Felix Salmon

Alea today posts the timeline for physical settlement of credit default swaps, once a credit event has been declared. He doesn’t say why he’s posting it, but the main thing to note is that it’s likely to take a couple of months between (a) the credit event being declared in Greece, and (b) the final settlement of all credit default swaps on Greece.

And that, in turn, reveals a significant weakness in the architecture of CDS documentation. It may or may not be a big deal, this time round. But market participants have already been spooked by the possibility that Greece might be able to default without triggering its CDS at all. Now they can add to that another worry: that Greece might be able to default in such a manner as to leave the ultimate value of the CDS largely a matter of luck.

The way that CDS auctions work, you start with a credit event. Then, using an auction mechanism, the market works out what the cheapest bond of the defaulting issuer is worth. If it’s worth, say, 25 cents on the dollar, then people who wrote credit protection end up paying 75 cents to the people who bought protection: that’s equivalent to the people who bought protection getting 100 cents on the dollar, and handing their bonds over in return.

With Greece, however, the bond exchange is going to complicate things — a lot. Remember that it has a natural deadline: March 20, when a €14 billion principal payment comes due. If Greece’s old bonds haven’t been exchanged for new bonds by that point, then things will get even uglier, and even more chaotic, than anybody’s expecting right now. So it’s very much in Greece’s interest, and Europe’s more generally, to have everything wrapped up by March 20. Bondholders too, truth be told — they hate uncertainty.

But then there’s the CDS holders. In the best-case scenario for Greece and Europe and bondholders, every €1,000 of old Greek bonds will get converted to new bonds with a face value of just €315. Those bonds will probably trade at about 30% of face value, which means the new-Greek-bond component of the exchange will be worth about 10 cents for every dollar in face value of old Greek bonds that you might currently hold. Add in another 15 cents of EFSF bonds, and the total value of the exchange will be about 25 cents on the dollar, which is why people are talking about a 75% “present value haircut”.

The important thing, here, is that Greece is issuing new bonds worth around 10 cents on the dollar, while the EFSF is issuing new bonds worth around 15 cents on the dollar. The structure of the new Greek bonds is secondary: these ones involve a nominal haircut of 68.5%, and a market price of about 30 cents on the dollar. But theoretically, Greece could have constructed bonds with a significantly higher coupon and a bigger nominal haircut — maybe the haircut would be 85%, with the bonds trading at 67 cents on the dollar. Bondholders would still receive about €100 worth of new Greek bonds for every €1,000 of old Greek bonds they hold. But instead of the new Greek bonds trading at 30 cents, they’d trade at 67 cents.

Why does it matter what the nominal price of the new Greek bonds is, so long as the total package, including EFSF bonds, is worth about 25 cents on the dollar? Economically speaking, it doesn’t. But for the purposes of the CDS auction, it matters a great deal.

The reason is that the key number in the auction is the nominal value of the cheapest-to-deliver Greek bond — that’s the price at which the auction clears. And here’s the rub: this auction is going to take place after March 20, after the old Greek bonds have been exchanged into new securities. Because Greece intends to use collective action clauses to change the terms of all its outstanding bonds, even if they’re not tendered into the exchange, there effectively won’t be any old bonds in existence by the time the CDS auction happens. The only outstanding reference securities will be new bonds.

In the auction, market participants will not be bidding on the value of the package that is being offered in return for every old bond. The new EFSF bonds are obligations of the EFSF, for instance: they’re not obligations of Greece, and they have no place in a Greek CDS auction.

The way that CDS auctions are meant to work is that once a borrower defaults on its debt, that defaulted debt continues to be traded in the market, and its value then determines the amount that credit default swaps need to pay out. But in this case, Greece’s defaulted debt might well not continue to be traded in the market. In which case, when traders need to find a cheapest-to-deliver bond to bid on in the CDS auction, they’re going to have to use one of the new bonds, rather than one of the old ones.

And now you can see why the nominal price of the new Greek bonds is so important. Right now, it seems that they’ll be trading at a nominal price of about 30 cents on the dollar, which is close (ish) to the current market price of the old Greek debt. But there’s no particular reason why that should be the case. If Greece had gone for an 85% nominal haircut rather than a 68.5% nominal haircut, then the nominal price of the new Greek bonds would be 67 cents on the dollar — and anybody who wrote credit protection on Greece would only have to pay out 33 cents on the dollar rather than 70 cents on the dollar.

In other words, Greece’s CDS really aren’t protecting holders of Greek bonds at all — or if they do, it’s more a matter of luck than of law. When they get paid out on their CDS holdings, people owning protection against a Greek default won’t get paid according to how much money they lost on their old bonds. Instead, they’ll get paid according to the nominal price of the new bonds.

What this means is that the CDS architecture is broken, and can’t cope with collective action clauses. And as a result, according to the hedge fund manager who tipped me off to the whole problem, “this Greece CDS imbroglio might be the final blow for sovereign CDS as a product.”

Now there is a possible solution here: ISDA could try to decree, somehow, that the total package bondholders receive in return for their old bonds will count as a deliverable security for the purposes of the CDS auction. Bundle up the new bonds, the EFSF bonds, the GDP warrants, everything — and that bundle can be bid on in the auction, to determine where the CDS pays out. That would be fair and right. But the problem is, it might not be legal. There’s really nothing in the ISDA CDS documentation which explicitly allows that to happen.

The whole point about credit default swaps is that they’re meant to behave in a predictable manner in the event of default; one thing we know for sure about Greece is that the behavior of its CDS is going to be anything but predictable. We don’t even know for sure whether they’ll be triggered, let alone what they’ll be worth if and when they are.

Now there are a lot of people, among them European policymakers, who would actually be quite happy if the Greek default killed off the sovereign CDS market as a side effect. But I actually believe that sovereign CDS, when they work, are rather useful things. It’s just that Greece is having the effect of showing that they don’t necessarily work. And if you can’t be sure that they’ll work when triggered, there’s really no point in buying them at all.

Peter Eavis is too smart, and knows too much, to be writing disingenuous stuff like this, about Greece’s credit default swaps:

If parties have to make good on the credit-default swaps, the situation could send shivers through the market. An important and long-planned measure that aims to strengthen the derivatives market is not yet in place, raising questions about how the financial system will react if the credit-default swaps have to pay out.

In the financial crisis of 2008, banks feared that their trading partners might not be able to meet such obligations on derivatives and other financial arrangements. The situation set off a chain reaction that paralyzed global markets until governments and central banks provided enormous financial support.

To prevent a similar disaster from happening again, finance ministers in the United States and Europe committed in 2009 to move derivatives like credit-default swaps onto clearinghouses. These organizations, if they work properly, can sharply reduce the chances that a large bank will not make good on such contracts.

There are lots of very good reasons why credit derivatives should be moved to exchanges — even though such a move is no panacea. But it’s silly to think that Greece in particular “could send shivers through the market” with respect to counterparty risk. Counterparty risk in the CDS market is highly correlated to jump risk — the risk that a seemingly-healthy company suddenly defaults on its obligations, causing a massive unexpected payout by anybody who had written protection on that name. In a case like Greece, where default is already priced in to the CDS market, there’s no jump risk at all, and anybody who has written protection has already posted enough margin that there shouldn’t be any problems at all.

More generally, the 2008 credit crunch was never related to worries over traded derivatives; it was — like all credit crunches — related to much more general worries over bank solvency and the quality of banks’ balance sheets. And in any case, the size of a bank’s derivatives obligations is unrelated to whether those obligations are settled bilaterally or centrally. If a bank has written so much credit protection that it becomes insolvent, then there’s significant systemic counterparty risk regardless of how its derivatives trades are cleared. Moving to an exchange might make its CDS counter parties more likely to get paid out in full, but it wouldn’t prevent other banks from refusing to do business with the insolvent bank, pulling their repo lines, and generally moving back in the direction of another credit crunch.

So the move to central clearing was never — could never have been — designed to prevent counterparty risk leading to a credit crunch. I welcome all wonky Peter Eavis articles about central clearing and why it hasn’t happened yet. But I’m very disappointed by this attempt to tie the issue into the Greek default in particular, which is entirely unrelated to the central-clearing issue. More generally, I think it’s a bad idea to sell central clearing as a potential means of preventing another disastrous credit crunch: it could never live up to that billing. It’s a perfectly good thing even if it doesn’t have such mythical abilities.

