Felix Salmon

When monetary policy needs to incorporate fiscal policy

Felix Salmon
Apr 13, 2012 01:38 UTC

I’m in Berlin this week, at the annual INET meetings, where the big theme this year seems to be an attempt to rope in everyone from anthropologists to neuroscientists in an attempt to solve the big economic problems which are proving intractable to economists. But still, it’s the economics and finance folk who are top of the agenda. And since George Soros is footing a large part of the bill for this conference, he and his latest op-ed are getting star billing. Sadly, however, most of the delegates have been at the conference all day and therefore haven’t had the opportunity to read Mohamed El-Erian’s speech in St Louis, which is equally germane.

The two, in fact, complement each other quite nicely. El-Erian’s main point is that central banks can’t solve the crisis on their own; Soros has an intriguing idea which addresses that fact, and attempts to add some fiscal-policy bite to the operation of monetary policy.

The EU’s fiscal charter compels member states annually to reduce their public debt by one-twentieth of the amount by which it exceeds 60% of GDP. I propose that member states jointly reward good behavior by taking over that obligation.

The member states have transferred their seignorage rights to the ECB, and the ECB is currently earning about €25 billion ($32.7 billion) annually. The seignorage rights have been estimated by Willem Buiter of Citibank and Huw Pill of Goldman Sachs, working independently, to be worth between €2-3 trillion, because they will yield more as the economy grows and interest rates return to normal. A Special Purpose Vehicle (SPV) owning the rights could use the ECB to finance the cost of acquiring the bonds without violating Article 123 of the Lisbon Treaty.

Should a country violate the fiscal compact, it would wholly or partly forfeit its reward and be obliged to pay interest on the debt owned by the SPV. That would impose tough fiscal discipline, indeed.

None of this is easy, but the big-picture idea is a good one, which is to tie monetary policy much closer to fiscal policy, so that fiscal policymakers are no longer capable of leaving all the dirty work to central bankers. In this case, if I understand him correctly, Soros is suggesting that the ECB buy up a large chunk of national sovereign debt every year. If any given country is following the EU’s fiscal-compact rules, then the interest on its debt gets rebated to the country; if it isn’t, then the ECB keeps the interest payments for itself.

If you look at what’s happened since the crisis of 2008, elected policymakers have generally turned to central banks and said “hey, we’re bound by all manner of real and imagined constraints, so please can you do what’s necessary in the short term, since we can’t.” This was quite explicit at the height of the crisis, when Hank Paulson felt quite comfortable telling Ben Bernanke what he needed to do. And then, of course, a couple of months later, Barack Obama appointed Tim Geithner, the country’s second most important central banker, as his Treasury secretary. The effect was to ensure that the central bank would always act in line with what the government wanted — and indeed that is exactly what has happened.

But that course of action has unintended consequences. For one thing, it makes the central bank politically unpopular. And for another, it tends to increase imbalances, including income and wealth inequalities, rather than decrease them. The way that El-Erian sees it, monetary policy during a crisis is like a bridge loan: it’s a short-term way of plastering over the gap, while a longer-term fiscal solution is put together. But if that longer-term fiscal solution isn’t put together, then the world’s central banks will just have built a “bridge to nowhere”, and ultimately made things worse rather than better.

El-Erian gives the world’s central banks an either-or choice: if they don’t manage to build a world where they’re rowing with the fiscal-policy tide, they’ll end up finding themselves “having to clean up in the midst of a global recession, forced de-leveraging and disorderly debt deflation”.

I’m not entirely sure I buy all of the analysis here. Central banks’ policies during the financial crisis were necessary, whether or not fiscal authorities end up doing their bit. While a future fiscal recession would be bad, it’s not at all obvious that we would have been better off just letting the world fall off a cliff at the end of 2008.

But it’s certainly true that central banks aren’t in full-on crisis mode right now. The problems they face — none greater than unemployment, in both its long-term and its youth flavors — are not the kind of things which happen suddenly and need to be addressed with massive and instantaneous liquidity programs. Indeed, they’re the kind of things which really ought to be addressed with fiscal policy. Monetary policy is a blunt tool, and, as El-Erian says, central banks can’t engineer “good inflation”, in things like house prices, without “bad inflation”, in things like oil prices.

And so long as central banks continue to push their zero-rate policies alongside unorthodox measures like LTRO and QE, politicians will find the pressure on themselves being lifted, even as the central banks get most of the market attention. As Ryan McCarthy says, the CNBC types are much more obsessed with the Fed than they are with Treasury: fiscal policy simply isn’t seen as economically important in the way that monetary policy is. Not even in an election year.

El-Erian’s main point is a pretty subtle one: bimodal dynamics mean that that we’re now moving towards a topsy-turvy world where good policy can be bad policy. “A good portion of policy making” he says, “and important underpinnings of conventional portfolio management, are based on a traditional bell curve governing the distribution of expected outcomes.” What that means is that if the central bank makes things better, that’s all good.

In a world where the outcome distribution is not a bell curve, however, the right action for a central bank is not nearly as clear-cut. Think of a bimodal distribution with two peaks: a bad one on the left, and a good one on the right. In that world, loose monetary policy will, at the margin, push the outcome to the right: it will make a good outcome better, and a bad outcome less bad. El-Erian’s point is this: what if, at the same time, by taking pressure off politicians, that kind of monetary policy makes a good outcome less likely, and a bad outcome more likely? If loose monetary policy pushes both peaks a little to the right, but at the same time makes the left-hand peak significantly larger than the right-hand peak, it can still be a very bad idea.

