Felix Salmon

Sovereign ratings aren’t very important

Felix Salmon
Jun 19, 2012 18:58 UTC

Bloomberg has another one of its meandering monsters today, this time under the headline “Austerity Doesn’t Pay as Debt Markets Ignore Rating Cuts”. The 3,300 words can be reduced quite easily to one sentence: Countries are implementing austerity measures in order to bolster their credit ratings and keep their borrowing costs low, but it turns out that credit ratings have no effect on borrowing costs after all.

Bloomberg put a lot of work into this piece: it looked at “314 upgrades, downgrades and outlook changes going back as far as 38 years”, and compared government bond yields on the day of the ratings action to the same government’s bond yields one month later — to allow “time for markets to adjust to assessment changes while minimizing the effects of subsequent unrelated events.” The results show that there’s no real correlation there: 53% of the time rates followed the ratings move, and 47% of the time they didn’t.

This comes as no surprise, for three reasons. Firstly, the news from ratings agencies which causes markets to move is normally when countries get put on watch for a possible ratings change, not when the change actually happens. Markets specialize in pricing in future events, and few if any ratings actions actually come as a surprise.

Secondly, the ratings agencies are, famously, lagging indicators when it comes to bond spreads and yields: a rise in spreads does a much better job of predicting a ratings downgrade than the other way around. The Bloomberg study would have been much more interesting if it looked at the change in spreads before the ratings action, rather than the change in spreads after it. After all, the whole thesis of the Bloomberg article is that governments are using the ratings agencies as a proxy for the bond vigilantes. And in that sense it doesn’t make any difference at all whether the ratings agencies or the bond vigilantes get there first.

And finally, the Bloomberg findings come as no surprise because they were already well known:

In a January analysis of Moody’s rating changes, researchers at the IMF used credit derivatives to show that prices moved in the expected direction 45 percent of the time for developed countries and 51 percent for emerging economies. For outlook changes, the ratios were 67 percent and 63 percent.

Why did Bloomberg feel the need to replicate the IMF study, which it cites, but doesn’t link to? That’s not clear. And it’s also unclear why Bloomberg doesn’t publish its results in a tractable form: for instance, they don’t give separate figures for the effect of outlook changes on bond spreads. Indeed, while bits and pieces of the methodology are sprinkled through the article, the actual results are confined to a single number — 47% — in the seventh paragraph; no more numbers can be found in the associated graphics, which give anecdotal examples of yields falling after downgrades but no aggregated numbers from the dataset as a whole.

More invidiously, Bloomberg talks about “the austerity policies prized by the rating companies”, without ever mentioning that to a significant degree the ratings agencies actually want less austerity, not more. For instance, here’s S&P in January, announcing a mass downgrade of European sovereigns:

We believe that a reform process based on a pillar of fiscal austerity alone risks becoming self-defeating, as domestic demand falls in line with consumers’ rising concerns about job security and disposable incomes, eroding national tax revenues.

And here’s S&P on Spain, in April:

We believe front-loaded fiscal austerity in Spain will likely exacerbate the numerous risks to growth over the medium term, highlighting the importance of offsetting stimulus through labour market and structural reform.

The fact is that austerity is a political decision more than it is an economic one: fears of bond vigilantes are ex-post justifications for political decisions, rather than genuine reasons for implementing those decisions.

Ultimately, the whole thesis here is a little silly. As former Moody’s sovereign chief Vincent Truglia says at the end of the article, ratings agencies are supposed to pay a lot of attention to governments, but governments really shouldn’t pay much attention to the ratings agencies. And neither, frankly, should market reporters, lest they massively oversensationalize the impact that downgrades can have. This, for instance, is pretty ludicrous:

S&P’s downgrade of the U.S. last year contributed to a global stock-market rout that erased $6.1 trillion in value between July 26 and Aug. 12.

The fact is that the press tends to care much more about ratings actions than the markets do. The bond markets were undoubtedly lulled into complacency by the dodgy triple-A ratings on structured bonds in the run-up to the financial crisis, but that had nothing to do with upgrades or downgrades. And frankly the idea that Europe’s austerity policies come in response to imprecations from Moody’s and S&P is pretty ridiculous as well.


Sovereign downgrades only effect bank balance sheet as they have (semi)strict rule on capital holdings. The downgrade becomes costly when banks have to dump one sovereign for another otherwise their capital formulas are out of whack and regulators/analysts bark at them. As to the rest of the market, ya, ratings agencies REACT to price moves or political instability, not the other way around – though a downgrade can exacerbate a condition that was already deteriorating.