Andrew Ross Sorkin today asks why Treasury is letting AIG keep billions of dollars in net operating losses, rather than forcing it to pay income tax. I’ll hazard a guess at one part of the answer, as informed by my conversation with Jim Millstein in October 2010: if you want to have a high value for your insurance company, you want it to have a rock-solid credit rating. And so you boost the value of the equity cushion in the company by padding it with net operating loss carryovers and the like, even if that means you lose a certain amount of corporate income tax in the meantime.

But there’s something else going on here too, which is the optics of the AIG bailout. The New York Fed today announced that it had finally exited its Maiden Lane II portfolio — the toxic securities bought at a discount from AIG in the 2008 bailout — at a healthy profit of $2.8 billion. It held on to those securities in May 2011, when AIG itself offered to buy them back at a much more modest profit for the Fed. And when forced to choose sides between AIG and the Fed in 2011, Treasury sided with AIG. At all times, Treasury wants what’s best for AIG’s share price, so that it can, hopefully sooner rather than later, sell off its entire 77% stake in the company at some kind of profit.

It’s already taken longer than Treasury would have liked: there was a feeling when I spoke to Millstein that the sale of AIG might be reasonably imminent, and yet here we are, more than 16 months later, and we don’t seem to be all that much closer to such an event. So unless and until AIG gets sold, expect Treasury to continue to shower it with as much regulatory forbearance as it can possibly corral.

I’m sure there are a lot of people at Treasury who would dearly love the company to be fully privatized before the election, and there’s essentially no chance that’ll happen if the share price is much below the break-even point of $29 per share. We’re close, now, and I’m sure that Treasury wishes that AIG had managed to buy back those Maiden Lane II assets on the cheap so that the share price could have been even higher. There’s still time to privatize AIG while Tim Geithner is still Treasury secretary. And Treasury will do everything it can to make that happen, if it can do so without exiting at a loss.

Back on February 17, the European Central Bank sprinkled its magical pixie dust on its Greek sovereign bonds, with the effect that they effectively ended up exempt from the restructuring and haircut being inflicted on everybody else. I wasn’t very excited about this development at the time:

On a conceptual level, it makes sense that the Troika — of which the ECB is a third — might be granted immunity from haircuts, in return for providing new money to Greece. On a legal and practical level, however, this is ugly — and you can be quite sure that it’s only going to get uglier from here on in.

Today, we’re beginning to get a hint of the messiness that this decision caused.

First, there’s a formal question which has been put to ISDA’s Determinations Committee, asking whether the ECB magical pixie dust, combined with the passage of the Greek law to allow the haircut, doesn’t in itself constitute a credit event under ISDA rules.

The question takes the form of a single 179-word sentence, which some lawyer somewhere probably thinks is very clever. But here’s the idea: the two events together have effectively cleaved the stock of Greek bonds into two parts, with one part (the bonds owned by the ECB) being effectively senior to the other part (the bonds owned by everybody else). This is known as Subordination, and Subordination is a credit event under ISDA rules.

Now there’s no doubt that the private sector’s Greek bonds are de facto subordinate to the ECB’s Greek bonds now, and that they weren’t subordinate a couple of weeks ago. But so far there’s nothing de jure about this subordination — there’s no intrinsic reason why bonds with CACs, for instance, should be subordinate to bonds without CACs. So my guess is that this request is going to go nowhere, and/or get overtaken by events.

But now there’s news that another European institution has managed to get its hands on the ECB’s magical pixie dust.

The European Investment Bank, owned by the 27-member bloc, is getting exemptions from Greek debt writedowns in the same way as the euro area’s central bank, according to two regional officials familiar with the matter.

The European Central Bank negotiated a deal to avoid the 53.5 percent loss on principal that’s costing private investors as much as 106 billion euros ($143 billion). The EIB, which unlike its Frankfurt-based counterpart represents the entire European Union, also owns Greece’s debt and is sidestepping the so-called haircut in the same way, said the officials, who declined to be identified because the plan isn’t public.

While the ECB exemption was understandable, on the grounds that the ECB was part of the Troika and the Troika is putting up new money here, an EIB exemption is less so. The EIB is not putting money into this latest Greece bailout. Indeed, it represents countries like the UK which are quite explicitly removing themselves from any such thing.

Now, admittedly, the European Commission is a member of the Troika, and the European Commission is the executive body of the European Union, and the European Union collectively owns the European Investment Bank. So this decision is, as the lawyers would say, colorable. But if the decision to exempt the ECB from the Greece haircut was ugly, then the decision to exempt the EIB is, at the margin, even uglier. I’m not saying it’s the wrong decision, necessarily. After all, sovereign restructurings necessarily have an ad hoc, make-it-up-as-you-go-along element to them.

Indeed, if the ECB’s magical pixie dust means that there’s substantially more EU support for this deal, then it might well be worth spreading it around a bit. But at the same time, predictability and consistency are important as well. And both of those seem to have gone out the window at this point. I wouldn’t be at all surprised if ISDA’s Determinations Committee just said “enough already” and declared an event of default. Because in recent weeks private-sector bondholders have been treated in an extremely cavalier manner. And those decisions have consequences.

The WSJ has an interesting if unsurprising article today, showing that expensive homes are less likely to be foreclosed on than cheaper homes.

This stands to reason, of course. For all the talk of strawberry pickers buying McMansions at the height of the subprime bubble, expensive homes are much more likely to be owned by rich people than cheap homes are. And if a rich person owes a bank somewhere north of a million dollars, the bank is likely to be quite aggressive in attempting to get all of the money it’s owed, rather than simply letting the borrower walk away from their house. For a $200,000 house, by contrast, the cost of aggressively pursuing the homeowner is much less likely to be worth the marginal benefit.

On top of that, there’s a reasonably liquid market for smaller homes — if you put them on the market in a fire sale, there’s a good chance that they will sell, quickly, for within $25,000 or so of their fair market price. In the million-dollar-plus range, however, homes stay on the market much longer, the discounts for fire sales are larger, there’s no real rental market, and the cost of maintaining the home while it’s unsold can be substantial.

That said, there is a problem here, and it’s not that people in expensive houses get to live rent-free for 792 days on average. Rather, it’s that people in normal-sized homes are treated unnecessarily badly by Fannie and Freddie.

Smaller mortgages are more likely to be bundled into securities and later resold to investors with backing from Fannie Mae and Freddie Mac. Fannie and Freddie, the government-controlled mortgage giants, have set strict foreclosure timelines and will fine mortgage servicers that are found to be needlessly delaying the foreclosure process.

There’s no reason why mortgage workouts should be long, drawn-out affairs. Indeed, if you’re going to do some kind of restructuring, it’s always better to do it sooner rather than later. But the fact is that the big banks in America are pretty incompetent when it comes to these things: they lose paperwork all the time, they don’t provide a single point of contact for homeowners, their left hand doesn’t know what their right hand is doing, etc etc. But here’s the problem: as all those obstacles and delays get thrown up, the banks get ever closer to the Frannie-imposed deadline, and are effectively forced to foreclose even if they have good workout options. Freddie Mac tells the WSJ that it requires mortgage servicers to “explore every possible avenue to help a struggling borrower avoid foreclosure” — but if at first that servicer messes things up, Freddie’s far from sympathetic about giving them time to try to rectify the error.

It gets worse. The WSJ piece includes the story of Virgilio Wani and his wife, who became delinquent on their mortgage when they both lost their jobs. As soon as Mr Wani got a part-time job, he tried to start making payments again, but the bank refused those payments and foreclosed instead, handing title to Freddie Mac. What did Freddie Mac do with the house once it had title? First, it evicted the Wanis. Then, it started talking to them about a loan modification. Not to put too fine a point on it, this is the wrong way round.

It’s entirely possible that Freddie Mac and the Wanis will find a solution which allows the Wanis to get back the title to their home. So long as that’s a possibility, the Wanis should absolutely remain in their home: evicting them does nobody any good at all.

It’s a perennial frustration to me that foreclosure always and everywhere seems to be followed immediately by eviction. That’s just stupid, for all concerned. Kicking people out of their home creates a lot of deadweight losses which can’t ever be recovered. In a case like this one, where there’s a good chance that the original homeowner will regain title, the best solution is clearly for that family to remain in the home until the situation is resolved one way or the other.

But even when there’s no chance of the former homeowner being able to buy their home back, it still makes sense to keep that family in their home. These days, many if not most of the people buying homes out of foreclosure are buying those homes to rent out, rather than to live in. And it makes perfect sense to rent the home to the family which has been living there for years, if you can. It’s always worth a try.

So for me the important thing isn’t the amount of time between delinquency and foreclosure, but rather the amount of time between delinquency and eviction. Let’s allow families to stay in their homes even after they’ve been foreclosed upon, unless and until the home is sold to someone who doesn’t want to keep that family on as renters. It would improve the quality of life for millions of people, and would create economic value at the same time. What’s not to love?