It’s an intriguing idea — but it’s also one which is pretty much impossible to model. And yet, the message of INET, or at least one of them, is that economists should be doing exactly that. Central bankers don’t like to try to anticipate the effect that their actions will have on politicians. But if they don’t, the politicians won’t play ball. And if the politicians won’t play ball, there’s nothing the central bankers can do on their own to avert a major fiscal crisis.


@StillJaded, I agree that inflation of house prices is bad. However deflation of house prices is worse! Some support to soften the degree of deflation is appropriate.

That said, house prices are driven by mortgage rates as much as by any other single factor except incomes. By keeping mortgage rates artificially low, the Fed is already supporting house prices — with presumably less effect on oil and other cash-traded commodities. Very few things are leveraged to the degree that housing is.

@Twundit, I get the impression that most economists don’t think it matters whether we spend money building roads, improving our secondary education, or digging holes and filling them in again.

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Counterparties: ‘Bridges to nowhere’ in central banking

Apr 12, 2012 21:33 UTC

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Traders and financial journalists have a favorite game: guessing when the Fed will step in and juice the markets. “The Fed signals possibility of something!” “Fed governor leaves door open for potential action at an unknown date!”

We all know this pattern; it still moves markets and sends CNBC anchors into a lather. But it’s worth taking a step back and taking in the latest comments from Mohamed El-Erian and George Soros about central banks. The real problem here isn’t Fed-obsessed traders making the market more volatile. Rather, they suggest, the world’s central banks could be doing more macroeconomic harm than good.

Both El-Erian and Soros are adamant that the European crisis is getting worse, despite the ECB’s huge interventions. Soros says: “the crisis has entered what may be a less volatile, but potentially more lethal phase.” The ECB’s LTRO operation, he writes, has helped the markets but “obscured underlying deterioration” that threatens to break up the EU.

El-Erian, for his part, says “the problems in Europe are getting bigger.” But his most fascinating comments are focused on the U.S. (His full speech, given at the Federal Reserve bank of St. Louis, is a must-read.) Cut through the wonkiness of El-Erian’s speech, and you have some of the harshest warnings about modern central banking in recent memory.

Among the potential consequences of central bank actions, according to El-Erian: damage to pension and money market funds; “artificial pricing, lower liquidity and a more cumbersome price discovery process”; contributions to higher commodity prices; pressure on emerging economies to lower rates; a gusher of speculative cash destabilizing emerging economies; and, last but not least, exacerbated income inequality, as the stocks and bonds owned by the wealthy become more valuable.

The broader idea, says El-Erian, is that the world’s central banks have transformed the world’s priorities, so that traders with a short-term outlook are dominating investors who might be able to make distinctions more useful than simply “risk on” and “risk off”.

We trade too much and invest too little – and a lot of that is the fault of the Fed and the ECB. Their liquidity helped to put out the fires of 2008, but looking to central banks to fix the world’s economic problems, El-Erian says, is just asking for expensive “bridges to nowhere.”

On to today’s links.

Double Agents
Meet the “Fox News Mole” – Gawker

Tax Arcana
“Accountants are today’s cowboys” – David Foster Wallace’s tax classes – New Yorker
A brief reminder on how the Buffett Rule actually works – WashPo

Treasury fund for “hardest hit” homeowners has spent just 3 percent of its funds in two years – NYT

The Fed
El-Erian: “central banks can no longer – indeed, should no longer – carry the bulk of the policy burden” – Pimco
Philly Fed Chairman: conditions don’t justify to new action – WSJ

Raging Bulls
Even excluding Apple, the S&P 500 has doubled since 2009 – Bloomberg

Goldman settles charges related to trading “huddles” for $22 million – SEC
Goldman sheds leveraged loans, and Buffet is the buyer – WSJ

Centralized Banking
Chanos says Chinese banks are instruments of state policy and won’t be broken up – CNBC

Positive Indicators
New York’s subway had more riders in 2011 than any year since 1950 – NY1

Old Normal
Gated communities: “we used to call them castles” – Atlantic Cities

Impatient Capital
Fred Wilson on what private equity can teach entrepreneurs about staying independent – AVC

Department of Collections
Recovering economy boosts tax revenue and shrinks the deficit by $50 billion – WSJ

Jamie Dimon ready to fight any repurchase claims on $95 billion of mortgage securities – Bloomberg

Sitting down is killing you, but a standing desk is a power trip – Kempt

New Normal
More people are quitting their jobs – and that’s decidedly good news – WSJ

Good News
At a state level, housing pricing prices and economic performance are decoupling – SF Fed

World Bank says China will be able to achieve a soft landing – World Bank

Oaktree’s IPO was marked to Howard Marks –  Reuters Breakingviews

The U.S. has a higher percentage of low-wage workers than any other OECD country - Economist’s View


Rare misdirected by Klein. The point of the Buffett rule is to get the effective rate up to 30%, so there actually quite high marginal rates during the phase-in in order to het a modest increase in the effective rate.