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The Fed’s credit problem

Felix Salmon
Jun 19, 2012 15:17 UTC

Jon Hilsenrath, the Fed Whisperer, has a very good piece this morning on a key worry facing monetary policymakers as we go into the latest FOMC meeting: the Fed might be able to push long-term interest rates down, but as any fixed-income professional knows, there’s a huge difference between rates and credit. And something worrying is clearly happening in the mortgage market: rates are low, but credit is very, very hard to come by. Or, as millionaire homeowner Chris Hordan put it to Hilsenrath, “If you don’t need the money, you can get it all day long. Thank you, Ben Bernanke.”

This is a long-term trend, which has only been getting worse in the so-called recovery: fewer and fewer homeowners who could really use the savings are finding it possible to refinance their homes.


This is not entirely irrational on the part of banks. As Mary Umberger reports:

In recent years, when facing financial pressure, homeowners have been more likely to let the mortgage slide before they would fall behind on their credit card bills, researchers have found.

But it turns out that the mortgage is even less sacred than we thought: When times are tight, consumers put paying for their cars first. Then the credit cards will be paid.

The once-mighty mortgage has slipped to No. 3.

In other words, even as interest rates have fallen, default risk on mortgages continues to be high, especially for borrowers with less-than-stellar credit. According to Hilsenrath, mortgage rates for a household with a credit score of 650 are now just 4.04%; while that’s higher than the rates available to households with a score of 750, it’s still so incredibly low that banks will reasonably decide that it’s just not worth taking the credit risk, if all they’re getting is 4% in interest. Once upon a time, banks basically ignored credit risk on mortgages; now, they’re hyper-sensitive to it. And insofar as there’s a broadly-based societal trend whereby mortgage debt is moving from senior to junior status, then that’s all the more reason to stay on the sidelines for the time being.

Here’s how Hilsenrath puts it:

Credit is the most important and most direct channel through which Fed policies affect the economy. The problem for the Fed is that the pipes in the financial system through which its easy money travels are clogged.

It seems we don’t need Ben Bernanke any more, we need Super Mario to come in and unclog those pipes. It’s a hugely important job, but the problem is that no one knows how to do it, especially insofar as the clogs look like rational market pricing more than crisis-related market inefficiency. (Remember, the prepayable fixed-rate 30-year mortgage itself is something which is never found in a laissez-faire capitalist system: only government intervention can ever persuade banks to issue such things.)

All of which helps underscore my belief that we’ve more or less reached the limits of what the Fed can do. In order to get this economy back on track, what we need is fiscal, not monetary, stimulus. Don’t hold your breath.


And what reason do we have to think that any politically, legally, and administratively practical fiscal measure will be LESS broken as a channel for stimulus????

You want stimulus? Print up $x per living person in the US and send it to them, as paper currency, exempt from all income taxes.

Whether people retire debt, increase most forms of savings, or consume with it, it will help work off the hang over.

ANY mechanism that depends on “channels” will be of very limited effect in the current environment. Because the channels will defend themselves one way or another.

You have to go direct.

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Bishop vs Krugman

Felix Salmon
Jun 18, 2012 23:16 UTC

Paul Krugman was not happy with the choice of Matthew Bishop to review his new book in the NYTBR, and the main locus of the disagreement seems to be, at heart, how much respect Krugman should give to people who disagree with him.

Here’s Bishop:

No opportunity to preach to the choir is missed by the populist Mr. Krugman, nor any chance to mock those he calls the “Very Serious People” who disagree with him. This is often entertaining: during a stern speech in 2010 by Germany’s finance minister, Krugman’s wife dismissed those who regard austerity as a sort of moral purification with the whispered aside, “As we leave the room, we’ll be given whips to scourge ourselves.” But the book’s preachiness gives those politicians and economists who most need to read this book an easy excuse to ignore it.

To this Moderately Serious Reviewer, Krugman’s habit of bashing anyone who does not share his conclusions is not merely stylistically irritating; it is flawed in substance… The austerians may be excessively fearful of so-called “bond vigilantes,” but that does not mean there is no need to worry about what investors think about the health of a government’s finances. Sure, ridicule those fundamentalists who believe it is theoretically impossible for an economy ever to suffer a shortage of demand, but does Krugman really need to take passing shots at Erskine Bowles and Alan Simpson, the chairmen of the widely respected bipartisan Bowles-Simpson Commission on deficit reduction appointed by President Obama? Maybe his case for stimulating the economy in the short run would be taken more seriously by those in power if it were offered along with a Bowles-­Simpson-style plan for improving America’s finances in the medium or long term. Instead, Krugman suggests cavalierly that any extra government borrowing probably “won’t have to be paid off quickly, or indeed at all.”

