the artist: “Ohhh… Alright…”, a 1964 canvas, sold in the same sale last year for $42,642,500. Is “I can see the whole room” the most expensive Lichtenstein ever sold at auction? According to Christie’s it is. But given Thornton’s reporting, there has to be some doubt about this.

I’ve got a call in to Christie’s about this, and we’ll see what they say, but I’ll only really be happy with one thing: a clear statement that a guarantor — or any other buyer, for that matter — cannot get any kind of rebate when he ends up being the high bidder. In order for published auction prices to mean anything, we need to know that the buyer actually paid the sum reported. Right now, we don’t know that — and in the case of the $43,202,500 Lichtenstein, there’s solid reason to believe that the price as reported by Christies, and embedded in places like the Artnet auction database, could actually be a lie.

(Incidentally, the Lichtenstein is a great poster child not only for auction-house opacity, but also for contemporary-art price appreciation. It was last sold for $2,090,000 in 1988 — and before that was sold for $450 in 1961. That’s a 50-year CAGR of somewhere over 25%.)

Update: Christie’s gets back to me, with this statement. The emphasis is mine:

When a third party agrees to finance all or part of Christie’s interest in a lot, it takes on all or part of the risk of the lot not being sold, and will be remunerated in exchange for accepting this risk. The third party may also bid for the lot. Where it does so, and is the successful bidder, the remuneration may be netted against the final purchase price. If the lot is not sold, the third party may incur a loss.

This seems to me an admission that the recorded final purchase price may indeed not be the actual price of the artwork to the buyer. And that therefore we can not trust that, to take just this example, a new artist record has just been set for Roy Lichtenstein. And, I can’t see how the third party will ever incur a loss, unless they never wanted the artwork in the first place. The worst-case scenario, for the guarantor, is that they end up buying the artwork for the amount they said they were willing to buy it for.

Update 2: TGDC and Auros, in the comments, make the case that Guy Guarantor really did pay the full $43,202,500:

He paid in in the form of the $40.3mm in net cash paid PLUS forgoing the $2.9mm he would have otherwise gotten had he not won. The guarantee is a sunk cost/gain since it happens in advance and is irrevocable. At the margin, he decided he’d rather have the painting than the $43mm in cash he’d have if he didn’t make that final bid. That is the market price.

If Guy had decided not to make a further bid above his original irrevocable $35M, he would’ve gone home with a paycheck. The service he provided, for that paycheck, has been renedered, whether he bids or not. The paycheck has to be considered separately from the cost of the art.

I think that TGDC is wrong that Guy Guarantor would have had $43 million in cash if he hadn’t made that final bid. In fact, to make that bid he needed only $40.3 million in cash. But the case here is definitely colorable. It just doesn’t change the fact that the buyer didn’t actually pay the amount he’s reported to have paid.

Update 3: I feel like I’m disappearing down a rabbit hole here, but I’m going to make one more stab at the question of Guy Guarantor’s cash situation. We can basically bring it down to two choices: either he buys the painting, or he doesn’t. (We’ll assume it’s hammered down for $38.5 million either way.) If he buys the painting, he’s down $40.3m in cash, and up one painting. If he doesn’t buy the painting, he’s up $2.9m in cash. So it’s reasonable to say that, in cash terms, the difference between buying and not buying is the difference between -$40.3m and +$2.9m, which is the headline $43.2m figure.

So here’s the question. When you make a purchase, is the amount you spend on that purchase the amount you spend on that purchase? Or does it make more sense to think of it as the difference between the amount of money you have after the transaction, on the one hand, and the amount of money you would have spent if you hadn’t made the transaction, on the other?

In the case of art, there’s a case to be made for looking at it either way. But by convention, sale prices never include sales tax. If I buy a painting at auction in New York and hang it in my New York apartment, I have to pay sales tax on that. But the price of the painting is not the full amount I pay; it’s just the price of the painting, sans tax. If auction results exclude sales tax for those people who pay it, they should also exclude the opportunity cost of guarantors’ foregone profit, I think.


TFF, the fact that a single buyer was willing to pay price X at a public auction actually gives you a substantial amount of information about what the painting would sell for to another buyer. If no other buyers were interested in the painting at between 35M and 38.1M, it would have sold for the low guarantee of 35M. So we know that there was at least one other buyer willing to pay some amount between those two numbers. If we know more about the bidding process, we could further refine that number. If the bidding is fine grained enough, then using the purchase price as a “value” is a reasonable rough estimate.

