Felix Salmon

Counterparties: America’s worst long-term trends

Ben Walsh
Jun 14, 2012 21:40 UTC

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In a speech today on the economy, President Obama framed the election as a contest of economic policies. Voting for Romney is a vote for Bush, the argument goes. Given that two-thirds of the public blames Bush for the state of the economy, it’s not a bad one to make.

But Obama will be fighting more than a few long-term trends that he didn’t mention – and that aren’t as obvious as the headline unemployment rate. Last week, a Federal Reserve study showed that the net worth of the median family has fallen to mid-1990s levels. Looking closer at the Fed’s data, Felix thinks “it’s fair to say that the median US household is no richer now than it was 30 years ago”.

For a view of what a long-term lack of growth looks like, Monica Potts chronicles the life of the Christian family, which is trying to make a living in one of the poorest counties in America:

For most of their adult lives, the Christians have made less than $22,113 a year, the poverty line for a family of four. This makes them like a lot of families in Owsley County, where 40 percent of the population lives in poverty and 30 percent lives just above it. More families rely on food stamps than make the national median household income of $49,445.

As more Americans join the ranks of the long-term unemployed, it’s worth reading the story of a 58-year-old man who has been out of work since 2010 and applied for more than 380 jobs. And for those who can get jobs, employment doesn’t always provide that much value. Mark Bittman looks at food service workers and concludes that “we don’t seem to mind or even notice that our servers might be making $2.13 an hour”. – Ben Walsh

On to today’s links:

Primary Sources
The memos Goldman execs use to prepare for meetings with hedge fund managers – DealBook

A surprisingly plausible “end of the world as we know it” – Dani Rodrik

EU Mess
A plain-English guide to Target2 – Felix
Europe’s cross-border banking system is unraveling – and that’s a bigger worry than Greece – WSJ
Spain is now making Ireland’s crippling mistakes – Harvard Business Review
It’s never a good sign when the lender of last resort refuses to buy your bonds – Tim Duy

Grieving father struggles to pay his dead son’s student loans – ProPublica

New Normal
Wealth inequality is even worse than income inequality – Bloomberg View
The Fed’s survey of wealth and income is out: How’d you do? – Dealbreaker

Another Foxconn employee jumps to their death – Techland

Allen Stanford gets 110 years in prison for a $7 billion Ponzi scheme – NYT

Data Points
Reminder: The rise of China is about growth rates, not absolute wealth – Bill Easterly

How JPMorgan’s derivatives bets caused chaos in the the market for blue-chip corporate CDS – Reuters

“Muthuball”: How a Stanford undergrad’s paper could change the NBA – GQ

New Normal
There is something called Underearners Anonymous – WSJ

Old Normal
The plague – yes, THAT plague – is resurfacing in affluent neighborhoods in New Mexico – Yahoo


Understood, Curmudgeon, but you can successfully pay back $200k in student loans on a high school music teacher’s salary. (That is very different from saying it is a good investment.)

I agree that the system of private student loans desperately needs reform. We can begin by stripping them of bankruptcy protection.

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Apple’s strategy of built-in obsolescence

Felix Salmon
Jun 14, 2012 21:27 UTC

Ross Miller made a good point about Apple’s new flagship laptop, in his review for the Verge. Once you take into account that it has a solid-state drive, it’s actually not nearly as expensive as you might think.

Yes, $2,200 is a lot of money. But if you want a basic MacBook Pro with 8GB of RAM and a 256GB solid-state drive but without a Retina display, that’ll cost you $2,400. And if you upgrade both to a 512GB solid-state drive, the new computer is $2,800 — but the older, heavier, slower, clunkier computer, featuring a mere 1440×900 pixels of screen space, will set you back $3,100. Essentially, if you pay for the solid-state drive, you get the Retina display for less than nothing.

I’ve been a convert to solid-state drives since I got my first MacBook Air, and I custom-ordered the desktop machines both at home and at the office to have them as well. They’re wonderful things, and I’m never going to buy another computer with a hard drive. (I hate hard drives, they always fail on me at the worst possible moment.) Right now, computers with solid-state drives are still in the early-and-expensive stage of technological progress, but Apple’s on the right side of history here, and prices will surely come down.