I’m a big user of OpenTable — I’ve used it to reserve three lunches just this week, and I’d use it to book dinner on Wednesday, too, if it wasn’t for the fact that the restaurant I want to go to doesn’t take any reservations at all. I like its reliability: I’ve been using it for over a decade now (my first reservation, according to the site, was in June 2001), and so far I’ve never had a reservation be lost. OpenTable’s particularly good for business lunches with someone you’ve never met before: you just give the name on the reservation at the front desk, you’re shown to your table, and there’s none of that weird shuffling around trying to work out who it is you’re supposed to be meeting.

All the same, for a hot San Francisco technology company, OpenTable does seem to be changing diners’ habits at a veritable snail’s pace. Even at restaurants with the OpenTable system installed, a large majority of diners still prefer to make their reservation by phone. And at reservation-accepting restaurants in general, just 12% of reservations are made online.

Using the telephone really doesn’t make much sense, most of the time, if you have the choice; Bret Easton Ellis once crafted an entire comic set-piece in American Psycho using nothing but restaurant reservations and call waiting. Maybe it’s just my natural misanthropy coming through, but I don’t like calling restaurants on the phone, and it seems to me that the only people who could credibly claim to prefer it are the elite who can drop the right names and make empty tables magically appear when they do.

So what’s preventing online reservation services from being more popular? Why do they still have such low market share? I think that OpenTable CEO Matt Roberts is more right than he thinks when he says that it’s a function of his service having to be sold, essentially, door-to-door, one restaurant at a time.

There’s a slogan online that “if you are not paying for it, you’re not the customer; you’re the product being sold” — and this, to me, is probably the main issue facing OpenTable. The company sees itself as selling reservations systems to restaurants, much more than it sees itself as selling convenience to diners. And as a result, OpenTable is having difficulty gaining traction in a world where social media is doing most of the heavy lifting when it comes to connecting our online and offline worlds.

For instance, it still insists that you use your unique OpenTable username and password to log in. It should, of course, be asking you to log in using Facebook, instead. Indeed, OpenTable should more or less live on Facebook, much as Farmville does, most of the time. And even when you go to a restaurant’s website, or to opentable.com, it should take just a couple of clicks to invite any of your Facebook friends to lunch or dinner. When they accept, that reservation should then turn up in their OpenTable account, as well as yours. Similarly, when you’re searching for a place to eat, and looking at the reviews from OpenTable diners, the site should show you where your friends eat and what they’ve said about the restaurants you’re looking at. Foursquare is miles ahead of OpenTable on this front, which is crazy; if OpenTable wants to encourage people to leave reviews, then a really good way of doing so is for those people to know that their reviews will be seen by, and useful to, their own Facebook friends.

For most of 2010 and the beginning of 2011, OpenTable’s stock went on an absolute tear, rising from $25 to over $115. A lot of that was misplaced excitement about OpenTable entering the deals space, I think, but the company absolutely should have used the currency of its highly-valued equity to make a big investment in consumer-facing communication generally, and social in particular. If OpenTable could make restaurant reservations fun and easy enough that people actually started eating out more, then the pushback from restaurants in terms of OpenTable’s cost would surely dissipate overnight.

Instead, OpenTable decided to double down on its restaurateur-facing strategy, wheeling out new software which makes it easier for the computer to combine tables on the fly, to create say a 4-top from two 2-tops, and also a new iPad app for owners giving them detailed analytics on their restaurants.

All that new flashy software is great, I’m sure. But as far as a consumer like me is concerned, I still get asked, the tenth time I’m making a reservation at one of my regular lunch spots — and after I’m logged in to the site — whether or not I’ve ever eaten at this restaurant before.

I’m not asking, here, for sophisticated Netflix-style algorithms which look at where I eat, and where my friends eat, and how I rate restaurants, and which then make personalized recommendations for me and which will give me hints as to where I might like to take a certain person for dinner. (That might be a bit creepy, actually.) I’m just asking for a level of polish and customer service from OpenTable which matches the service I get from OpenTable’s participating restaurants. Because it seems to me that if OpenTable wants more people to make use of its product, then it should probably work on getting more people to like that product. Right now, it’s a clunky utility, albeit one which is much better than the telephone alternative. It can, and should, do a lot better.

Nick Paumgarten was told repeatedly, both before and during his first trip to Davos, that he couldn’t possibly get it right after going only once. But he had to try, and he ended up delivering what might be the best description of Davos yet: accurate, well-written, keenly observed.

The Davos of Niall Ferguson, for instance, tells you pretty much everything you need to know about Niall Ferguson:

“What this is is Brownian motion, with human beings,” Niall Ferguson, the financial historian, said one morning, outside the Congress Hall, as his eyes darted about. Vikram Pandit (Citigroup) marched by, and then Brian Moynihan (Bank of America). “Last year, I bumped into Tim Geithner, and he said, ‘We’re going to prove you wrong with our fiscal policy.’ ” At that moment, Ferguson was jostled by a woman who was pushing swiftly through the center, with an entourage of journalists and aides. “Hello, Christine!” he said. It was the I.M.F. chief, Christine Lagarde. She touched his shoulder in greeting. Ferguson turned back to me. “See there? Right on cue.”

Paumgarten decided not to fillet Davos, in the end, although he easily could have done. He goes surprisingly easy on Richard Stromback, for instance, the founder of the you-couldn’t-make-it-up Piano Bar Partners. Stromback’s LinkedIn page identifies him first as “Davos” and second as “YGL”, which is another way of saying “Davos”; his current positions include both “Managing Partner at Piano Bar Partners” and “Young Global Leader at World Economic Forum”.

And Paumgarten also went easy on the Global Shapers, the new set of ultra-earnest twentysomethings who infested Davos this year but who in the end didn’t even get mentioned in his piece.

He even ends with a scene which could have been dictated to him by Klaus Schwab, the Forum’s founder. Davos is glistening; “The mountains, newly covered in snow, sparkled beyond the rooftops. Snow misted down from the pines like pixie dust; now and then, as the sun warmed the boughs, clumps fell noiselessly to the street.” Two men, leaders in their respective fields, engage in a fruitful interdisicplinary conversation about what each can do for the other, after the executive had attended the scientist’s WEF panel earlier in the day. Finally, the two “exchanged cards, shook hands, and parted ways.”

Such genuine and useful encounters do happen in Davos, normally at the rate of once per attendee per year. But they’re not really what Davos is about. Paumgarten gets that the monks and the scientists are “window dressing”, but I think what he misses is the way that that they’re being wheeled out as brain-ticklers for the financiers and plutocrats who actually pay for the whole thing.

In the case of Victor Pinchuk’s annual panel discussion, the power relationship is clear: many of the people up on stage (Jeff Koons last year, Chelsea Clinton this year) are not invited to the WEF meetings at all, and have simply been summonsed by Pinchuk in a highly-conspicuous display of just how rich and important he is. Other famous people flit in and out of Davos while barely being noticed: this year, for instance, Paumgarten’s New Yorker colleague Malcom Gladwell was flown in by Deloitte, gave a speech to a select group of clients at dinner, and then immediately left.

But even within the Forum and the conference center itself, the economics are clear. Paumgarten says that the big spenders “subsidize the scores of academics, scientists, artists, journalists, and N.G.O. chiefs who attend for free” — but that’s putting it politely. The truth is that the academics, scientists, artists, journalists, and NGO chiefs are there for the big spenders, and would immediately be uninvited if the big spenders didn’t want them to be there. And the genius of Klaus Schwab is to persuade those academics, scientists, artists, journalists, and NGO chiefs that being invited to Davos is a great privilege, rather than something they should charge for.

Schwab tells Paumgarten that “you cannot buy your way in” to Davos, but the astonishing number of hedge fund managers with white badges puts the lie to that. The hedgies are ubiquitous at Davos, and they love to talk about how brilliant it is to be able to organize a private dinner with Larry. And when Paumgarten says of the meetings at Davos that “all that’s missing is the hourly rate”, I think he’s wrong twice over. For one thing, companies justify the immense cost of Davos by working out the cost per hour-long meeting, and working out how much those same meetings would cost to organize elsewhere. And for another thing, certain big-name “gets” really do ask for money if you want them to attend your dinner. One of them even included the contact details of his speaking agency in the “Not for Distribution” press release announcing his attendance.