I can see why Krugman finds this annoying. Krugman’s whole point is that Bowles, Simpson, and the like are wrong and dangerous. And as he reminds us today, he was right and they were wrong, two years ago. He should get credit for that. But Bishop, the kind of person who loves nothing more than schmoozing important people at Davos, thinks that Krugman “would be taken more seriously” if he were more polite to “widely respected” people with the word “chairman” in their names.

This criticism is off-base for three different reasons, I think. Jared Bernstein deals with the substance very well:

Krugman has been consistently empirical on this point. His argument is not that investors’ sentiments don’t matter. It’s that they’re embedded in prices and can be followed on an hourly basis. Those numbers—the bond yields on sovereign debt—show that markets judge US debt to be safe and Spanish and Greek debt to be risky. If you want to criticize Krugman on this count, you need to explain what’s wrong with the markets themselves—why they’re giving the wrong signals. Otherwise, you’re into phantom-menace land, just across the way from where the confidence fairy hangs out.

This is a point I myself tried making to Bishop back in April, with no visible success: Bishop’s convinced that when it comes to gauging future inflation expectations, we should for some reason trust the volatile and largely-insane gold market at least as much as we should trust the most liquid and efficient market in the world, that for US Treasury bonds.

As for the style, there is no shortage of Serious liberals willing to do exactly what Bishop suggests. Indeed, Erskine Bowles probably counts as one himself, even as he sits on the board of Morgan Stanley. Pretty much the entire Obama administration deals constantly with calls for fiscal prudence and austerity, and takes them very seriously. There’s something of a bipartisan consensus on the issue — so if like Krugman you think that the consensus is bonkers, the only real way to get your point across is to be very clear that no matter how grand these people are, they’re simply wrong, and do not deserve to be taken seriously.

And then there’s the whole class-based undertone to the discussion, which I think if anything Krugman doesn’t make forcefully enough. The thing that Serious liberals and Serious conservatives have in common — the thing which in large part makes them “widely respected” in the first place — is that they’re rich. Usually, very rich. And rich people, as I said in my own review of Krugman’s book, don’t actually worry much about unemployment: it doesn’t really hurt them, even if they lose their jobs. What they do worry about is inflation, since that erodes the value of their dollars. And so when Krugman calls for a nice dose of inflation to help cure the economy’s ills, what he’s really calling for is for a significant chunk of the fixed-income portfolios of the rich to be devalued in real terms.

The rich don’t like that, and the austerity consensus is in large part a closing of ranks — one of the few areas where left and right can agree, at least at the upper end of the income spectrum. And that’s why my own review of Krugman’s book was a pessimistic one. When rich liberals and rich conservatives agree on something, that thing is going to happen. Especially when that thing is in their own self-interest.


My principal issue with Krugman’s argument is that he seems to believe that just because the market is sanguine today, it will also be so tomorrow and/or that there will be time to make adjustments after the market gets spooked. All one has to do is look where CDS on CDOs were trading in late-2006 and where European sovereign CDS were trading prior to the financial crisis or even as late is the winter of 2009.

Fixed Income and derivative markets often stick at irrationally tight levels for long enough that the issuer is allowed to over-issue. Then when sentiment turns, the weight of the outstanding liabilities crushes the issuer. It is unfathomable to me that this would even need to be explained to a Nobel prize winner.

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Counterparties: Euro next

Ben Walsh
Jun 18, 2012 21:40 UTC

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Sunday’s Greek election ended with a narrow victory for the conservative, pro-bailout New Democracy party, which now must try to form a coalition government. That is, of course, the same untenable status quo that preceded the election.

Meanwhile, the NYT reports that European leaders are working toward a “grand vision” that, at first blush, sounds a lot like the many vague promises we’ve heard from eurozone officials before. The plan this time is to prevent bank runs and what the NYT’s Jack Ewing calls the “vicious cycle of government debt problems turning into banking crises”. But like everything in Europe, the politics of this are tricky; Lisa Pollack walks us through who wants banking union, a closer political union, a fiscal union or some permutation of the three.