That said, however, Richard Gaywood makes an equally good point about the new Apple machine: it’s much less accessible than anything which has ever carried the “Pro” name in the past. You can’t upgrade the RAM, because it’s soldered to the motherboard. You can’t upgrade the solid-state drive, because it’s an Apple proprietary drive, and no other drive will fit there. You can’t replace the battery. And so on. It even has proprietary pentalobe screws.

Writes Gaywood:

My last MacBook Pro saw a little over 2.5 years as my primary computer, and I would expect no less of any computer I was paying in excess of $2200 for. In that time, I upgraded the memory once, the hard drive three times, and replaced the battery once. None of these options would be available to me with a new MBPwRD. SSDs, batteries, and RAM can degrade or fail in time — is a $349 AppleCare purchase a hard requirement now? What if I want to keep my MacBook longer than the three years coverage AppleCare offers?

Of course AppleCare won’t just give you a new hard drive or new RAM or a new battery just because you feel like an upgrade — all those cost extra too, and cost much more if you buy them from Apple (which you have to, now) than if you just buy your own and do the fix yourself.

Which means that the Apple ecosystem has just closed in much further — while on every previous Pro machine consumers could fiddle around quite a lot, this one is a completely inaccessible box. It’s about as far as you can get from the Apple 1, which came as a kit. The control-freakery which started in the operating system and then moved into software is now very much built into the hardware as well.

As a result, Apple’s post-purchase revenue from every one of these new laptops that it sells will be significantly higher than what it’s seeing right now on the MacBook Pro line.

And have you wondered why the Mac Pro is little more than an afterthought, these days? It was originally released in 2006, and has had only evolutionary changes since then; the basic model has less RAM than the new laptop, comes with no display at all, weighs 40 pounds, and still contrives to cost $2,500. With Thunderbolt allowing power users to add as many screens and external hard drives to the new laptop as they like, Apple’s treatment of the easy-to-upgrade, easy-to-customize Mac Pro looks very much like deliberate neglect.

Apple Computer became Apple Inc back in 2007, and the overwhelming majority of its half-trillion-dollar market cap has absolutely nothing to do with revenues from selling laptops or desktops.* The real money, it turns out, is in flows rather than stocks: the income stream from selling songs and apps, or from a cellphone contract, is much more valuable than a one-off computer purchase.

And it seems to me that with this latest model, Apple is trying to turn its computers into a flow product, too. It’s a beautiful shiny object — but it has much more built-in obsolescence than anything the Pro line has ever had in the past. And the more frequently Apple can persuade its customers to upgrade or replace their computers, the more its Mac operation will be worth. You might adore that Retina display now. But I suspect you’ll be replacing it sooner than you might think.

*Update: See, for instance, the analysis from Trefis, which says that just 11% of Apple’s market cap is Mac-related. The entire Mac franchise, even with the halo effect from the iPhone and iPad, is worth less than the amount of cash Apple has on hand.


I’ve lusted after Macs for years, but coudn’t justfy the cost. But after reading this, the only way I’ll ever own one is if the price to me is relative chump change (in other words, I’d have to have won at least several million dollars in a lottery).

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from Ben Walsh:

Green finance datapoint of the day, BofA edition

Ben Walsh
Jun 14, 2012 19:07 UTC

Bank of America has joined Goldman Sachs in making a new commitment to clean energy. BofA is making a $50 billion dollar 10-year plan, which is $10 billion more than Goldman over the same time frame, so it wins the headline arms race. But BofA's announcement shares the same faults as Goldman's. (Full disclosure: I used to work in the Goldman's Environmental Markets Group, which in part set and tracked the firm's green initiatives).

Both announcements are deeply depressing. These dollar figures are basically the amount of financing and investment the banks will offer to businesses and consumers to do things like expand wind and solar energy production and increase energy efficiency. It you listen to the story banks tell about what they are great at -- raising capital, allocating risk, etc. --  they should be diving into this market.