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Ed DeMarco and the spectre of strategic modifiers

Felix Salmon
Apr 12, 2012 12:10 UTC

After Ben Walsh covered Ed DeMarco’s speech in the Counterparties round-up yesterday, I got a very smart note from the undisputed kind of the housing blogosphere, Calculated Risk:

I think DeMarco made a key point about “strategic modifiers” as opposed to what people have been calling “strategic defaulters”.

In the 2nd case, these are people who can afford their mortgage, but walk away because they are so far underwater that continue to pay makes no sense.

DeMarco is talking about people who will want to keep their home, but default for the purpose of receiving a principal reduction.

I think this is more likely than the classic strategic defaulter (something I’ve played down for years).

The reason is Fannie and Freddie will have to make the program guidelines clear and public. People are very good at figuring out how to game the rules. So, unless the rules are very tight, there will be more “strategic modifiers”.

Certainly this is something that DeMarco is worried about: in his speech, he defines a “strategic modifier” as “a borrower that either claims a financial hardship or misses two consecutive mortgage payments in order to attempt to qualify for HAMP and a principal forgiveness modification.” If there are enough of these borrowers, he says, then the financial benefits of principal reduction could go away quite quickly.

DeMarco’s worries are not entirely unfounded, given, as he says, that three quarters of the Enterprises’ deeply underwater borrowers are current. But the distinction between a strategic defaulter and a strategic modifier is a very subtle one, given that their actions — defaulting on their mortgage while being capable of making payments in full — are indistinguishable.

The difference is not in what they do, but rather in their motivation: the strategic defaulter expects to lose the house at some point, while the strategic modifier expects to retain the house, and the mortgage, but get a principal reduction along the way.

Personally, I don’t believe that the problem of strategic modifiers (over and above the problem of strategic defaulters) is likely to be huge. One reason is that I’ve been writing about the upside of strategic default for a long time, and it really hasn’t caught on, outside a few second homes and the like. Strategic default is not something that Americans like to do, and one of the main reasons is that they really care about their credit rating. Even if a strategic modifier keeps her house, she’ll suffer the same hit to her credit rating as a strategic defaulter would. And people don’t like that at all.

On top of that, the strategic modifier will still be running the risk of getting far behind on her mortgage payments, being unable to make them up, and then for some reason not qualifying for a principal reduction or indeed any other kind of modification. DeMarco is right that the principal-reduction program would be broadly publicized. But it will be publicized to people who are having real difficulty making their mortgage payments. If you can’t make those payments, then applying for a principal reduction is a no-brainer: it’s all upside and no downside. But if you can make those payments, the calculus is a lot more complex.

Even if principal reduction were made available to people who hadn’t missed a single mortgage payment — and I doubt that it would be — it would still constitute a write-off of a large chunk of debt, and would likely be considered a default as far as FICO was concerned. And if you do have to be in default to apply for a principal reduction, then not only do you suffer the hit to your credit rating, but you also run the risk of falling into a major mortgage-related nightmare which might well end up with you losing your home.

CR is right that people like to game rules. But he misses a crucial point here, which is that any principal-reduction program would be run by mortgage servicers. And the one thing that everybody knows about mortgage servicers is that they’re incompetent. No one will trust the servicers to play the game perfectly by the rules.

I, for one, would be petrified of playing this game, because I would have no faith at all that my mortgage servicer would do the right thing and give me that principal reduction, rather than having its left hand lose lots of paperwork while its right hand started foreclosure proceedings.

So let’s try principal reductions in the real world, and see what happens. If they turn out to be incredibly expensive, then we can revisit the issue. But my guess for the most likely outcome is not a wave of strategic modifiers. Rather, it’s that the program turns out to be much like all other government attempts to deal with underwater borrowers: a damp squib where very little happens at all.


That is just plain silly.

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Counterparties: DeMarco’s principal principle

Ben Walsh
Apr 11, 2012 21:07 UTC

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The most hotly debated cure for America’s gigantic and protracted foreclosure crisis is all about principal – or rather, principle. The idea behind principal reduction is straightforward: Instead of valuing a struggling borrower’s mortgage at its original value, you reduce the amount to something closer to the market value. That, the argument goes, lowers the borrower’s payments and makes him or her all the more likely to stay in that home.

The business press jumped yesterday when it seemed that Ed DeMarco, head of the FHFA (Federal Housing Finance Agency), the regulator that oversees Fannie and Freddie, seemed finally to change his principles on principal reduction. The American Banker this morning was rightly skeptical – DeMarco in fact only opened himself to discussing the topic. DeMarco’s argument against principal reductions is that they could trigger “strategic defaults.” Of course, this moral hazard argument is somewhat ironic coming from the regulator of taxpayer-owned Fannie and Freddie.

It’s unfortunate that DeMarco, who has taken a huge amount of criticism for his intransigence on mortgage modifications, trotted out this tired logic. Although calling him “America’s most dangerous man” is going a bit far, DeMarco’s speech (and accompanying presentation) was deeply disappointing in its focus on the bogeyman of “strategic modifiers”:

One factor that needs to be considered is the borrower incentive effects. That means, will some percentage of borrowers who are current on their loans, be encouraged to either claim a hardship or actually go delinquent to capture the benefits of principal forgiveness?