All of which explains the power dynamics of Davos. The CEOs and hedgies might be paying for everything, but in a sense that just makes them the punters, rather than the stars of the show. It’s the people who don’t pay, but whom everybody wants to get, who have the power — whether they’re politicians or Nobelists or rock stars. And then of course, always, above it all, is Klaus Schwab himself, manipulating the puppet strings and keeping everybody on their toes, convinced that they’re missing the real action, wherever that might be. It would be a masterful exercise in relational aesthetics, if only anybody but Klaus himself were able to actually observe it.

Jonathan Stray has a great essay up at Nieman Lab entitled “Why link out? Four journalistic purposes of the noble hyperlink”. I basically agree with all of it; links are wonderful things, and the more of them that we see in news stories — especially if they’re external rather than internal links — the better.

It’s very easy to agree that if a story refers to some other story or document, and if that other story or document is online, then it should be hyperlinked. But Stray goes further than that:

In theory, every statement in news writing needs to be attributed. “According to documents” or “as reported by” may have been as far as print could go, but that’s not good enough when the sources are online.

I can’t see any reason why readers shouldn’t demand, and journalists shouldn’t supply, links to all online resources used in writing a story.

Tellingly, Stray provides no hyperlinks at all for his assertion that “every statement in news writing needs to be attributed”. Is this really true? It certainly isn’t in the UK, where I come from. What’s more, even before the WSJ got taken over by foreign marauders like Rupert Murdoch and Robert Thomson, it followed this rule mostly just by inserting the stock phrase “according to people familiar with the situation” into any story. That phrase, of course, tells the reader exactly nothing.

In recent days, a debate has emerged online on what I consider to be two very different subjects, which are getting unhelpfully elided. The first question, raised by MG Siegler, is whether outlets like the WSJ have an obligation to say who first broke a piece of news, when they report that news. The second question, which is often mistaken for the first, is whether outlets like the WSJ should link to outside sources of information.

To the second question, my answer is simple: yes. But look at the story by Jessica Vascellaro about Apple acquiring Chomp. There’s only one part of that story which obviously needs a hyperlink, if such a thing were available, and that’s in the first sentence, where we’re told that Apple said it has acquired Chomp. If there’s some kind of public press release from Apple saying such a thing, then the WSJ should link to it. But there isn’t, so the lack of any link there is forgivable.

What Siegler wants is for extra text to be added in to Vascellaro’s story, saying that he first broke the news. And I’m pretty sure that Stray would want the same thing — after all, Vascellaro’s own tweet does imply that she first got wind of the story online, before confirming it with Apple. If it was Siegler’s article which caused Vascellaro to call Apple, then Siegler certainly counts as an online resource used in writing the WSJ story, and should therefore, by Stray’s formulation, be fully linked and credited.

On the other hand, if Stray agrees with Siegler, that doesn’t mean that Siegler agrees with Stray. Siegler cited no source at all, named or anonymous, for his scoop that Apple had bought Chomp: he simply asserted the fact. “Apple has bought the app search and discovery platform Chomp, we’ve learned.” If every statement in news writing needs to be attributed, then Siegler just failed that test.

But I don’t think it does. If you attribute a statement like that to “sources familiar with the situation”, or something along those lines, then the attribution looks a lot like a CYA move. Consider the difference between (a) “Apple has bought Chomp”, and (b) “Apple has bought Chomp, say sources familiar with the situation”. Technically speaking, if the sale falls through, then (a) is false, while (b) was actually true. In that sense, failing to provide attribution is a way of sticking your neck out and asserting news to be a fact. Here’s Siegler:

I reported the Apple acquisition of Chomp as a fact for good reason — It. Was. A. Fact. If I had reason to believe it may not be a done deal or not 100% certain, I would have said that. I did not because I didn’t need to.

Not too long ago, I had a conversation with a journalist who was adamantly sticking up for her story in the face of criticism. The story included a statement of the form “X, says Y”, where Y was an anonymous source. Various other people were saying that X was not, in fact, true. But the journalist was standing firm. I then asked her whether she was standing firm on the statement “X, says Y”, which she reported — or whether she was standing firm on the statement that X. And here’s the thing that struck me: it took her a long time to even understand the distinction. A lot of American journalists stick the sourcing in there because they have to — but they very much consider themselves to be reporting news, and if X turned out not to be true, they would never consider their story to be correct, even if it were true that Y had indeed said that X.

Elsewhere, however, those conventions don’t hold. In a lot of political reporting, you have one person saying “X”, and another person saying “not-X”, and it’s left to the reader to decide whether one or the other or neither is telling the truth. And even facts can end up being attributed to people, which is even more confusing. Consider this, for instance, from a recent NYT article by Motoko Rich:

The home ownership rate has been falling from its peak of 69.4 percent in 2004, according to census data. By the fourth quarter of 2011, it was down to 66 percent. That means about two million more households are renting, said Kenneth Rosen, an economist and professor of real estate at the Haas School of Business at the University of California, Berkeley.

This is Rosen’s only appearance in the article, and he’s not being used to give an opinion, or an expert analysis: he’s being used to count rental households. And, at least on the face of things, he’s not particularly good at that. According to the 2010 census summary, there are 116,716,292 occupied housing units in America. So a basic back-of-the-envelope calculation would say that if the proportion of those units which went from owner-occupied to rented moved from 69.4% to 66%, then the increase in rental households would be 3.4% of 116,716,292, which comes to almost exactly 4 million. That’s double Rosen’s number.

Or, we can get more accurate, and go back to the 2005 American Community Survey, which showed 36,771,635 renter-occupied housing units in total. Contrast that with 2010, where there were 40,730,218 renter-occupied housing units. The difference, again, is almost exactly 4 million.

Most accurately of all, you can look directly at the Census Bureau’s quarterly estimates of the US housing inventory. According to that series, the number of renter-occupied houses in the US was 32,913,000 in the second quarter of 2004; it’s now 38,771,000. The difference there is not 2 million or 4 million but rather 5.9 million. (In the same time, the number of owner-occupied households has increased by 1.2 million.)

Now Rosen may or may not have good reason to believe that in fact the real increase in renting households is only 2 million rather than 4 million or 6 million. But if he does, that reason is not the drop in the homeownership rate from 69.4% to 66%. Not given the number of households in this country. (The homeownership data is here, by the way; it’s worth noting that Rich didn’t link to it.)

All of which housing wonkery is to say that even basic facts like the increase in US rental households can be non-trivial to pin down, and that both Rich and her readers would probably have been better off if she hadn’t bothered phoning Rosen at all, and had just got her numbers for the increase in rental households directly from the people measuring such things. Citing sources doesn’t help the reader at all, here: if Rich had been forced to assert the increase in rental households, rather than simply attributing the number to Rosen, then she would probably have got something closer to the truth.

The difference between linking and citing is the difference between showing and telling. I’m not a big fan of citing, mainly because it gets in the way: we might learn a lot about where the Haas School of Business might be, but at the same time we’ll learn nothing useful about the increase in the number of rental households. On the other hand, if Rich had simply said that “about six million more households are renting”, complete with hyperlink, that would have been shorter, more useful, and more accurate, even if there were no explicit citation.

Similarly, there’s a case to be made that Vascellaro could and should simply have put out a one-line story under the exact same headline (“Apple Acquires App-Search Engine Chomp”), saying “I’ve talked to Apple and they confirm this story is true.” Vascellaro had exactly one new piece of information: Apple’s confirmation of the news. In a world where TechCrunch is only a click away, why write out a lazy rehash of what Siegler had already written, rather than just linking to his story and moving on to breaking and writing something more interesting?

One reason is that the WSJ still has a hugely successful print product, and that therefore WSJ journalists’ pieces need to work in print as well as online. What’s more, as people increasingly read WSJ.com stories offline, on things like the WSJ iPad app, the need for those stories to be reasonably comprehensive remains. Even in the age of the hyperlink. Here’s Stray:

Rewriting is required for print, where copyright prevents direct use of someone else’s words. Online, no such waste is necessary: A link is a magnificently efficient way for a journalist to pass a good story to the audience.

The problem is that a journalist never really knows whether their work is going to be read online or offline, even if they’re writing solely for the web. The story might get downloaded into an RSS reader, to be consumed offline. It might be emailed to someone with a Blackberry who can’t possibly be expected to open a hyperlink in a web browser. It might even get printed out and read that way.

Besides, the simple fact is that even if people can follow links, most of the time they don’t. An art of writing online is to link to everything, but to still make your piece self-contained enough that it makes sense even if your reader clicks on no links at all. Cryptic sentences which make no sense until you click on them are arch and annoying.