But instead of ambitious plans, we get very small amounts of good wrapped up in press releases aimed at grabbing headlines and generating glossy sustainability reports. It's pretty pathetic, but not entirely surprising. Since the financial crisis, banks have largely failed in their efforts to prove their social utility; climate change is no different.

Just how minute is BofA's $50 billion decade-long commitment (aka $5 billion a year) in the context of their other businesses? In 2011, they extended $557 billion in credit and raised $644 billion in capital for clients. Of that $1,201 billion, $5 billion is just 0.4%. That's just not enough. The International Energy Agency estimates that the global economy needs $36 trillion in additional green investment by 2050 (just under $1 trillion a year). 0.4% of capital raised and credit extended certainly is not a number BofA should be praised for.

There's also the small problem of BofA's large role in financing US coal companies. Topping the US coal-financing league table is directly at odds with the intent of their environmental commitment. They do have a corporate policy on coal, but it's phrased to mean as little as possible and restrict lending to only a few offenders. BofA will "phase out financing of companies whose predominant method of extracting coal is through mountain top removal". [emphasis added] They also strangely say that mountaintop removal mining can be done with minimal environmental impact. I don't know anyone not paid by the coal industry who's ever come to that conclusion.

Then there's the way the bank talks about achieving its goals ahead of schedule. Five years in, it has already achieved its previous $20 billion ten-year commitment, which was set in 2007. Here's the quote from CEO Brian Moynihan:

We met our prior goal in about half the time we set for ourselves, so more than doubling our target is ambitious but achievable.

That's true -- but only in comparison to a low goal that BofA set for itself. The increase still accounts for just 0.4% of its comparable businesses. It's more achievable than ambitious. And that's the point, from BofA's perspective. They're terrified of failing but insistent on making some gesture to demonstrate their good intentions. Instead, Moynihan shows he doesn't fully understand his company's potential value to society. Or, if he does, then he's happy with BofA failing miserably on that front.


What a farce ! what else would you expect form our ‘socialized’ & corrupt banking system.

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Don’t worry about Target2

Felix Salmon
Jun 14, 2012 01:05 UTC

Moody’s just slashed Spain’s credit rating three notches — a clear sign that the bank bailout, even though it hasn’t happened yet, is being seen in the markets as decidedly deleterious for Spain’s creditworthiness. Spain’s 10-year bond yield is now 6.75%, up from less than 5% in early March, and approaching the levels at which market access shuts down entirely. Worries over the future of the euro are back — and, like clockwork, whenever those worries appear, people start talking about Target2.

Last week, George Soros warned about the “the Bundesbank’s claims against peripheral countries’ central banks within the Target2 clearing system”; today, in the NYT, Hans-Werner Sinn says that the Bundesbank is owed $874 billion in Target2 money by Europe’s periphery. “Should Greece, Ireland, Italy, Portugal and Spain go bankrupt and repay nothing, while the euro survives, Germany would lose $899 billion,” he writes.

Meanwhile, in a recent report, Jonathan Carmel, of Carmel Asset Management, publishes this chart, with the explanation that “the Bundesbank has replaced the exposure to peripheral debt that the German banks reduced”; he explains that “periphery debt is now the Federal Republic of Germany’s problem”.


These are big and scary numbers, and Sinn in particular is doing his best to scare as many people as possible with their magnitude. Last year, I blogged a Martin Wolf column about Sinn’s theses, and got a lot of pushback as a result. So here’s my attempt at a do-over: my attempt to explain that the chart above really just shows private risks in Germany going down. The line which matters is the blue one, not the green one.

It’s worth backing up here, a little bit. The eurosystem, as it’s known — the system of national central banks, plus the ECB — is highly federalized. The ECB itself sets interest rates, and has a modest balance sheet of its own, but the only banks it deals with are the national central banks. It’s the central banks, like the Bundesbank or the Banco de España, which perform all the liquidity operations, lend money to their commercial banks, and generally keep the euro functioning as a currency.