Felix: I think others are correct that 43.2 is essentially the real price, since it is the difference in the buyer’s financial assets (minus the painting) between buying and not buying. I have one niggle, though. Since the bidding is not infinitely fine-grained. What matters is what price the painting would have sold for if the gaurantor had not made the final bid. If this is, say 100k less than the final purchase price, then 65% (or whatever the deal is) of that difference should be taken off the price. If the steps were much wider, and this difference was 500k or even 1million, that ends up making a pretty big difference in the actual purchase price.

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Can austerity cure contagion?

Felix Salmon
Nov 21, 2011 16:37 UTC

I love this video from Mark Fiore:

Sovereign Transmitted Debts don’t have to be embarrassing or keep you from other financial relationships…

Contagion-Ex works by releasing a powerful dose of austerity on troublesome workers, reducing your risk of financial infection so your wealth can be preserved.

It’s easy to believe that this is what Europe’s leaders are up to — after all, Mario Draghi, Mario Monti, and Lucas Papademos are all proud alumni of Goldman Sachs. Aren’t these exactly the kind of unelected technocrats who would shaft their putative constituents so that the 1% can continue to rake it in?

As Paul Krugman points out, though, the prescriptions coming from Europe’s unelected leaders tend to feel “more like a religious proclamation than a technocratic assessment.” For here’s the real irony: austerity will cause untold harm for hundreds of millions of European citizens — and it will harm the fat-cat bankers, too.

Look at the prices of the sovereign bonds that they’re holding, or at the share prices of their banks: austerity doesn’t seem to be helping the bankers at all. We’re in a liquidity crisis, here, and austerity doesn’t provide liquidity to anybody. Quite the opposite.

But here’s the cunning bit: the bankers don’t really have their banks’ best interests at heart. They just want to keep on getting their coupon payments until this year’s bonuses are paid. And then, once those bonus checks are cashed, they’ll start trying to get next year’s bonus payment, too.

The bankers and technocrats know full well that the longer they manage to kick the can down the road, the worse it’ll be for everybody in the long run. But in the short run, they get very wealthy. Even as crucial government services are cut to the bone, and the risk of major social unrest increases greatly.

Update: Sorry for saying that Papademos used to work for Goldman Sachs. He didn’t. But people think he did. Just like Tim Geithner!


In what extremely cases is austerity needed?

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Correlation chart of the day, hedge-fund edition

Felix Salmon
Nov 21, 2011 14:58 UTC


Mark Gongloff finds this astonishing chart in a Morgan Stanley note this morning. It shows the degree to which hedge fund returns, in aggregate, are correlated with our old friend the S&P 500. And it turns out that even though the correlation has never been higher, it’s still somehow rising.

Now this isn’t all hedge funds — it’s just looking at the HFRI Equity Hedge index. That index covers, broadly, any hedge fund which invests mostly in stocks — but is entirely agnostic as to whether you’re long or short. It includes market-neutral funds, which aspire to be uncorrelated with the market; it also includes short-bias funds, which aspire to a negative correlation with the market, at least in times when the market is rising. And it also includes things like quantitative directional funds, which are algo-driven and tend to make momentum plays rather than long-term investing decisions.

And yet, look at the performance of all those funds put together, and it turns out to almost exactly mirror the performance of the S&P 500.

The result is predictable:


Once upon a time, according to this chart, hedge funds playing in the stock market actually outperformed the S&P 500. They did so during the dot-com bubble, and they did so after the bubble, too. You can quibble about what exactly is being measured here, and survivorship bias, and performance fees, and things like that. But whatever’s being measured, it’s now gone negative. Put all the smartest hedge-fund managers together in a room, tell them to go out and make lots of money, and over the past five years you would have been better off in an index fund.

As Gongloff says, “the current market environment of extreme correlation has made it nearly impossible to pick stocks well”. And this has lessons even for those of us who simply invest in index funds, too. A lot of financial advisers get quite excited about diversifying index funds — rather than just investing in the S&P 500, you should invest in a growth fund here and a value fund there and an emerging-markets fund and a large-cap fund and a small-cap fund and probably a RAFI fund or two just for good measure.

But the one thing you can be quite sure of, when it comes to all these clever ETFs and index funds, is that they have significantly higher fees than your bog-standard S&P 500 index tracker. And with correlations where they are, it’s increasingly difficult to believe that there’s much if any reason to pay those higher fees. Even if they’re a lot lower than the 2-and-20 charged by the HFRI crowd.