As Nick Timiraos points out, DeMarco’s model shows the taxpayer savings from principal reduction are lost if from 1 percent to 5 percent of homeowners who are underwater but not delinquent strategically default. HUD Secretary Shaun Donovan, however, says “the vast majority of homeowners don’t operate that way.”

After decades of Americans hearing the benefits of homeownership from all angles, it’s hard to believe that a Fannie-Freddie principal reduction program would lead to a wave of people defaulting. There’s some evidence that strategic default isn’t all that big a problem and may actually be declining. There’s even a whole genre of media profiles that chronicle just how difficult and painful it is for homeowners to decide to walk away from their homes.

But strategic defaults continue to scare DeMarco, just as they do Rick Santelli and Dick Bove. DeMarco’s tone is obviously different, but the vision of the American homeowner as the post-crisis welfare queen is the same.

It’s true that we don’t have good data to know precisely how homeowners will react to a principal reduction program at Fannie and Freddie. But if a principal reduction plan is, as DeMarco says it is, an argument about “which tools, at the margin” make a difference, why not give it a go? Bank of America, for one, is trying a variation of it.

It’s a strange day when a key regulator hews closer to the views of TV pundits than the Treasury Secretary. – Ben Walsh

And on to today’s links:

Government-owned AIG is getting back into the real estate investing game – WSJ

Consider Yourself Warned
Subprime loans are back as lenders return to “business as usual” – NYT

Foreclosure record-keeping is so bad, BofA is repeatedly suing itself in Florida – HuffPost

EU Mess
German bond yields are at record lows – WSJ

Tax Arcana
How big company execs’ “personal safety perks” (read: corporate jets, etc.) become tax write-offs – NYT

Shock! There are more efficient ways for the government to collect taxes – NYT

What’s going on with Google’s $12 billion toy? – WSJ

Primary Sources
Full text: The DOJ’s e-book price-fixing suit against Apple, publishers – Reuters Legal

Publishers caught conspiring in “upscale Manhattan restaurant” – MoJo

Facebook may have gotten a major deal on Instagram (on a per-user basis) – Wired

Why banks aren’t lending more – Bonddad Blog

Zimmerman to be charged in Trayvon Martin shooting – WashPost

Austan Goolsbee wants you to learn from his mother’s “strategic toilet paper reserve” – WSJ

Carlyle is seeking an IPO as big as $8 billion – Bloomberg

There is a penny lobby. And it is powerful – Fortune

As If You Needed To Ask
“Are people finally getting bored with the tech-blog circle jerk?” – SF Weekly

Just four jobs are worse than being a newspaper reporter – Poynter

Dismal Science
There’s no “invisible hand” of the market. Please update your records – Harvard Business Review


Also can I suggest that people actually read his speech rather than the mickey mouse claims about what he is saying. Fundamentally principal reductions would only “make financial sense” to Frannie because for every dollar the GSEs forgive, they get up to 63 cents from the government. This is the key part of the speech.

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Charts of the day, house-price edition

Felix Salmon
Apr 11, 2012 13:39 UTC

If you haven’t read it, I can highly recommend Paul Kiel’s magnum opus on the US foreclosure crisis, available online or as a Kindle Single. Kiel tells the national story using synecdoche: the story of Shelia Ramos is representative of millions of others. And Kiel makes it very clear just how typical her tale is, zooming back out to a big-picture view on a regular and welcome basis.

What Kiel doesn’t do is look forward, and give his informed opinion on whether the new rules being outlined by the Consumer Financial Protection Bureau are likely to work to prevent such events from happening again. The question isn’t whether the new rules are good ones; the much more important and salient question is whether they will be followed and enforced. I’ll believe it when I see it: as Kiel shows, servicers are really bad at this kind of thing, and there’s a strong case to be made that they’re simply not capable of following the rules that the CFPB is laying out.

Meanwhile, the weird cognitive disconnect in the housing market seems greater than ever. If you look at Fannie Mae’s latest monthly survey, it shows lots of new highs being set: the percentage of people thinking that house prices are going up, the percentage of people thinking it’s a good time to buy, and, especially, the amount that people think they’re going to have to pay for housing if they don’t buy.


And yet, the facts on the ground don’t support any of this. Check out the latest quarterly home price report from LPS, for instance. Not only are prices still falling, they’re actually falling at a faster rate than they were a couple of years ago:


The rate of relatively slow price declines, from January 2009 to May 2010, was the time when there were tax incentives for first-time homeowners. When those tax incentives went away, so did the artificial support for the housing market; in hindsight, most of those first-time buyers would probably have been better off just waiting, and buying a house now without the tax incentive instead.

What’s more, this index, unlike other indices, excludes short sales. If you include short sales, then the numbers are far worse. And as the mortgage industry moves from foreclosures to short sales (since short sales don’t require the lender having to prove title to the home), the discount on short sales is growing alarmingly, and approaching the discount on foreclosure sales.


In Kiel’s story, Ramos abandoned her house to the mercy of her lender, rather than suffering through a foreclosure: in that sense, when it was finally sold it was more of a short sale than a foreclosure sale. But the distinction is less and less important these days — and there’s still a shadow inventory of millions of homes being lived in by delinquent borrowers, which are going to come on the market sooner or later at discounts of more than 20% to their peers. So long as that’s the case, it’s hard to see how house prices are going to stop going down and start going up.