Every bank in the eurosystem has an account at its respective national central bank — and if you add up all the money in all those accounts, the total is the Target2 balance at the central bank in question. It’s worth mentioning, here, that there’s one thing pretty much everybody agrees on when it comes to Target2: so long as the euro zone stays together, there’s really no problem at all. All the Target2 balances at the various central banks always sum to zero, and the system works efficiently and well.

If a Spanish woman writes a check to her therapist, the money comes out of her account and goes into the therapist’s account. So long as both accounts are at Spanish banks, this is just a transfer from one bank to another, and the Target2 balance at the Banco de España is unchanged. But let’s say our Spanish depositor decides to move €1,000 from Banco Santander to an account at Deutsche Bank. In that case, the balance on her Santander account will go down by €1,000, and the Banco de España will likewise deduct €1,000 from Santander’s account at the central bank. In Germany, €1,000 appears in the Deutsche Bank account, and in the first instance Deutsche Bank will keep that money in its account at the Bundesbank, so the Bundesbank adds €1,000 to Deutsche Bank’s balance.

Essentially, the Banco de España just destroyed €1,000, and the Bundesbank just created €1,000. That’s fine — they’re central banks, and creating and destroying money is what central banks do. But for simple bookkeeping purposes, everything in the eurosystem has to balance. Remember that what we normally think of as assets, banks think of as liabilities. So Deutsche Bank owes €1,000 to our Spaniard — that’s what it means for her to have €1,000 on deposit at Deutsche Bank. In turn, Deutsche Bank has €1,000 on deposit at the Bundesbank, which is to say that the Bundesbank owes €1,000 to Deutsche Bank. And then the chain goes on: the ECB owes €1,000 to the Bundesbank, the Banco de España owes €1,000 to the ECB, and Santander owes €1,000 to the Banco de España, since Santander effectively needed to borrow money from the Banco de España in order to give that money to Deutsche Bank.

This being high finance, obligations to the national central banks here are collateralized, so the Banco de España is holding collateral from Santander which more than covers the €1,000 it’s owed. On the other hand, the Banco de España in turn is not asked to post collateral at the ECB. Central banks don’t do that sort of thing: there’s no need to post collateral when you can just print money whenever you need it.

In any event, it’s easy to see how the Bundesbank’s Target2 balance has been rising of late, as the balances in the periphery have been declining: there’s a flight-to-safety going on, and German banks are (rightly) perceived as being safer than banks in Spain, Greece, and other peripheral countries. Similarly, German banks which lent money to Spanish borrowers — and especially to Spanish banks — are not rolling over those loans. When the loans are repaid, the German banks just keep that money on deposit at the Bundesbank, rather than lending it out again to some country in serious difficulties. Once again, that increases the Target2 balance at the Bundesbank, and whenever that happens, there’s an equal and opposite decrease in the Target2 balance elsewhere.

Now to the naked eye, all of this looks like exactly what it is: money flowing to Germany. It’s people in the PIIGS countries either repaying the money they owe German banks, or moving their money so that it’s on deposit at a German bank. As such, it’s a bit weird that people like Sinn and Soros characterize this money as money which Germany has lent out to the periphery — at heart, the flows are in exactly the opposite direction. But because of the way that bookkeeping works, these flows create internal accounting obligations between the various eurosystem banks, and it’s those internal accounting obligations that Soros and Sinn are seemingly so worried about.

As Karl Whelan says, however, it’s far from clear that those internal accounting obligations are worrisome at all. The eurosystem as a whole is always in balance, and any money which is created in one corner of the euro zone is destroyed in another corner. The only way that these particular chickens could ever come home to roost would be if a country or countries left the euro entirely. And even then, it’s not obvious that the consequences would be particularly bad.

Certainly a Greek exit would be small enough not to worry about at all. Greece has a negative Target2 balance of about €100 billion. What that means is that Greek banks owe the Bank of Greece €100 billion, which is fully collateralized; and that in turn the Bank of Greece owes the ECB €100 billion on an unsecured basis. If Greece were to chaotically devalue and default, then it’s entirely reasonable to assume that the Bank of Greece would default on those obligations to the ECB, and would keep the Greek banks’ collateral for itself, to help prop up as much as possible the nascent drachma.