Update: It’s not a thing of beauty, but here are the correlation charts for other hedge-fund strategies. The thick line is hedge funds generally; the only strategy which doesn’t have high correlation right now is Macro.


I’m biased but one of the best (only) ways left to get true alpha is to invest in startups/private growth companies… (of course that doesn’t mean it is risk free, just that returns will have a very low correlation to public markets…)

Posted by parkparadigm | Report as abusive

Why tuition costs are rising

Felix Salmon
Nov 21, 2011 06:13 UTC

I’m late to Jim Surowiecki’s column on student loans, but I wanted to respond quantitatively to his theory about productivity growth at universities:

Education costs, and student debt, are rising at what seem like unsustainable rates. But this isn’t the result of collective delusion. Instead, it stems from the peculiar economics of education, which have a lot in common with the economics of health care, another industry with a huge cost problem. (Indeed, in recent decades the cost of both college education and health care has risen sharply in most developed countries, not just the U.S.) Both industries suffer from an ailment called Baumol’s cost disease, which was diagnosed by the economist William Baumol, back in the sixties. Baumol recognized that some sectors of the economy, like manufacturing, have rising productivity—they regularly produce more with less, which leads to higher wages and rising living standards. But other sectors, like education, have a harder time increasing productivity. Ford, after all, can make more cars with fewer workers and in less time than it did in 1980. But the average student-teacher ratio in college is sixteen to one, just about what it was thirty years ago. In other words, teachers today aren’t any more productive than they were in 1980. The problem is that colleges can’t pay 1980 salaries, and the only way they can pay 2011 salaries is by raising prices.

On its face, this makes sense. In widget factories, wage inflation is offset by productivity growth. In universities, it isn’t. So while the cost of a widget can stay the same or go down over time even as the widget makers get paid more, the same isn’t true of tuition costs.

In reality, however, the numbers show that wage inflation is — literally — the least of the problems when it comes to university cost inflation. Check out this excellent report, for instance, entitled “Trends in College Spending, 1999-2009″. The first thing to note is on page 26: spending on faculty compensation is never more than 40% of total spending, and “has remained steady or decreased slightly over time”. Then have a look at the numbers.

Overall, if we exclude for-profit schools, which were a tiny part of the landscape in 1999, we have seen tuition fees rise by 32% between 1999 and 2009. Over the same period, instruction costs rose just 5.6% — the lowest rate of inflation of any of the components of education services. (“Student services costs” and “operations and maintenance costs” saw the greatest inflation, at 15.2% and 18.1% respectively, but even that is only half the rate that tuition increased.)

The real reason why tuition has been rising so much has nothing to do with Baumol, and everything to do with the government. Page 31 of the report is quite clear: “except for private research institutions,” it says, “tuitions were increasing almost exclusively to replace losses from state revenues or other private revenue sources.”

In other words, tuition costs are going up just because state subsidies are going down. Every time there’s a state fiscal crisis, subsidies get cut; once cut, they never get reinstated. And so the proportion of the cost of college which is borne by the student has been rising steadily for decades.

There are other culprits, too, behind the rise in tuition costs. Surowiecki touches on one when he talks about “the arms-race problem”, where “colleges compete to lure students by investing in expensive things, like high-profile faculty members, fancy facilities, and a low student-to-teacher ratio”. Another is simply the ever-increasing amounts of money being spent on administration rather than instruction. And a third is the fact that administrators at many high-profile universities have no incentive to decrease costs, and in fact have an incentive to increase costs, since total spending outlay tends to show up as an input in university-ranking algorithms.

But of all the reasons why tuition’s going up, teacher productivity is — literally — at the bottom of the list. Whether or not teachers today are or are not more productive than they were in 1980 (and I suspect that actually they are more productive), that’s not the reason student debt in America is approaching one trillion dollars.


This is undoubtedly valuable post. Many thanks… Put it in my bookmarks and will be checking back soon…

Screen capture http://freescreenrecorder.net/

Posted by Miranda_Johnson | Report as abusive

CDS conspiracy theory du jour, Gretchen Morgenson edition

Felix Salmon
Nov 20, 2011 18:14 UTC

Why oh why does Gretchen Morgenson insist on writing about credit default swaps as though she understands them? She’s done it again today, with an article about Greece which ratchets the conspiracy theorizing up to frankly bonkers levels:

The money managers with whom I spoke said BNP Paribas seemed to be motivated either by its desire to generate fees from the exchange or, perhaps, by worries about its own exposure to Greece. They wondered, for instance, if BNP Paribas has written a lot of insurance on Greek debt. If so, getting people to unwind such swaps now would be less costly for BNP than having the insurance pay off.