So what explains Americans’ optimism surrounding house prices, especially when they think mortgage rates are going to rise? My guess is that it’s the fact that the recovery is proving itself to be real, combined with a natural bullishness when it comes to housing, which somehow wasn’t eradicated by the 2008 crisis.

But color me contrarian: if house prices can’t rise even with mortgage rates at all-time lows and the government desperately underwriting nearly all the mortgages in the land, I can’t imagine how they’re going to go up in future when rates go up and the government manages to extricate itself from the market. And if house prices don’t go up, of course, then the number of underwater borrowers will stay high, and the foreclosure crisis is going to remain a big problem for the foreseeable future. That’s the real horror of Kiel’s story. Not that it happened in the past — but that it’s likely to be repeated into the future, as well, for many years to come.


Why buy a house now? Buy later after prices crater for 65% less.

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Argentina, Elliott, and the pari passu war

Felix Salmon
Apr 10, 2012 22:13 UTC

Anna Gelpern puts it well: “for the small but committed contingent of pari passu pointy heads, this is WorldCupOlympicMarchMadnessSuperBowl.” I’m one of the contingent, and I’ve been actively enjoying myself reading various appeals and amici briefs in the case of Elliott Associates vs Argentina. (Technically, it’s not Elliott Associates but rather NML, an Elliott sub-fund, but make no mistake: this is very much a fight between Argentina and the most famous vulture fund in the world.)

Elliott, which is run by the billionaire Republican activist Paul Singer, has suffered a rare and public loss with respect to its Argentina strategy. It bought up Argentine debt around the time the country defaulted, and then refused to enter into the country’s bond exchange, taking its chances in U.S. court instead. That, in hindsight, was a mistake: Argentina’s new bonds, turbo-charged with GDP warrants, performed extremely well. While its defaulted debt has gone absolutely nowhere.

When Elliott started litigating its defaulted debt a decade ago, it quite explicitly told the judge in the U.S. Southern District, Thomas Griesa, that it wouldn’t wheel out the most notorious and legally dubious weapon in its arsenal: the pari passu argument it used to devastating effect against Peru in 2000. In 2003, indeed, Argentina’s lawyers asked the court for a declaration that the argument was legally bonkers; the only reason that Griesa didn’t provide that declaration was that Elliott Associates — in line with all the other holdout creditors — said that it had no intention of making the argument, “at any time in the near or distant future”.

In fact, Elliott was just playing the waiting game — waiting, that is, for 91% of the other creditors to go away, persuaded by Argentina to accept its exchange offer. And then, after a decent amount of time — five years — it suddenly decided that it was going to attempt to use its rather odd pari passu argument after all.

Waiting that long held dangers, since it smells of what lawyers call “laches” — unreasonable delay in making a claim. But it was also quite smart, since at that point Elliott had been fighting Argentina in front of Judge Griesa for a decade, and Griesa was officially Fed Up with the whole thing and just wanted to make it go away.

Griesa’s orders (here here here) are notable for their lack of legal reasoning: Griesa is throwing his hands in the air, here, and basically punting the whole issue up to the appeals court. Each one is very short, certainly in comparison to the long, compelling, and clearly-argued amici briefs, let alone Argentina’s masterful, 84-page response. After reading that, and the briefs from the Justice Department and The Clearing House , it’s basically impossible to see how Griesa’s order can possibly be upheld on appeal.

It’s hard to count the number of reasons why Griesa’s ruling doesn’t make sense, but it’s worth running down a few of them. For one thing, the whole thing is based on the “ratable payment” reading of the pari passu clause — that, in the words of NYU law professor Andreas Lowenfeld, “a borrower from Tom, Dick, and Harry can’t say ‘I will pay Tom and Dick in full, and if there is anything left over I’ll pay Harry’.” Unfortunately, that’s exactly what the borrower can do. If I owe money to my landlord and to my credit-card issuer and to my brother-in-law, it’s up to me which of them I repay, and in which order. All those creditors might have legal recourse if I don’t pay them. But the landlord can’t claim the money I’m paying to my brother-in-law, nor vice-versa.

In this case, Argentina is paying the holders of its new bonds, or, to be precise, it’s paying the trustee who accepts money on their behalf. Once it has transferred money to the trustee, that money no longer belongs to Argentina: it belongs to the new bondholders, the people who accepted a large haircut on their debt as part of Argentina’s bond exchange. What’s scary about Griesa’s order is that he’s ordering and injunctioning not only Argentina, but also the innocent bondholders of Argentina’s new debt. It’s almost impossible to see why they should be paying off Elliott, especially since Elliott wants to be paid all principal and interest payments on its bonds, sans any kind of haircut at all. That doesn’t sound very pari passu to me, if all the other bondholders have taken a 70% haircut.

The problem for Elliott, here, is that it rushed, very soon after Argentina defaulted, to convert its Argentine bonds into court judgments.* That’s easy: Any bondholder who has been defaulted on can become a judgment creditor pretty easily. But becoming a judgment creditor also happens to be the remedy, in the bond documentation, if Argentina violates the pari passu clause. (Which, incidentally, no one knows what it means.) Griesa, in going after the trustee for other Argentine creditors, is going well beyond the letter of the contract, just because that seems to be the only way of getting Argentina’s attention.