There are already indications a banking union is on the horizon: European Commission president Jose Manuel Barroso reiterated his earlier statement that some form of deposit guarantee system and resolution authority will be proposed by this fall. You can wait until then, right?

In the interim, Tim Duy thinks the only way to stop lurching from one sovereign-debt panic to another (aka the status quo) is for the ECB to be able to act as lender of last resort when euro zone countries are at risk of default. Hugo Dixon says that as imperative as a banking union may be, it will take years to complete.

Years, unfortunately, is exactly what Europe doesn’t have. Spanish 10-year bond yields are back above 7%, European bank stocks dropped, and Greek banks look shakier. – Ben Walsh

On to today’s links:

Dear Mark Zuckerberg, humankind’s capacity to self-obsess actually has its limits – Ad Age
Morgan Stanley demanded full control of Facebook’s IPO and is now set to get most of the blame – WSJ

Yes, executive pay is still rising – NYT

Obama administration’s homeowner refinancing program helps big banks earn $12 billion – WSJ
“Every region of the world is experiencing some type of slowdown” – Bonddad

How the ECB began dictating political policy in Europe – Slate
The Fed has a brand-new approach to inflation – but it’s just not using it – Economist
“Batten down the hatches” and other nautical or weather-related metaphors for the global economy – Nouriel Roubini

David Grann explains his reporting process – and his 200-to-300-page outlines – Nieman Storyboard
The New York Times deigns to partner with BuzzFeed – Capital New York

New Normal
Drugs, gangs and sexual abuse: Life at a privatized New Jersey halfway house – NYT

How depressives search the Internet – NYT

HENRYS (High Earners Not Rich Yet): the potentially made-up demographic that is threatening the U.S. recovery – Bloomberg


Interesting piece from the Economist, but…

“For example, because consumers suffer from money illusion, they may expect higher prices but not higher wages.”

That’s an illusion?!? Plenty of evidence that this is the reality of the last twenty years for most of the middle class.

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Why Kickstarter’s great for tax revenues

Felix Salmon
Jun 18, 2012 18:17 UTC

Matt Yglesias has a very odd piece at Slate entitled “The Kickstarter Recession”. In a nutshell, he seems to think that a crowdfunded economy would run on less money than the current economy, and therefore produce less in the way of much-needed tax revenues. He’s wrong on both counts, I think.

Kickstarter, when it works well, is a disintermediation tool for creative projects. Films get made, albums get recorded, art projects get realized which would otherwise never have seen the light of day — because the people who love those things are sending money directly to the creators, without production companies or record labels or art galleries feeling the need to veto any project where they can’t make money themselves. When the inefficient intermediary is cut out, many more projects become viable, and the cultural economy expands rather than contracts.

Up until now, the cultural world has been reliant upon intermediaries to the degree that it was basically impossible for a creative person to be successful unless and until they could support not only themselves but also a pretty large number of professionals whose job it was to help package and sell whatever it was that was being created. The result was a heavy artificial dampener on the creative economy. With Kickstarter, that’s changing: while professional packaging and selling still has its place, it’s no longer the determinant of whether something gets the opportunity to generate money or not.

But even if the creative economy didn’t expand as a result of Kickstarter, the chances are that crowdfunding would still increase rather than decrease tax revenues. Here’s Yglesias:

In conventional finance, money doesn’t care about your passion or the joy you get from being your own boss. People deposit money in bank accounts, and then the banks try to make a profit by lending it out. That means giving credit to people with sound business plans and likely profits. The genius of Kickstarter is to open the door a bit more widely. People sponsor something like Neal Stephenson’s sword-fighting game or the wildly successful Pebble smart watch project not because they think kicking in capital is the optimal investment strategy, but because they—like the founders—are just enthusiastic about the idea. In other words, Kickstarter gives investors the chance to do what workers and small business people have been doing forever—sacrifice potential earnings for the sake of passion.

What Matt misses here is the tax implications of the two models. I deposit money in a bank account, and get some derisory rate of interest on it: I’m not going to be paying any significant taxes on that income. The bank lends the money out to Neal Stephenson or to Pebble — but because these are risky startups, a lot of them fail, and the bank has to write off a lot of those loans. Overall, its profits on that lending are small — and as we all know, banks never pay much in the way of taxes in the first place. Maybe a few bankers will get a slightly higher bonus, and pay income taxes on that bonus. But as a percentage of my original bank deposit, the amount of money we’re talking about here is tiny. And the loan itself, of course, isn’t taxable: Neal Stephenson and Pebble only have to pay taxes once they’ve paid back the loan and started making profits.