Note the levels of deniability here: if you look at how BNP’s actions “seem” to be motivated, they are “perhaps” being driven by BNP’s own exposure, which could be reduced “if” it has a lot of CDS exposure to Greece. And, of course, the whole thing is wrapped up in its own invisible quote marks — it’s all the opinion of anonymous money managers, without Morgenson giving us any indication at all of why we should be listening to them in the first place, or what their conflicts might be.

(There is actually a truth to the matter, here, as Peter Thal Larsen points out: BNP Paribas had €5 billion of direct exposure to Greek debt at the end of 2010, and a mere €0.1 billion of indirect exposure.)

The other explanation of BNP’s actions in this passage is simultaneously obvious and very weird: the bank, says Morgenson, might be “motivated by its desire to generate fees from the exchange”. Which is pretty much the most prejudiced possible way of saying, simply, that BNP has a job to do, and it’s doing that job.

BNP, you see, has been hired by the government of Greece to gin up interest in Greece’s bond exchange and try to ensure it goes smoothly. That’s a smart move by Greece, because BNP is one of the largest holders of Greek government debt. And this is quite an elegant way of Greece ensuring that BNP, rather than having to be persuaded to go along with the deal, will in fact be trying to persuade everybody else to go along with the deal.

But that obvious and true explanation of what BNP is doing isn’t good enough for Morgenson, who instead indulges anonymous money managers in flights of fancy about how BNP might have “written a lot of insurance on Greek debt”. There’s no evidence for this whatsoever — and I don’t believe for a minute that it’s true. In fact, I can’t think of any bank which has ever amassed a significant long position in any given name, through the CDS market, for any significant length of time. The poster children for that kind of misbehavior were the big insurers, including AIG, who ended up with long positions in highly-bespoke CDS. The closest thing I can think of at a bank was Howie Hubler’s disastrous mortgage-bond trade at Morgan Stanley, where a relative-value play blew up in his face. But the one thing all those blow-ups had in common was that their long position was in super-senior debt which was considered ultra-safe.

And in any case, if BNP had indeed written a lot of protection on Greece, it’s very hard to see how (a) it could manage to get the Greek government’s mandate because it had that position; or (b) how having the mandate would actually help the bank at all with respect to its position. Morgenson makes a very big deal out of the fact that one of the BNP bankers — Belle Yang — is on ISDA’s determinations committee for Europe, and can therefore help influence whether Greece’s CDS pay out or not — but that would be the case whether or not BNP had the mandate.

What’s more, Morgenson is objecting to some extremely unexceptional statements by Yang. Here’s Morgenson:

The BNP Paribas bankers have been telling bond holders that their credit insurance may not pay off down the road, because after the restructuring is completed, the terms of the old debt might be changed, these money managers said.

Normally, investors would shrug off such an argument…

According to one of the money managers, Ms. Yang told the investors that one potential hitch would be if Greece were to change the terms of its old bonds…

If investors think debt terms can be changed by fiat, they will flee the market. Ditto if they find that their insurance can be made worthless. Indeed, some of the volatility in European debt recently may be attributed to investor fears about these issues.

Morgenson’s saying, here, that it’s unthinkable for Greece to unilaterally change the terms of its old bonds, and that no one even considered such an eventuality until recently, when “some of the volatility” we’ve been seeing of late might be a result of investors suddenly realizing that it’s possible and that one of the ISDA committee members might somehow allow it to happen.

This is ludicrous. Everybody knows that Greece can and should take some kind of tactical advantage of the fact that most of its debt has been issued under Greek domestic law. Never mind the fact that a BNP banker sits on an obscure ISDA committee: why not look instead at what’s been written by the dean of sovereign-debt lawyers, Lee Buchheit, on this very subject? Buchheit works for Cleary Gottlieb, and is working directly for the Greek government. And more than 18 months ago he laid out Greece’s options very clearly, in a paper which was posted freely on the internet and which has been downloaded thousands of times, not to mention being passed around in PDF or printed-out form to pretty much everybody who’s involved in making decisions about Greek bonds. Yang, it turns out, was saying nothing which Buchheit wasn’t saying in May 2010:

The greatest advantage that Greece would enjoy in a restructuring of its debt derives from the fact that so much of the debt stock is expressly governed by Greek law. This raises the possibility, discussed in more detail below, that the restructuring could be facilitated in some way by a change to Greek law…

International investors are often leery of buying debt securities of emerging market sovereign issuers that are governed by the law of the issuing state. Why? Because investors fear that the sovereign might someday be tempted to change its own law in a way that would impair the value or the enforceability of those securities. Such changes in local law would normally be respected by American and English courts if the debt instruments are expressly — or otherwise found to be — governed by that local law.