What’s more, as Stray says, “online writing needs to be shorter, sharper, and snappier than print”; his link will take you to Michael Kinsley, moaning about how “newspaper stories are written to accommodate readers who have just emerged from a coma or a coal mine”. In that context, does it really behoove reporters to build a long list of sources into all of their stories? Does every news story need to link to the organization which first broke the news? Does every journalist need to hat-tip the friend of theirs who retweeted the nugget which ultimately resulted in their story?

My feeling is that commodity news is a commodity: facts are in the public domain, and don’t belong to anybody. If you’re mentioning a fact which you sourced in a certain place, then it’s a great idea to link to that place. And if you’re matching a story which some other news organization got first, it’s friendly and polite to mention that fact in your piece, while linking to their story. But it’s always your reader who should be top of mind — and the fact is that readers almost never care who got the scoop.

There’s one big exception to that rule, however. Often, a reporter spends a long time getting a big and important scoop, which comes in the form of a long and deeply-reported story. When other news organizations cover that news, they really do have to link to the original story — the place which did it best. Otherwise, they shortchange their readers. A prime example came last August, with Matt Taibbi’s 5,000-word exposé of the SEC’s document-shredding. Anybody covering that story without linking to Taibbi was doing their readers a disservice.

As a result, like most things online, it’s very dangerous to try to come up with hard-and-fast rules about such things. In general, it’s good to link to as many different people and sources as possible, because the more links you have, the richer your story is. On the other hand, the journalistic web is full of garbage hyperlinks — automated links to irrelevant topic pages, for instance, or links to an organization’s home page when that organization is first mentioned.

As for crediting the news organization which broke some piece of news, that’s more of a journalistic convention than a necessary service to readers. It’s important enough within the journalism world, at least in the US, that it’s probably a good idea to do it when you can. But most of the time it’s pretty inside-baseball stuff. And in the pantheon of journalistic sins, failing to do it is not a particularly big deal. What’s much more important is that your reader get as much information as possible, as efficiently as possible. Which means that if you’re writing about a document or report, you link to that document or report. Failure to do that is a much greater sin than failure to link to some other journalist.

So while sometimes the failure to link is unavoidable, I look forward to a time when journalists face much more criticism for not linking to primary documents than they do for not linking to some other news organization which got the news first.

Reading Warren Buffett’s latest shareholder letter, I was struck by the number of times he talked about bolt-on acquisitions — situations where one of his subsidiary companies makes an acquisition of its own. They’re mentioned six times in this letter, and then at the end he mentions a “tuck-in” acquisition, which is essentially the same thing.

I wondered if he’d ever been so keen to talk about such things in the past, so I called up the last ten years’ worth of shareholders’ letters. He’s never used both terms in the same letter before, and he’s never used the term “bolt-on” more than once.

This could of course simply be random variation, but I think that something important is going on here. The big question, with Berkshire Hathaway, is how it’s going to invest its billions of dollars, especially now that companies like Swiss Re, Goldman Sachs and General Electric are exercising their options to return billions of dollars of emergency funding from Berkshire.

In the past, Buffett has talked about spending enormous sums buying very large companies: last year, for instance, he said that Berkshire will need “major acquisitions” (his emphasis), adding that “our elephant gun has been reloaded, and my trigger finger is itchy.”

This year, there’s no talk of elephants. Instead, various bolt-ons are scattered throughout the letter, Princeton Insurance being the only one mentioned by name. The rest are relatively small and anonymous. But I see a message here: just because you don’t see Berkshire bagging elephants, that doesn’t mean it isn’t growing by acquisition. It probably is, but just at the level of subsidiary companies, buying other companies you probably haven’t heard of and which probably aren’t big enough to warrant Berkshire’s shareholders being told the details.

Essentially, Buffett is saying “trust us: we’re growing, even if you can’t really see it.” But what you can see is the change in his language. The only real difference between a bolt-on and a tuck-in is that a bolt-on sounds bigger and more important. And so after using the term “tuck-in” seven times between 2006 and 2008, he’s now largely abandoned it. And the bolt-ons are coming thick and fast.

John Hempton singles out one 2002 acquisition which Buffett made and which has been extremely successful — but the fact is that the company in question was bought for $139 million and is now worth maybe $1 billion, after throwing off $180 million in cash. That is indeed impressive, but it doesn’t move the needle for a company with a market capitalization of $200 billion. You need a lot of such acquisitions to do that, and they don’t scale: they’re hard to find, and don’t come along every month.

At the beginning of every annual letter, Buffett compares the performance of Berkshire Hathaway’s book value to the performance of the S&P 500. Here’s two ten-year periods: on the left is 1973-1982, and on the right is 2002-2011.

What you’re seeing here is something that Buffett makes no secret of: it’s much easier to grow very fast when you’re relatively small than it is when you’re huge. Check out that run of growth beginning in 1975, in the first column: it’s simply astonishing. And even the relatively modest performance in 1973 and 1974 looks fantastic when you compare it to what the rest of the market was doing.

Buffett’s kept his ability to stay conservative and outperform in down markets. His two best years of the past ten, if you look at the “relative results” column, were — by far — 2002 and 2008, when the broad stock market fell a lot, but Berkshire’s book value did much better. And that’s largely an apples-to-oranges test in any case: after all, the book value of the S&P 500 didn’t fall nearly as much as its market value either.

If you look at Buffett’s own favored metric, the per-share book value of Berkshire, he’s had some good years of late, but nothing which even comes close to the numbers he was posting in the 70s.

That’s to be expected: big, mature companies don’t grow as fast as the best small companies. But when you’re a public company, shareholders’ desire for growth never goes away. Especially when, as at Berkshire, the stock doesn’t pay any dividends. As a result, every year Buffett does two things in his letter to shareholders. Firstly, he tries to downplay expectations as to how fast Berkshire is going to be able to grow going forwards. And secondly, he tries as best he can to explain where the future growth they want is going to come from. He’s consistent on the first part. But on the second he moves around a bit more. And this year, the message is that he’s going to encourage his subsidiary companies to make lots of acquisitions.

If you go to the official website for the Greek bond exchange, greekbonds.gr, you can now find an actual official document! The rest of the website, it says, “will be available shortly”, whatever that’s supposed to mean.

The document gives us most — but not all — of the information that bondholders will need in order to be able to decide whether or not they’re going to tender their bonds into the exchange. It’s written in very dense legalese — the first sentence is 70 words long, with only one comma — so let me try to pull out the important bits.

This is complicated, as you might imagine. It makes a significant difference (a) what bonds you hold, whether they’re Greek law or English law, and also (b) where you live, whether it’s in Europe or in the US. (There are also, it turns out, Swiss-law bonds as well, which have their own very special treatment.) But at the end of the day, most bondholders are going to get pretty much the same things when they tender their bonds; you’ll forgive me for ignoring some of the more niggly stuff.

Firstly, they’re going to receive new Greek bonds, maturing in 2042. It doesn’t matter whether the bonds you’re holding mature on March 20, or whether they mature in 30 years’ time — everybody gets the same new long-dated bonds, according to the face value of what they now own. In other words, the value of Greek bonds right now is wholly a function of what their face value is, and has nothing to do with their coupon or their maturity date.

The new Greek bonds have a step-up coupon: 2% through 2015, then 3% through 2020, then 3.65% in 2021, and then 4.3% from 2022 through 2042. Bondholders will receive new bonds with a face value of €315 for every €1,000 of old bonds they hold. (Again, remember that it’s face value which matters here, not market price.) What’s the market price of the new bonds going to be? Not very much; my guess is that they’ll trade at roughly 40% of face value. Which means that the “NPV haircut”, as far as the new Greek obligations are concerned, is somewhere on the order of 87%.

But bondholders will get more than just Greek bonds; they will also get new EFSF notes. The new EFSF notes come in two flavors: one-year notes and two-year notes; their face value is going to be 15% of the face value of the tendered bonds. The working assumption right now is that they’re going to be worth €150 for every €1,000 of bonds tendered: in other words, if you look at the value of what bondholders are going to be receiving in exchange for their bonds, it’s going to be split roughly 50-50 between Greek bonds and EFSF notes.

We don’t know that for sure, however, because for reasons I don’t pretend to understand, the coupon on the EFSF notes is still undetermined; we’re just told that it will be revealed on the Issue Date. (And no, we’re not told what the Issue Date is going to be.) In any event, bondholders in the US won’t receive EFSF notes at all; instead, they’ll receive “the cash proceeds realized from the sale of the EFSF notes they would otherwise have received”.