In the crowdfunding model, by contrast, when Kickstarter writes a check to Neal Stephenson, that’s Neal Stephenson’s income, right there, and he has to pay taxes on it. Yes, he can probably write off associated expenses. But the fact is that the tax revenues associated with a successful Kickstarter campaign are enormous compared to the tax revenues associated with putting the same amount of money into a checking account. And remember that Kickstarter, too, pays income taxes on its own profits.

When I fund a Kickstarter project instead of keeping that money in a checking account, it’s silly to consider me to be “sacrificing potential earnings” — I’m just spending money, which is a different thing entirely. It’s consumption, and it’s taxable: it’s exactly the kind of 21st-Century economic activity which the government wants to encourage.

Now it’s possible that when Yglesias talks about Kickstarter, he isn’t really talking about Kickstarter, but rather about the crowdfunding mechanisms built into the JOBS Act, none of which yet exist, and which Kickstarter has said it has no interest in being part of. Since they don’t yet exist, we can’t really judge them — but they’re still equity rather than debt, and that alone means that they are going to generate much more tax revenue than funding from banks.

In other words, when you cut out the middleman, be it a bank or a record label, that’s good for the economy and great for tax revenues. Kickstarter was not built as some kind of engine for the US macroeconomy. But at the margin, it can only help.


“Thinking creating jobs and start-ups could be bad for our economy is out of sense, unless the one who says that is stupid ….” (Photon)

I’m often (correctly) accused of exactly that. Was thinking about this thread before falling asleep (Good God – I gotta get a life!) – it’s probably a societal benefit that people explore ideas by listing on KS, and finding out that nobody wants their crazy stuff, rather than borrowing a couple hundred thousand $ from a bank and then finding out.

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Infographic du jour, Hearst edition

Felix Salmon
Jun 18, 2012 13:14 UTC

Infographics are invidious things: they seem to have an astonishing ability to make people simultaneously switch off their brains and reblog them. And today sees a prime example, from Hearst, which managed to get a credulous news article out of Steve Smith and Lauren Indvik by sending them this infographic. Here’s how it begins:


That was enough for Smith, who obediently headlined his news article “Hearst Claims Nearly 2000% Increase in Mobile Traffic In A Year”.

But of course an increase from 5% to 19% is not in itself an increase of 2,000% or anywhere near that: it looks much more like an increase of 280% to me.

So I did some back-of-the-envelope calculations, and by my lights, if mobile traffic increased by 2,000% and still only accounts for 19% of website traffic, then total website traffic must have increased by 550%. And even if you strip out mobile, traffic to Hearst’s websites would have to have gone up 470% over the course of the past year.

Have Hearst’s websites seen their non-mobile traffic increase more than fivefold in just the past year? I’m pretty sure that if they had done, Hearst CEO David Carey would be shouting that from the rooftops, rather than talking seriously to David Carr about the disruption which is represented by the Huffington Post. Much more likely, I think, is that the 2,000% figure is simply wrong.

But the weird thing is that I can’t for the life of me work out where it might have come from. People are bad at calculating percentages, I know, but what kind of sums would you have to do in order to come to the conclusion that a rise from 5% to 19% represented an increase of 2,000%? Any ideas?


Finally got a response from Hearst. Accurate percentage is 200%.

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Counterparties: Greece votes

Jun 15, 2012 20:48 UTC

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On Sunday Greece will hold yet another election, which is being widely portrayed as a referendum on whether it will stay in the euro zone – even if, among the main political parties, only the communists want to ditch the euro. The resurgent leftist Syriza party, which has vowed to reject the euro zone’s crippling bailout requirements, is the strongest opponent of the conservative, pro-bailout New Democracy party.

As the election nears, reports from the field in Greece are getting increasingly grim. The WSJ spoke to one writer whose friends are “hiding money in jars, under the bed, even burying it in the mountains” in the event of post-election chaos. This is more rational than it seems: In just one year unemployment is up 57%. Greece’s healthcare system is barely hanging on, as underfunded and understaffed hospitals struggle; some Greek diabetics have been unable to get insulin. Late last year, Greek suicides were found to have increased by 40% over the same period in 2010.

What can we expect to happen on Sunday? FT Alphaville has some concise answers (to the extent that answers exist). We won’t learn anything definitive about Greece’s membership in the euro zone on Sunday; expect an unclear result, which could open the door to a new government coalition that will try to keep Greece in the euro. Nearly 80% of Greeks, polls show, want to remain in the euro zone.