Buchheit proposes one action that Greece could take — a “Mopping-Up Law” which would essentially change the payment terms on untendered bonds so that they were the same as the payments being received by bondholders who tendered into the exchange. There are many others: a sovereign country can change its own law pretty much any way it likes. And although there would surely be legal challenges if it tried to do so, I don’t think there’s anybody who’s optimistic such challenges would succeed.

If there were any investors out there, 18 months ago, who didn’t realize that Greece’s debt terms can be changed by fiat, there weren’t any after Buchheit’s paper came out. So when Morgenson says that investors “will” flee the market when they work this out, she’s at least 18 months behind the curve. And indeed one of the big reasons why Greece’s debt is held overwhelmingly by banks rather than by institutional bond investors is precisely this one.

More generally, Morgenson’s simply wrong when she says that the treatment of CDS is a “a big point of contention” in this restructuring. She’s been talking to an unknown number of “investors” and “money managers”; the only one she names is David Kotok, of Cumberland Advisors. But as everybody involved in the Greece deal knows, institutional investors in general, and American institutional investors in particular, are essentially an afterthought here; the deal will succeed or fail based entirely on the degree to which it’s embraced by Europe’s banks.

The funniest part of Morgenson’s article is this:

Investors who own Greek debt and have bought insurance on it, in the form of credit default swaps, wonder why they should accept the offer that’s on the table…

The discussions with BNP Paribas confirm the view of some investors that credit default swaps are not insurance at all.

Does Morgenson really believe that CDS is an insurance product and used that way by investors? That there’s a bunch of bond investors out there who bought Greek bonds, and then, rather then selling those bonds, bought protection on them instead, using that protection as insurance against a bond default?

The truth of the matter is that the set of “investors who own Greek debt and have bought insurance on it, in the form of credit default swaps” is utterly minuscule, and that every single member of that set is a highly sophisticated player who knows all about issues surrounding Greek domestic law and the potential problems with this kind of basis trade. The last thing that any of them need or want is Gretchen Morgenson going to bat for them on the front page of the Sunday business section of the NYT. And their plight is certainly not of interest to the NYT’s readership as a whole.

Update: Just when you thought this whole thing couldn’t get any sillier, it now emerges that BNP might not actually be advising the Greek government after all! Athens News reported on November 6 that Greece “has terminated its collaboration” with BNP, Deutsche Bank, and HSBC.


Gretchen Morgenson is an idiot, pure and simple. She exhibits, at best, a rudimentary understanding of the things she writes about, but in this climate of “Wall Street is Evil” she’s made a name for herself (and a nice living) inventing scandals and imagining misconduct. I can’t read her anymore – I’m a die-hard liberal and I’m really close to canceling my NY Times subscription just so I won’t have to see her byline anymore.

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Nick Rizzo
Nov 19, 2011 00:24 UTC

Europe’s web of debt, illustrated — BBC

S&P makes a bit of an error with a headline about Brazil’s credit rating — Bloomberg

Miners in Australia can earn $200,000 annually — WSJ

The new head of the FDIC “could make Sheila Bair look like a kitty cat” — WSJ

The “do-nothing” economic budget plan that would save us $7.1 trillion — Washington Post

Krugman: let the Supercommittee fail — NYT

Nate Silver on which economic indicators best predict Presidential elections – Five Thirty Eight

Sean Parker’s thinking of Thanksgiving, says the tech “gravy train” is almost over — CNET

Newsweek staffer: “I mean, Regis Philbin is our cover this week” — WWD

One of the worst parts of the euro zone crisis, for me, is watching the televised vindication of that nut Nigel Farage — Zero Hedge


chris9059, it’s not a horror, but they are engaged in extraction. And since the natural resources existed in the ground without someone creating them, in the Ricardian economic sense we can refer to the ownership of those resources as giving rise to “rents”. So it just strikes me as funny you used that phrase.

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