Certainly Argentina has no intention of paying Elliott anything. The country’s view of Elliott is that it’s an annoyance, which is causing it to rack up millions of dollars in legal expenses. And as a result, Griesa’s view of Argentina is that while it will happily send expensive lawyers to appear in front of him on a regular basis, it will never actually pay the plaintiffs, no matter what he rules. Which is why, I think, he finally cracked and issued this pari passu ruling: it was the only way he could think of to get Argentina’s attention.

The ruling doesn’t make a lot of sense. For one thing, it requires that Elliott will suffer “irreparable harm” if it isn’t paid. But of course the harm here isn’t irreparable: it’s just money. You pay Elliott money, the harm goes way. That’s pretty much the definition of reparable harm. And then there’s the fraught sovereign-immunity aspect of everything: Griesa’s ruling flies in the face of the Foreign Sovereign Immunities Act, which for obvious reasons the U.S. and most other countries are big fans of. Argentina did waive its sovereign immunity in its original bond issue, but the degree to which that’s even really possible is far from settled under case law.

All of which is to say that Reynolds Holding is wrong when he says that Elliot has “shown it’s possible to win against debtor nations”. Elliott has been a judgment creditor of Argentina for a decade now, and it’s still a judgment creditor: Griesa is a judge, and he can’t ultimately do much more than hand down judgments. The difficult bit has never been getting a court to rule that you’re owed money: that’s the easy bit. The difficult bit is actually collecting on that judgment. And the base-case scenario here is that Elliott is not going to collect.

In fact, the sovereign-debt world is probably a little bit relieved that the Court of Appeals now has the opportunity, once and for all, to set a clear precedent on what the pari passu clause really means in sovereign debt contracts. This issue has been up in the air for far too long, unhappily for sovereigns. When Griesa gets his ruling overturned on appeal, we’ll finally have the pari passu ruling we’ve been waiting for since 2000. Of course, it’s conceivably possible that the appeals court will uphold Griesa’s ruling, and thereby deal a massive and pretty much unenforceable blow to sovereign debt management around the world. But it’s very unlikely. Elliott might have won the battle for its unorthodox pari passu interpretation. But in doing so, it’s set itself up for losing the war.

Update: I’m now told that despite litigating this suit for a decade, Elliott has chosen not to become a judgment creditor. Which may or may not be smart. In any case, bondholders have the right to accelerate their bonds — make all principal and interest due and payable immediately — if the pari passu clause is breached. But Elliott has already done that.

*Update 2: Elliott now confirms that it is a judgment creditor of Argentina after all. Right first time. Sorry about that.


Griesa had a temper tantrum and simply ignored the law. Check the transcript and you se his own statements acknowledge that his ruling is very questionable. His ruling on the laches issue simply has no basis.

I can certainly understand the judge’s exasperation with Argentina. Nevertheless, this is no excuse for a federal judge to ignore the law.

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Counterparties: Why Facebook bought Instagram

Apr 10, 2012 17:02 UTC

Welcome to a preview of the Counterparties email, a collection of the day’s very best links on finance and economics! The sign-up page is here, it’s just a matter of checking a box if you’re already registered on the Reuters website. Send suggestions, story tips and complaints to Counterparties.Reuters@gmail.com

By now you’ve heard all about Facebook buying the two-year-old photo-sharing app Instagram for $1 billion. In the process, Facebook made Instagram’s handful of employees and investors filthy rich, pissed off Internet nerds and made the front page of the NYT and the WSJ.

Commentators like Dan Primack have argued that this was a defensive acquisition: Facebook was simply buying up its biggest competitor in the photo-sharing space. It’s also completely reasonable that Facebook, built on the browser, as Robert Scoble and Jenna Wortham note, was making a play for the growing mobile-web audience.

But there’s something else going on here. Om Malik, who says he spends “an hour a day on Instagram,” is on to something when he says Instagram is built on the vagaries of human emotion:

Instagram created not a social network, but instead built a beautiful social platform of shared experiences

People like Facebook. People use Facebook. People love Instagram. It is my single most-used app. I spend an hour a day on Instagram. I have made friends based on photos they share. I know how they feel, and how they see the world. Facebook lacks soul. Instagram is all soul and emotion.

But what if Malik’s “soul” is really just another word for quality?

Instagram just may be the first company that’s figured out the quality problem with user-generated content on the Web. This is bound to be incredibly appealing to advertisers, who are increasingly moving away from static news and content and into the social-media space. (Just ask BuzzFeed.) Compare an Instagram feed (here’s a hacked-together link to mine; I’m not a photographer, but Instagram somehow makes me better) with what’s being uploaded to YouTube and written on Twitter or even with photos shared on Facebook itself.

Would you rather run your ad next to an artfully sepia-toned photo of a cityscape or in the comparatively messy worlds of Facebook, Twitter or YouTube? You don’t need to be Don Draper to see which is more appealing.

Facebook certainly knows how to target ads to its audience’s interests, but as we all know by now, Facebook users post any number of boring, self-interested or otherwise forgettable updates (this happened roughly when your parents joined). Instagram photos, as Jack Shafer suggests, are simple and frequently brilliant.