Finally, bondholders will receive GDP warrants of some description, which are the vaguest thing of all. “The GDP-linked Securities will provide for annual payments beginning in 2015 of an amount of up to 1% of their notional amount in the event the Republic’s nominal GDP exceeds a defined threshold and the Republic has positive GDP growth in real terms in excess of specified targets.” How much are these warrants going to be worth? The working assumption has to be zero, at least until we get some numbers for the minimum GDP and GDP growth that Greece needs in order to pay out on them.

When bondholder tender their old bonds to receive new ones, two things will happen. First, the old bonds will have been accruing interest since their last coupon payment. That interest will not be paid out in cash; instead, it will be paid out in the form of six-month zero-coupon EFSF notes. Why? This is just stupid nickel-and-diming: is there any reason why the EFSF is better off paying that money in six months rather than just paying it now?

Second, the bondholders will almost certainly vote, when they tender their old bonds, to bail in everybody who doesn’t tender their bonds, and force them to accept the same deal. That’s the Collective Action Clause (CAC) that you might have been reading about.

Will the CACs be used? Will the exchange even happen? That depends entirely on how many bondholders decide to tender into the exchange. (We’ll assume for the time being that if you tender, you’ll also consent to implementing the CACs; there’s no obvious reason why anybody would do the former without doing the latter.)

In order for the CACs to even come into existence, let alone be triggered, Greece needs two-thirds of its old bonds to be tendered. If it doesn’t reach that threshold, then the whole exchange is a bust and won’t happen at all. Indeed, Greece says in this release that it won’t go ahead with the exchange unless it gets at least 75% participation. If fewer than 75% of Greece’s bondholders tender into the exchange, then Greece won’t accept those tenders, and we’ll have a chaotic default.

If more than 90% of Greece’s bonds are tendered, then the exchange will be a success, the CACs will be triggered, and Greece’s old bonds will be replaced by new bonds. And because the CACs will be triggered, you can be sure that CDS will be triggered as well.

And what happens if the participation rate is between 75% and 90%? That’s vaguer. In that case, says the press release, “the Republic, in consultation with its official sector creditors, may proceed to exchange the tendered bonds without putting any of the proposed amendments into effect”. Which seems to me to say that if you tender into the exchange then you’ll get new bonds, and if you don’t tender into the exchange then, um, well, you’ll be left with your old bonds. The implied threat here is that Greece will pay out on its new bonds but won’t pay out on its old bonds — and bondholders who didn’t participate in the exchange will be left with claims on the Greek government which they’ll be lucky to ever collect on. Of course the CDS would be triggered in that case, too — it would be a clear-cut default. But Greece would have a large outstanding stock of unpaid debt for the foreseeable future.

The idea here is to prevent would-be free-riders from holding out in the exchange, refusing to tender their bonds on the basis that if they hold out, then they’ll just get bailed in by the CACs anyway. That strategy works if there’s more than 90% participation, but it becomes very dangerous if there’s less than 90% participation.

Will this strategy be enough to get 90% of Greece’s bondholders to tender into the exchange? I suspect it might. And of course if the takeup is between 75% and 90% Greece still has the option of exercising the CACs and bailing everybody in anyway. (Note that “may” in the press release which I bolded.) Chances are, that’s what it would do: it’s better for Greece to have one series of bonds outstanding which it isn’t in default on, rather than lots of series of bonds outstanding where it’s in default on most of them. But we won’t know for sure until after the results of the bond exchange are made public. And we won’t even know what bondholders are thinking with respect to the terms of the exchange until we get more details on the GDP warrants and the coupon on the EFSF notes. When will that come? Your guess is as good as mine.

Yesterday morning, a very exciting new journalism project was launched on Kickstarter. It’s called Matter, and it’s going to be home to long-form investigative narrative journalism about science and technology. “No cheap reviews, no snarky opinion pieces, no top ten lists,” they promise. “Just one unmissable story.”

They hit a nerve: as I write this, some 31 hours after the Kickstarter campaign was launched, it has already reached $44,395 of its $50,000 goal, with 569 backers. That’s an average of almost $80 each. “People are giving way more than I thought they would,” said co-founder Jim Giles when I talked to him today. “We have tapped into frustration with the way the internet has promoted quick and cheap journalism and bashed longer-quality stuff, or at least undermined the business model that used to support that sort of thing.”

Matter will surely exceed its $50,000 goal, which is great news, because the more money it raises the better. In the first instance, the $50,000 will be enough to get a nice website up and running, and should also pay for the first three stories on the site. With more money, Matter can get more ambitious: commission more stories, for one thing, but also start building an iPad app which would live in the iOS Newsstand. Or maybe something on Android, or both. There’s a lot of opportunity out there.

This is an old-school Kickstarter campaign, where people are raising the money they need to create something great. It’s not one of those campaigns where donors are essentially pre-buying the product in advance: this isn’t about buying stories before they’re published, or buying subscriptions before the publication even exists. “We’re asking people to make an investment in a sustainable platform for really good journalism,” says Giles, “not to buy a whole bunch of articles in advance.” (That said, anybody pledging $10 or more will get the first three stories, $50 gets you the first six, $100 gets you the first ten, $300 gets you the first 50, and $1,000 gets you a lifetime subscription.)

Once Matter has launched, readers will have the option of buying individual stories for 99 cents each — the Kindle Single model, basically — or buying a subscription. It’ll be monthly at first, and then weekly, assuming everything goes according to plan.

The stories themselves are going to be really good, I think. Matter’s founders, Jim Giles and Bobbie Johnson, are both first-rate journalists, and they’ve quietly amassed a list of really good writers and editors they want to work with. They have a smart model: rather than soliciting detailed pitches, they’re more interested in writers coming to them with vaguer ideas. The writer then gets matched to an editor very early on — before the piece is even formally commissioned — and the final article comes together as a collaboration between the writer, editor, and publishers.

I like this model, because one big weakness of long-form narrative journalism is that it has failed to embrace everything the web is capable of. Writers get commissioned to write X thousand words on Y; they then hand in a document written in Microsoft Word, which goes through a few rounds of editing before getting laid out to a greater or lesser degree. (Ben Hammersley is really good at diagnosing this problem and suggesting how to begin solving it.) I’m optimistic that Matter’s editing process will help its stories be much richer than most of what we’re seeing today.

Matter is coming into a world where companies like The Atavist and Byliner have already broken important ground, and where willingness to pay for content is clearly going up. It’s entirely natural, online, to disaggregate things like magazines, and have a blog over here be really good at what would in a magazine be the front-of-book stuff, while a subscription site over there specializes in features.

And while Matter is quite narrow in what it wants to publish — chiefly long-form, narrative, investigative news stories about science and technology — it’s quite broad in terms of how it intends to distribute that content, and what kind of models it might embrace along the way. For instance, Giles is very keen to work with newspapers, who might help underwrite some of the cost of reporting these stories, in return for being able to break the news in them. Matter would then give those stories the long-form narrative treatment. Or maybe the same story could just appear in both places, if the newspaper covered the costs of the reporting.

In any case, this is a great project, and I’m pretty sure that a lot of the readers of this blog would love to support it. Most long-form journalism these days is political, with much of the rest being in the art-and-literature field. There are thousands of amazing stories in science and technology; I can’t wait for Matter to start uncovering them.

I was literally grinning when I read the framework for business tax reform put out yesterday by the White House and Treasury. Admittedly, it’s not going to get implemented any time soon. But it sets the agenda for any attempt to reduce the corporate income tax rate from 35%. And in doing so it makes an official and extremely strong case for massively reducing the tax deductibility of interest payments.

This is not a new idea, of course: Paul Volcker was pushing it in 2009, and the financial commentariat largely loves it: see Jim Surowiecki, for instance, or Steve Waldman, with a wonderful post from January 2008, before we saw a devastating global example of just how damaging too much leverage can be. And if you’re been reading my blog for a while, the idea certainly won’t be new to you.

But now the government has said, very clearly, that it’s on board — something I’ve never seen before. Remember the CBO report which showed that companies financing themselves with equity pay an effective tax rate of 36%, while companies choosing debt pay a negative tax rate of 6.4%? Well, this latest document does that one better:

The effective corporate marginal tax rate on new equity-financed investment in equipment is 37 percent in the United States. At the same time, the effective marginal tax rate on the same investment made with debt financing is minus 60 percent—a gap of 97 percentage points.