For cultural background on Greece’s crisis, turn to Nikos Konstandaras’s brutally frank, must-read NYT op-ed. Konstandaras, a top Greek journalist, holds out little hope for any of his country’s fractious political parties. A recent study, he writes, suggests that 7 out of 10 Greeks between the ages of 18 and 24 hope to leave their country for a better economic climate. This social catastrophe, which he likens to the fall of Constantinople, was at least partially self-inflicted:

What I want to remember from Greece in 2012 is how laziness and years of intellectual sloppiness can waste the gift of freedom and leave open the gates of the city – how we allowed our leaders to pander to us until we had no one capable of leading us, no one next to us at the barricades.

– Ryan McCarthy

On to today’s links:

EU Mess
The EU smiled while Spain’s banks cooked their books – Bloomberg
The man named international stock picker of the decade is betting $1 billion on European banks – Fortune

Why newspapers were doomed all along – Harvard Business Review

“The most interesting question in this whole saga is why they didn’t just lend those funds out” – FT Alphaville

What Obama could accomplish in a second term, as “cooperative idealism gives way to hard-nosed realism” – New Yorker

Data Points
Facebook knows your country’s “gross national happiness” – Technology Review

Consider Yourself Warned
The human impact of America’s latest drug hysteria, bath salts – Spin
Drug panics, bath salts, and face-eating zombies – Jack Shafer

Calling all Japanese college students with economic insights: The IMF is launching an essay contest – IMF

Right On
The Obama administration will stop deporting younger undocumented immigrants – Huffington Post

A map of NYC rappers’ neighborhoods of origin – Very Small Array

Old Normal
“The willingness of homeowners to carry housing debt has been radically altered” – Bloomberg


Couple of things, how did the Greek crisis come about? Greece was a poor debt risk prior to the EU Zone inclusion who suddenly they became AAA rated because they moved into a high class neighborhood. IMO the people that loaned them the money are more culpable than the borrowers. There was no change in the conditions, and the lenders had no reason to offer generous terms to a known risk. Now whether this will factor into debt negotiations is unknown; however, when the haircuts and Grexit come about, I’m leaning towards banksters and credit rating agencies for paying the biggest portion of the check.
BTW can someone inform me which US presidents were “convicted”? I am aware of two being impeached, but not being convicted by the Senate. I have heard of Chomsky’s famous claim about culpability under Nuremberg rules, but I am unaware of any brought before any tribunal, let alone convictions. Perhaps the reader thinks Charles Johnson was a US president.

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Don’t fear Target2. Fear its opponents.

Felix Salmon
Jun 15, 2012 20:44 UTC

Yanis Varoufakis is hosting what he calls “a debate between Felix Salmond and Marshall Auerback”, by asking Auerback to respond to my post on Target2. But here’s the thing: it’s not really a debate if the two sides agree on nearly everything. There’s very little to take issue with in Auerback’s post, and he doesn’t seem to disagree with me on the substance of Target2. Instead, he takes a step back and gives a bit of big-picture context for Target2, asks why the Target2 imbalances have grown so big, and speculates that it could be German attempts to kill Target2, rather than Target2 itself, which would cause chaos in the Eurozone.

Basically, the EU treaty allows for complete capital mobility within the Eurozone, something which caused no real problems until we hit the financial crisis. When money left one country and arrived in another — moved from Spain to Germany, say — the Spanish bank would cover the resulting hole in its balance sheet by turning to the interbank market, where there were no shortage of German banks willing to lend to their Spanish brethren. With the interbank market providing an efficient and effective mechanism for keeping money flowing around the Eurozone, the ECB just needed to work at the margins, running a daily auction for banks in need of a bit extra overnight liquidity.

But then in the summer of 2007 the European interbank market started seizing up; once Lehman Brothers collapsed, it was to all intents and purposes nonexistent. And so the ECB, faced with an imminent liquidity crisis, changed the rules: for the past few years, any solvent European bank has been able to borrow unlimited sums directly from its national central bank, at low ECB-set rates. And it’s those borrowings which ultimately resulted in today’s large Target2 imbalances.

Once Europe’s interbank market died, it stayed dead, and we’ve had a liquidity crisis ever since. As Daniel Davies put it in a report I blogged in November, “if we think of wholesale funding as commodity input, it is much more like the supply of limestone to a kiln than the supply of flour to a bakery – not only can the banking sector not produce loans without new financing, it cannot shut down for a short period of time either, it needs constant supply.”