Instagram has not yet tried to bring in any revenue, but I’m not sure that matters in valuing the company. Instagram’s growing audience of some 30 million people may end up being more valuable on a per user basis than Facebook’s. The conventional wisdom that Facebook sees Instagram as competition is not the whole story. It may also see Instagram as having particularly advertiser-friendly content that its own users currently have trouble producing.

Think of it as a $1 billion way to make your parents’ status updates more interesting.

And on to today’s links:

Instagram’s CEO will reportedly earn $400 million from Facebook sale – Wired
Zynga spent $1.2 million on home security systems for its CEO – WSJ
@Om: “Facebook lacks soul. Instagram is all about soul – GigaOm

Must Read
Home again in Mexico: Illegal immigration to the U.S. now at “net zero” – Christian Science Monitor

EU Mess
Spain will now be playing the part of an EU country caught between rising borrowing costs and austerity – WSJ
European companies now borrowing more from the bond markets than they are from banks – WSJ

Last year, 60 percent of hedge funds lost money in a flat market – Fortune

“Shadow banking” can get you a death sentence in China – Bloomberg

Regulatory Inertia
Ed DeMarco is still not ready for principal write-downs – HuffPost

Why Facebook’s purchase of Instagram was an act of panic – Fortune

Reuters Opinion
Instagram is taking media to a “post-verbal, post-textual” place – Jack Shafer
The Europe debate – Felix
Eliminating 100 million tax returns – David Cay Johnston
World Bank wackiness explains U.S. odd choice – Rob Cox

Tax Arcana
An argument that Obama is going to let all of the Bush tax cuts expire – Bloomberg
The White House unveils its Buffett Rule proposal for taxing the rich – White House
The Buffett Rule is arguably not that consequential – Bloomberg

Private equity not that private anymore – and it’s growing up – The Deal

Dismal Science
Issues on which economists can agree, but most of us can’t seem to – The Atlantic

Long Reads
One woman’s epic journey from homeowner to living in a tent in Hawaii – ProPublica

Helpful Reminders
“It’s important to remember that internet commenters are the scum of the earth” – Josh Barro

A glorious shredding of modern Internet company accounting – Grumpy Old Accountants

Apropos of Nothing
North Dakota “sovereignist” doesn’t like it when unmanned drones stop him from stealing cows – U.S. News & World Report



They are all platform, which people use in ways that vary over time. The GigaOm writer now spends an hour a day on Instagram, believing it’s higher quality, because he follows fewer and more discerning people there than on Facebook. It’d be interesting for the writer to follow only the same people in Instagram and Facebook.

If Instagram gets 500 million users, including parents, teachers, employees/ers, the store down the street, and people I wish I’d forgotten, and a user follows all of them just like accepting too many Facebook requests, then the perceived quality of a person’s Instagram follows will quickly disappear.

There does not seem to be anything unique about the Instagram platform that might enforce the current quality. I’m sure people thought their Facebook walls were quality back in 2007. The ‘quality’ of followed Tweets was probably better before large-scale adoption by marketers, spambots and idiots.

tl;dr: things that are cool when they are small can be much less cool when used by the world. Would Grandma’s Instagram feed be any better than her Facebook posts?

It’s the poster, not the platform, that matters.

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The Europe debate

Felix Salmon
Apr 10, 2012 01:00 UTC

Remember the Krugman vs Summers debate last year? That was fun, in its own way. But this year’s Munk Debate looks set to be simply depressing. The invitation has the details: the motion is “be it resolved that the European experiment has failed”. And I’m reasonably confident that the “pro” side — Niall Ferguson and Josef Joffe — is going to win.

That’s partly because Ferguson has the public-speaking chops to dismantle his meeker opponents, Peter Mandelson and Daniel Cohn-Bendit. Ferguson is likely to go strongly for the jugular, while Mandelson and Cohn-Bendit will noodle around ineffectually, hedging their conclusions and sacrificing rhetorical dominance for the sake of intellectual honesty.

You can see this, already, in the invite. Each speaker is introduced with a one-liner; Ferguson says that Europe is conducting “an experiment in the impossible”, while Mandelson says that Europe is, um, “getting there” and that the world is “very impatient”. Cohn-Bendit is weaker still: his quote, “We need a true democratic process for the renewal of Europe, in which the European Parliament has to play a central role,” seems to imply that Europe really is doomed, since there’s no way that the European Parliament is going to play a central role in anything, except perhaps an expenses scandal.

It wasn’t all that long ago that public intellectuals could make a coherent case that European union, both political and monetary, was and would be a great success story. In the wake of Greece’s default, however, and credible beliefs that Portugal is likely to follow suit, disillusionment and pessimism is the order of the day. The era of great European statesmen is over; in their place, we have David Cameron.

I was a believer in the European experiment; indeed, I thought it had a kind of grand historical inevitability to it, and that a strong whole could be made up of vibrant and disparate parts. And from a big-picture historical perspective, Europe is indeed a success: a bloody and war-torn continent has transformed itself into a political union where it’s unthinkable and impossible for one member state to invade another. But if by “the European experiment” we mean the euro, that’s been a disaster, and virtually everybody in Europe would have been better off had it never existed.

In this, curiously, the broad European population was much more prescient than the educated and political elites, who in large part imposed the euro on their unthankful and unwilling countries. Mandelson is a key member of that elite, and he was wrong about the euro and about the advisability of the UK joining it. It’s going to be very hard indeed for him to persuade an audience of Canadians that this time he’s right. Or, for that matter, that they should in any way welcome the prospect of a monetary union with Iceland.