This tax preference for debt financing has important macroeconomic consequences. First and foremost, outsized reliance on debt financing can increase the risk of financial distress and thus raise the likelihood of bankruptcy. Unlike equity financing, which can flexibly absorb corporate losses, debt and the associated contractual covenants require ongoing payments of interest and principal and allow creditors to force a firm into bankruptcy. A solvent firm with limited liquidity that is struggling to make its debt payments may experience losses of customers, suppliers, and employees. It may engage in destructive asset “fire sales” and forgo economically profitable investments. And, in an attempt to avoid bankruptcy, levered firms faced with financial distress may resort to high‐risk negative economic value investments. In the broader context, a large bias towards debt financing in the corporate tax code may lead to greater aggregate leverage and the associated firm‐level and macroeconomic costs of debt financing.

As part of the framework, then, the Obama administration explicitly proposes “reducing the bias toward debt financing”, although it doesn’t say by how much. Dan Primack addresses that question today in a smart post; he reckons that 65% of corporate debt interest should be tax deductible, while allowing companies with less than $20 million in revenues to deduct 100% of their debt interest. (And, presumably, banks, too.)

I think this is a very sensible way to have the debate. The tax code can decree the tax-deductibility of corporate debt interest payments anywhere on the spectrum from 0% (which I would love) to 100% (which we have now). There’s no good philosophical reason why it should be 100%, and there are lots of excellent reasons why it should be lower than that. So let’s have a debate about where it should be, and encourage the 1% to come up with their own ideas. As Dan says, a lot of capitalists in areas like venture capital would love the idea of reducing interest deductibility to pay for lower income tax. So let’s see what the Republicans think, and what the business community thinks, and arrive at some kind of consensus. We’re not going to get the deduction abolished completely. But we can definitely make a big move in the right direction.

Update: In the comments, @realist50 brings out the dual-taxation argument, saying that one person’s interest expense is another person’s taxable income. Which isn’t true: if I borrow money from a corporation which isn’t profitable, then no taxes are paid on my interest payments. And in general, interest income is revenue for the lender, not taxable profit. Besides, all dual-taxation arguments are silly. But in this case they’re particularly so. If I’m a company and I make my revenues by selling products to consumers, then my revenues all come from after-tax disposable income. If my revenues come by selling products to companies, then they come from tax-deductible corporate expenses. And if my revenues come by selling products to the government, then they come from tax revenues themselves. None of this helps to determine how much of those revnues should be taxable.

Another reader emails to say that removing the tax-deductibility of debt interest would “penalize investment”. In fact, it would just put various different types of investment — equity and debt — on a more level playing field. And we have a public interest in encouraging equity rather than debt investment: if anything the playing field should tip the other way.

Can countries issue equity? Greece is making a stab at it, giving its bondholders GDP warrants which start paying out “in the event the Republic’s nominal GDP exceeds a defined threshold”. Chances are, the market won’t give the warrants much value; they’re more symbolic, really, of Greece’s good faith.

But Bob Shiller is much more ambitious when it comes to such things: “Countries should replace much of their existing national debt with shares of the “earnings” of their economies,” he writes in the Harvard Business Review.:

National shares would function much like corporate shares traded on stock exchanges. They would pay dividends regularly. Ideally, they’d be perpetual, although a country could always buy its shares back on the open market. The price of a share would fluctuate from day to day as new information about a country’s economy came out.

This was a bad idea when Jonathan Ford proposed it in August 2009, it was a bad idea when Shiller wrote about it in December of that year, and it’s an even worse idea now, because Shiller’s decided to kick it up another five notches or so:

Greece’s real GDP fell 7.4% in 2010. If its Trills were leveraged substantially—say, five to one—then the dividend paid on them would have fallen by about 40%. This would have done much to mitigate the crisis, making it easier for Greek taxpayers to bear.

This is almost literally incomprehensible. I spent a long time on the phone today with Shiller’s co-author Mark Kamstra, and even he had no real idea what Shiller was talking about here. I can see how an investor might try to leverage an investment in Greek Trills (a Trill being a bond paying one trillionth of GDP every year, in perpetuity) by buying those bonds with borrowed money. But I can’t see how Greece itself could do so. Shiller doesn’t spell it out, but these things would obviously be symmetrical: Greece would have to pay out five times its annual GDP growth in good years in order to get these large savings in bad years. And that seems like a clear recipe for unsustainable debt growth.

Even Kamstra concedes as much. “I think that a country would not issue a levered Trill,” he told me. “I think it gets you in a lot of trouble.”

But even if you put aside the insane concept of leveraged Trills, the idea behind them is still really bad. Kamstra tried to persuade me that the price of Trills would be less volatile than the S&P 500, and he might be right during periods of relatively normal interest rates. But when rates fall, it seems to me that he’s clearly wrong. A perpetual bond like a Trill is valued by adding up the present value of its income stream: how much is this year’s payment worth to me today, how much is next year’s worth, and so on. When you apply a discount rate, future coupon payments are worth less the more distant they are, and the sum of the total converges to the value of the bond.

If the coupons are steadily increasing, however, the math becomes very dangerous. The coupons will rise at the rate of nominal GDP growth, which in the US will probably be somewhere in the 4% to 5% range over the long term. As a result, if you’re a risk-averse person who wants a perpetual US government security and your discount rate is say 3%, then the expected value of a singe Trill is actually infinite. Of course, no security trades at a price of infinity. But the fact that valuations can get so high in a low-interest-rate environment is all you need to know about just how volatile Trill prices could get.

The point here is that Shiller seems to think that the price of Trills would be driven mainly by “new information about a country’s economy”. But he’s wrong about that. new information about a country’s economy tells you quite a lot about what its GDP might do in the next few years. But if you’re holding a perpetual bond, fluctuations of 1% or 2% in the value of short-term coupon payments are not going to make much difference to the value of the bond. What really makes a big difference is the interest rate you use to calculate net present value. In other words, while Trills are designed to respond to news about the economy, in fact they would be an incredibly noisy and volatile instrument reacting mainly to changes in long-term interest rates.

But what if I’m wrong and Kamstra’s right, and economic news is more important than discount rates? At that point, measuring GDP accurately becomes extremely important: the markets would care greatly about differences of just a percentage point or two.

Except, you really can’t measure GDP to within that degree of accuracy. Here’s a recent paper from the Bureau of Economic Analysis:

Measuring the accuracy of national accounts esti­mates is a long-standing challenge for three main rea­sons. One, the early GDP and GDI estimates are based on partial data and are intended to provide an “early read” on the general picture of economic activity for decision-makers. These early estimates are revised as more complete and accurate source data become avail­able. Two, the source data for the national accounts come from a mix of survey, tax, and other business and administrative data; these source data are subject to a mix of sampling and nonsampling errors and biases that cannot be measured in terms of standard errors. Three, the national accounts are regularly revised to re­flect the changes in the economic concepts and meth­ods necessary for these accounts to provide a picture of the evolving U.S. economy that is relevant and accurate for today’s economy. These updates range from ex­panding the definition of investment from investments in plant and equipment to include investments in computer software to updating seasonal adjustment factors to reflect the most recent seasonal patterns.

What does all this mean in practice? Thomas Dall at the BEA helped me out, taking one recent datapoint as an example: nominal GDP at the end of the first quarter of 2009.

When it was first reported, that number was $14.097 trillion. But then three months later, in July 2009, it was revised upwards, to $14.178 trillion. A year after that it was revised back down, to $14.05 trillion, and a year after that, in July 2011, it came down further, to $13.894 trillion. In other words, between July 2009 and July 2011, the GDP figure for the first quarter of 2009 was revised down by $284.3 billion, or 2% of GDP.

And Dall didn’t pick that datapoint because it was particularly noisy: it’s the only one we looked at.

This is bad news for any government thinking of issuing Trills. Governments, after all, go to great lengths to issue easily-understandable series of bonds with fixed coupons, so that the financial markets can price them easily and have a transparent yield curve. The only people welcoming GDP bonds with open arms would be in futures markets, where traders love volatility and try to make lots of money off it.

Which, of course, is the whole reason that Shiller is pushing this idea so aggressively. Shiller is a principal in a company called MacroMarkets, which exists to create “innovative financial instruments to facilitate investment and risk management” — a/k/a volatile new derivatives.

If Trills existed, you can be quite sure that MacroMarkets would immediately create futures and options based on Trills, trying to make money off their volatility. The volatility would depress the price that governments could sell the Trills for, but at the same time it could make a fortune for Bob Shiller. “Bob’s experience in the markets is that if there isn’t enough volatility in the price of the contract, the speculators lose interest in the contracts,” says Kamstra.