Basically, if there hadn’t been a serious liquidity problem in the European banking system since 2007, the Target2 problem wouldn’t exist. The reason that there’s any worry at all about Target2 is entirely a function of the fact that the European interbank market still doesn’t exist, and the Eurozone’s banks seem to be no more willing to lend to each other today than they were in the worst days of the crisis in 2009. At least that’s certainly the case when it comes to cross-border loans to PIIGS.

So while Target2 isn’t a huge problem in and of itself, it bespeaks the lack of a Eurozone interbank market, and that is a problem. Worse, the Germans are unhappy. Germans are the people complaining the loudest about Target2 — and those complaints, if they’re based on German constitutional law, can be dangerous. As Auerback said on Wednesday, and as notorious Target2 alarmist Hans-Werner Sinn has been saying repeatedly, it’s arguable that the Target2 system, because it saddles the Bundesbank with potentially unlimited liabilities, violates recent German Constitutional Court rulings which say that aid from Germany to the rest of the EU must be limited and ratified by the German parliament.

If Target2 were to be found unconstitutional in Germany, that really would be devastating for the Eurozone: the ECB’s liquidity operations are the only place, pretty much, that European banks can fund themselves on a day-to-day basis. Rather than having an efficient web of interbank relationships, Europe has been reduced to a hub-and-spoke system where everybody just faces the central bank instead. If the biggest and most important of those spokes — the German one — is found unconstitutional, then that’s the end of the euro right there.

People like Sober Look, in response to my post, have been saying that the big problem with Target2 is that if the Eurozone falls apart, then Germany would be forced to write off a large chunk of its national wealth — a number which is literally incalculable. As with companies, the important wealth of a country lies in its ability to generate money going forwards, rather than in its ability to hold on to money it has generated in the past. I don’t think that arguments about hypothetical wealth figures are particularly compelling, and the amount of money that the Bundesbank earns each year is so small — less than a billion euros, last year, which is less than one tenth of one percent of German GDP — that if the Bundesbank stops remitting profits to the German fisc, no one will really notice.

The real thing to worry about Target2 in Germany, then, is not that the euro will fall apart and the Bundesbank will have to write off lots of paper assets. Rather, it’s the fear that someone will challenge the whole system in Germany’s Constitutional Court, that it will be found unconstitutional, and that the entire financial sector of Europe might fall apart as a result.


Armed with all this good info, IMO Felix is gonna do OK.

Posted by MrRFox | Report as abusive

How New York will improve its on-street parking

Felix Salmon
Jun 15, 2012 14:37 UTC

My latest video, above, is a reprisal of my blog post about variable pricing, and why it’s a great thing. The insight here is that pricing for a product like Broadway tickets is not the zero-sum game that it might seem at first glance. Yes, the more money that theatergoers spend, the less money they’re left with, and the more cash flowing into the pockets of New York’s performers and producers. (Which, incidentally, is quite the racket: one day I want to write a post about how theater producers get to effectively charge their investors 4-and-50, way more than the 2-and-20 we see in the finance world.)

But if you look beyond that initial dynamic, there’s much more going on here. By perfecting the art of variable pricing, Broadway manages to minimize the number of ticket scalpers, and therefore keep more money in its ecosystem. It manages to sell out every show, which just feels great. And it a means that there’s nearly always a ticket available for any show you want to see. That convenience alone is worth a lot.

The masters of variable pricing, of course, are the airlines, and while people are often resentful that they paid five times more for their ticket than the person sitting next to them did, the fact is that they would be much more resentful if they regularly tried to buy air tickets and found that all the flights were sold out. And conversely, of course, the airlines would lose even more money if they regularly wound up flying half-empty planes. Without variable pricing, one or the other would certainly happen.

In New York, as we’ve seen, Broadway is great at variable pricing, while the Yankees and the Metropolitan Opera are still in the pricing dark ages. But there’s one much more important area of New York life which is in desperate need of variable pricing: on-street parking.

San Francisco recently introduced variable pricing for on-street parking, and it’s an idea which ought to have been implemented in New York years ago. The basic idea is incredibly simple: you just price parking meters so that there’s always one empty parking spot on every block. The effect is electric, for two reasons. Firstly, drivers no longer have to pad their journeys by some unknowable amount of time to account for the time spent looking for a spot. And secondly, the whole city speeds up, since a huge proportion of congestion is caused by cars driving around in circles, looking for one of those precious spots.