Agreed, Fifth, that was PART of the subprime problem. Only the tip of the iceberg, though.

That Paul Mason report cites legitimate suffering, but consider the cause? Unemployment, divorce, unemployment. You can add medical bills to that list if you like. This story, at least, didn’t blame any of it on foreclosure. Rather, it is part and parcel of the greater recession/depression.

Europe definitely embraces a greater degree of socialism than the US — that is both your strength and your weakness.

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Counterparties: Should we fear Voldemort?

Ben Walsh
Apr 9, 2012 22:08 UTC

Welcome to the Counterparties email! The sign-up page is here, it’s just a matter of checking a box if you’re already registered on the Reuters website. Send suggestions, story tips and complaints to Counterparties.Reuters@gmail.com

Yes, a billion dollars is cool. But what about a team led by a mysterious trader nicknamed “Voldemort” making potentially market-distorting bets at the nation’s largest bank by assets? That’s really cool.

In Bruno Iksil, a JPMorgan trader also known as the “white whale,” Paul Volcker – and the regulation that bears his name – finally has the nemesis he deserves.

Bloomberg reported on Iksil last week, noting that he reportedly earned $100 million a year for the bank in recent years, which has rival traders claiming that Iksil’s bets could violate the Volcker Rule. The WSJ also wrote a piece on Iksil. Additional details and an improved pseudonym in a follow-up by Bloomberg vaulted him back into the headlines today:

JPMorgan Chase & Co. (JPM) trader Bruno Iksil’s outsized bets in credit derivatives are drawing attention to a little-known division that invests the company’s reserves and fueling a debate over whether banks are taking excessive risks with federally insured and subsidized money.

Iksil’s influence in the market has spurred some counterparts to dub him Voldemort, after the Harry Potter villain. He works in London in the bank’s chief investment office, which has assembled traders from across Wall Street to its staff of 400 who help oversee $350 billion in investments. While the firm describes the unit’s main task as hedging risks and investing excess cash, four hedge-fund managers and dealers say the trades are big enough to move indexes and resemble proprietary bets, or wagers made with the bank’s own money.

Lisa Pollack tries to unpack two crucial pieces of this story, the motivations of the sources and whether indeed Iksil is distorting the CDS market in question. Sober Look argues that the most likely scenario is that JPMorgan is hedging its exposure to its own debt, rather than setting up a proprietary trade, which would be banned under the Volcker Rule.

It’s a bit ironic that it was initially a small group of hedge fund traders who complained to the media about how Iksil’s trades were warping the free market.

But however market-distorting, it does seem likely that the trades are hedges, albeit massive and increasingly public ones. These are probably trades JPMorgan’s rivals in this particular CDS market just don’t like being on the other side of.

If the facts of the trades as now reported are true, we’re left with the same uncertainty regarding the Volcker Rule that we’ve had since it was proposed. How much harm does prop trading by deposit-taking institutions cause to the global financial system? How do you define prop trading? How do you enforce a ban on it? When does a hedge become a systemic risk?

To help think through these questions, we put together the best pieces on the still vague and hotly contested Volcker Rule:

We need a new Volcker rule for banks (Sheila Bair)
The Volcker Rule and ‘Flipping the Presumption’ (Economics of Contempt)
Financial Reform (Unfinished Business)
Attack on Volcker Rule Seen Exaggerating Cost of Disorder (Businessweek)
The Volcker Rule, Made Bloated and Weak (Jesse Essinger)
The Volcker Rule Is Still a Bad Idea (Brookings)
Bank Lobby’s Onslaught Shifts Debate on Volcker Rule (Bloomberg)

And on to today’s links.

Facebook just bought all of your artfully sepia-toned cellphone pics – All Things D

Right before acquisition, Instagram closed a $500 million funding round – TechCrunch

AOL sells $1 billion in patents to Microsoft – Tech Crunch

Rites of Spring
How the mild winter made the economy look better than it actually is – WashPo

Obama’s BFF (“best friend in finance”) has unenviable task of calmly defending him to Wall Street – WSJ

Return of the (John) Mack – NYMag

Gray Areas
Obscure banks are charging big fees to do (legal) trades with Iran – WSJ

We don’t need publishing anymore, “editing, we need, desperately” – Findings

Since ’05 publishers lost $26.7 billion in print advertising revenue and gained only $1.2 billion in new digital revenue – Reflections of a Newsosaur

Mr. Market doesn’t exist – Math Babe

Size Matters
Large companies recovering more quickly from the recession than small businesses – WSJ

Sony is cutting 6 percent of its workforce – Bloomberg

Jim Yong Kim says he “had no idea what a hedge fund was” until three years ago – WSJ

You’re On Your Own
Money for job training has nearly been cut in half – NYT

Bank of America is so hot right now – NYT

Be Afraid
Ikea is going to build an entire neighborhood in London – Design Taxi

Foreign spies are now lurking in U.S. universities, experts warn – Bloomberg

Consumption inequality has risen about as fast as income inequality – Slate



MrRFox, when you actually know what you are talking about feel free to engage again, otherwise can I suggest a career in financial “journalism”.

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