So let’s discount Shiller, here, as someone who’s way too conflicted to take at face value about such things. GDP bonds are like most financial innovations: they’re much more likely to do harm than they are to do good. And no country should even dream about issuing such things until some big corporation has blazed the trail first, as a kind of proof of concept. Lots of companies, from Walmart to ExxonMobil, do better in good economies and worse in bad economies: it might make sense for them to issue GDP bonds. Let’s wait until one of them does, so that we can get a feel for how such bonds behave, before we ask our governments to follow suit.

I feel we’ll be waiting a long time. If it’s true that the price of a GDP bond can skyrocket when interest rates fall, that bond would be extremely dangerous for any company issuing it. The market value of the company’s outstanding bonds could easily exceed the company’s enterprise value, with the result that technically shares in the company would be worthless. I can’t imagine any CFO or corporate treasurer risking it. And neither should any finance minister.

Are you alarmed by today’s headline in the NYT saying, disturbingly, that the “Greek Crisis Raises New Fears Over Credit-Default Swaps”? Don’t be. The article in question turns out to be a solid 770-word explainer by Peter Eavis in which he gives the final word to Stanford’s Darrell Duffie, saying that any such fears are “small potatoes”.

But at the beginning, Eavis talks about how European policymakers “fear that payments on the swaps might set off destabilizing chain reactions through Europe’s financial system”; later on, he writes that “the swaps will also come under heavy fire if there is any indication that activating the Greek instruments is leading to stress in the financial system”. It would have been nice if he’d named one of those policymakers, or explained what exactly their fears might be.

How, exactly, would a CDS trigger lead to stress in the financial system? After all, as Eavis concedes, every time banks’ balance sheets have been examined, regulators have found essentially nothing in the way of unhedged CDS exposures.

There is the possibility of counterparty risk — a spectre Eavis raises only to dismiss it. In order for counterparty risk to be a problem, you need two things. First, you need a bank with a very large unhedged CDS exposure to one single name — the kind of position I’ve never seen any bank have. (Remember here that credit default swaps were invented for banks to sell down their loan exposure, not to increase it.) And then, on top of that, you need jump risk: the risk that the single name in question will suddenly default, forcing the bank to pay out a huge amount of money at once.

But in Greece, there is no jump risk at all. Because a default has been priced in for months, any bank which has written default protection on Greece has had to steadily post more and more margin against that position. When Greece officially defaults at the end of March, there will be an auction to determine the clearing price of the swaps, and the margin will simply get transferred to the bank’s counterparty. The bank will probably need to make no payment at all.

In other words, counterparty risk on sovereign CDS is probably a non-issue, but it’s certainly a non-issue in Greece.

So what are the “new fears” of Eavis’s headline? I’m beginning to think that in fact the fears are not that the swaps will get triggered, causing some kind of financial calamity, but rather that they won’t be:

Some chance remains that the exchange could be done voluntarily, avoiding a default swap event. That outcome would most likely prompt a torrent of criticism that the swaps did not cover holders against losses, as they were intended to.

“The whole nature of the C.D.S. contract would be called into question,” said Richard Portes, professor of economics at the London Business School.

As Eavis says, the chance of the swaps not being triggered is extremely small, at this point. But it’s higher than the chance that the trigger will cause some kind of financial-market calamity. It’s possible — unlikely, but possible — that Greece will get such a large acceptance rate on its exchange offer that the size of the holdouts would be very small indeed. If that happens, it’s also possible-but-unlikely that Greece will choose to simply continue paying those holdouts in full, rather than defaulting on them or trying to bail them into the deal through CACs. If both of those possible-but-unlikely things happen, then it’s definitely possible ISDA would determine that there was no credit event. But we’re so far down the chain of speculation at this point that these things are really not worth worrying about; the unanimous consensus in the market is that there will be a default, in March, and that the CDS will get triggered.

The thing that really worries me is not the CDS market at all. In fact, for all that credit default swaps were an intrinsic part of the financial crisis, the traded market in CDS has been remarkably robust. It certainly withstood the bankruptcy of Lehman without any trouble, both in terms of counterparty risk relating to Lehman’s own positions and in terms of CDS on Lehman being triggered when the bank failed.

Rather, what worries me is that the vast majority of people reading this article in the NYT will see the headline about New Fears, and if they skim the article will just see a bunch of concerns and some quotes from people on both sides. In other words, Eavis’s article is to a large degree self-fulfilling: people will read it and start being worried about the CDS market all over again, especially if — like 99% of the population — they don’t really understand the CDS market at all, and have no particular need or desire to get into the nitty-gritty. All they know, or think they know, is that credit default swaps are Dangerous Complex Derivatives, and that the Greek crisis is making them more dangerous still.

Meanwhile, Eavis never touches on what I’m pretty sure is the real reason that European policymakers are worried about a CDS trigger. A lot of people have been asking me about the Greek deal in recent days and weeks, and I get a lot of questions like the one I was asked yesterday by Amanda Lang, who asked whether default was in fact inevitable and whether Greece was just putting it off with this deal, kicking the can down the road. A lot of otherwise very well-informed people still think that this bailout is like previous bailouts, designed to avert a default. When in fact a huge default is right at its very heart. When the CDS get triggered, it’s going to be very obvious that this is indeed a Greek default. That’s something which bond market professionals are acutely aware of, but it hasn’t really sunk in to the broader popular consciousness.

If the Greeks and the Europeans can structure a deal where the credit default swaps aren’t triggered and the bondholders voluntarily swap their old bonds for new bonds, then it’s actually possible that this misunderstanding could continue well past the bond exchange, to the point that the broad public thinks that we’ve just seen another bailout, and misses the footnote that the bailout was accompanied by the single largest bond default in the history of the world.

If all goes according to plan, this is going to be an orderly bond default, to be sure — in contrast to the very disorderly defaults we’ve seen in recent years in countries like Argentina and Ecuador. But make no mistake: Ecuador Greece owes €14 billion to its bondholders on March 20. It is not going to make that payment, and instead bondholders who are currently owed 100 cents on March 20 will find themselves instead with a mixture of securities worth maybe 26 cents on the open market. When the CDS get triggered, that fact is going to get hammered home. Because although it has long been priced in to the market, it still isn’t broadly understood.

I had a little bit of fun amidst all the seriousness on Canadian TV yesterday, laying out my genius solution to the Greek crisis: Canadians. (My segment starts at about 19:20 in.) Essentially, Germany wants Greeks to become German: to stoically accept real wage deflation while working hard and paying their taxes in a good Protestant manner. Canadians are well-educated, productive, and very good at paying their taxes; what’s more, they’d probably like somewhere warmer to live, especially in the winter. So bring all the Canadians to Greece, where they could help turn the economy around, and leave Canada to the commodity companies and the Chinese property speculators. It’s basically the Davos to Greece idea, taken to its logical conclusion.

Underneath it all is the simple truth that economic growth is caused by people. Ever since the Eurozone was created, Europe has been quite clear about the fact that economic and monetary union can’t work without labor mobility. But sadly, the ability of Europeans to work in any EU country has meant an outflow of skilled professionals from Greece, when what it really needs is an inflow.

If you really want structural reform in Greece, a lot of that is going to have to come from new blood — northern European entrepreneurs and corporations setting up shop in Greece to take advantage of the large supply and low cost of labor there, as well as all the advantages of being both in the EU and in the Mediterranean. But that’s not going to happen so long as you read stories like this one, about how it took ten months to get permission to launch a website selling olive-oil-based products to the US market.

Antonopoulos and his partners spent hours collecting papers from tax offices, the Athens Chamber of Commerce and Industry, the municipal service where the company is based, the health inspector’s office, the fire department and banks. At the health department, they were told that all the shareholders of the company would have to provide chest X-rays, and, in the most surreal demand of all, stool samples.

Once they climbed the crazy mountain of Greek bureaucracy and reached the summit, they faced the quagmire of the bank, where the issue of how to confirm the credit card details of customers ended in the bank demanding that the entire website be in Greek only.

When politicians talk about “structural reform” in Greece, they mean cutting out a lot of this kind of red tape. But that takes time, which Greece doesn’t have. Besides, you need some kind of financial system to support new businesses, and Greece’s banks are barely lending at this point.

The really big picture here is that European monetary union is a marriage — and not a happy one, right now. In any marriage, if one partner falls on hard times, it’s incumbent upon the other to support them. If they can’t, or won’t, then divorce is surely in the cards. Similarly, if one partner doesn’t trust the other, then the marriage will not last long. The latest Greek bailout is being sold with the idea that Europe will support Greece indefinitely, and trusts Greece to do everything it’s promised. Neither passes the laugh test. And so, rather than moving to Greece to help rebuild its economy, the rest of Europe will ultimately split up with its noncontiguous partner. The only question is when.