Which brings me to Matt Taibbi’s latest tirade, complaining about the idea that New York could raise as much as $11 billion by selling off its parking-meter rights. Anybody who wins this contract will have a contractual obligation to implement smart variable-pricing technologies, which will have to include apps showing where the spots are, the ability to pay by phone, and other ways of making everybody’s life easier. How is this not a good thing? Well, Taibbi’s upset that prices will rise:

Meter rates in some New York neighborhoods are already at $5 an hour. A Chicago-style price hike for fat-cat investors might leave us paying thirty bucks an hour to oil barons in Qatar and Saudi Arabia in order to park for dinner in the West Village.

I hate to break this to Matt, but has he seen the pricing at New York’s garages recently? Drivers would kill for the opportunity to pay $5 an hour. Matt lives in Westchester Jersey and therefore doesn’t pay New York City taxes, but he still seems to think that New York City should subsidize the cost of his jaunts in to the West Village for dinner. But even if Matt were somehow deserving of such a subsidy, which he isn’t, it’s a false economy: it might feel good to be able park for cheap, but it feels much worse to be stuck in traffic all the time. And the overwhelming majority of West Village diners manage to find a way of eating there which doesn’t involve a parking spot. Why should they subsidize Matt’s parasitical suburban lifestyle?

New York is not Chicago, where the mayor was forced to give up all control of the parking meters in order that prices might be able to rise to their optimal level. Instead, the city will retain control of pricing philosophy, holidays, and the like, while also receiving an enormous check.

A huge amount of good could be done with that $11 billion, both in the West Village and in the rest of New York. Even Matt, if he puts his mind to it, could probably think of quite a few areas where New York needs to beef up its infrastructure, both in terms of transportation and in terms of everything else. These are investments, which will pay off over the long term, and the rate of return on these investments is almost certainly going to be higher than the discount rate which the private sector is willing to pay right now for parking-meter revenues.

The fact is that right now is the best possible time for New York to sell off its parking meters. Matt says, with no backing whatsoever, that the meters will be sold “at a steep discount”, and that New York will only get “pennies on the dollar”. The truth of the matter is much more likely to be exactly the other way around: that by doing the deal now, when interest rates are at all-time lows, New York will be able to capture an impressive premium for these future revenues — while at the same time outsourcing all of the risks and difficulties associated with bringing parking meters into the 21st Century.

It’s not easy for New York City to borrow money, for various reasons. The city should be borrowing and investing right now, for all the same reasons that we need a second stimulus nationally. You don’t want to invest during a boom, because that’s expensive and pro-cyclical. You want to invest when interest rates are low and labor is more readily available. And by selling off its parking meters now, New York will have access to billions of dollars at extremely low interest rates.

If those oil barons in Qatar and Saudi Arabia are willing to send $11 billion to New York in return for future parking-meter revenues, I’d be inclined to take their offer with no little alacrity. $11 billion, if you do the math, works out at more than $120,000 per meter. Taibbi really thinks that’s a discount to the meter’s real value? How much would he pay for a parking meter?

The fact is that New York, like most cities, is bad at monetizing the value of its on-street parking. This deal gives the city the opportunity to change that, and at the same time to introduce technology which could reduce congestion substantially, while also raising billions of dollars for investment in the city’s future. It’s a win-win-win. Except, maybe, for commuters in Westchester Jersey.

Update: Matt responds, explaining that he actually lives in Jersey, not in Westchester. Sorry. He also says:

If prices do rise, some conglomerate of private investors, and not the citizens of New York, will see the benefit. The city might get $11 billion in the deal, but if that’s even a dime less than the real present value of these parking meters (to say nothing of the actual amount of revenue that will be collected over the life of this arrangement), then to me that’s bad and shortsighted public policy.

By this logic, then if $11 billion is a dime more than the real present value of the parking meters, then the privatization would be a good idea. And with interest rates where they are, and the way that cities are evolving, I’d guess that the present value of New York’s parking meters is more likely to fall from $11 billion than it is to rise.


I just want to chime in here supporting the Chicago parking deal, well, halfheartedly. Mostly, I don’t care how much drivers have to pay for parking since I ride a bike everywhere. When I do care about parking, it’s when my parents from the suburbs visit, and they need to find a parking space, and boy howdy it’s been a lot easier since parking rates went up. And municipal governments will always find ways of making ridiculously bad loans at shockingly poor implied interest rates. People just notice the parking because they encounter it day to day.

Posted by JamesLiu | Report as abusive