If that happened, the rump eurosystem — the remaining 16 central banks, plus the ECB — would take an accounting write-down of €100 billion. They have €86 billion in capital, and another €400 billion in capital they can create any time they want, just by revaluing their gold reserves. So coming up with €100 billion wouldn’t be hard — especially since the whole concept of an insolvent central bank is a little bit silly. If the capital of a central bank stopped being positive and started being negative, then in practice nothing at all would change. Central banks can never go bust, because they can print money.

But what if the entire eurosystem fell apart, and every country reverted to its own national currency? In that case, it’s still hard to see how there would be much of a hit to Germany. Germany’s banks, like Deutsche Bank, would see their Target2 balances redenominated from euros into Deutschmarks. And the Bundesbank would have a theoretical claim on the ECB, but at this point the ECB would barely exist. But that’s fine, it could simply declare that all those euros were now Deutschmarks, since the Bundesbank can create as many Deutschmarks as it wants.

The hidden assumption underlying Sinn’s doom-mongering is essentially that if the euro fell apart, German taxpayers would have to write a trillion-euro check to the Bundesbank, to make up for all the money that the Bundesbank would never be able to collect from the ECB. But that just isn’t realistic. Here’s Whelan:

The new Deutschemark would, like the euro, be a fiat currency and there would be no need for all D-marks to be fully backed by hard assets held by the Bundesbank.

If German officials were concerned about the need for the Bundesbank’s balance sheet to show assets greater than liabilities, then they could agree for the Bundesbank to write itself a cheque equal to the value of the TARGET2 credit and to top it up each year with interest. There would be no need to also top up its liabilities, so the Bundesbank’s technical solvency will have been restored without raising any taxes on German citizens.

I suspect some may suggest that a failure to fiscally recapitalize the Bundesbank would produce a currency that people will have no faith in and/or that this will result in inflation. However, this approach would do nothing to change the amount of money circulating in a post-EMU Germany. And a cheque tossed in an empty vault can’t trigger hyperinflation. More likely, because the value of a fiat currency depends largely on the faith of citizens that the quantity of the currency will be kept in limited supply, is that the new Deutschemark will appreciate significantly, with the result being deflation rather than inflation.

To put it another way: yes, the Bundesbank would essentially be printing a trillion euros’ worth of Deutschmarks, which isn’t a very Bundesbanky thing to do, and is in theory inflationary. But if you’re creating a new currency, then you need to print that currency. And so long as German banks kept those Deutschmarks on deposit at the Bundesbank, and remained shy about lending them out to borrowers in other countries, the money supply in Germany wouldn’t actually increase at all.

Here’s Sinn:

Should Greece, Ireland, Italy, Portugal and Spain go bankrupt and repay nothing, while the euro survives, Germany would lose $899 billion. Should the euro fail, Germany would lose over $1.35 trillion, more than 40 percent of its G.D.P. Has the United States ever incurred a similar risk for helping other countries?

Insofar as Sinn is talking about Target2 balances here — and those balances account for the majority of these numbers — I just don’t think he’s right. For one thing, as Whelan points out on his blog, the US did actually incur rather more than 40% of GDP in costs associated with helping other countries. In 1941, the US national debt was less than 40% of GDP; in 1946, it was more than 120% of GDP. Oh, and 400,000 American men died fighting, too. Much of that can reasonably be considered self-defense, but a lot of it was much-needed aid for the rest of the free world.

But more to the point, German depositors wouldn’t lose any money, German banks wouldn’t lose any money, and the German government wouldn’t lose any money. The only entity which might be considered to have lost money would be the Bundesbank — but really the Bundesbank would just have converted all of the euros in Germany to Deutschmarks. If the euro ceased to exist, obligations within the eurosystem would cease to exist as well — indeed, the whole eurosystem would cease to exist, since its entire raison d’etre is to support the euro. All those internal accounting conventions would disappear in a puff of smoke, and every national central bank would be on its own, running its own currency and looking after its own banks.

It’s maybe comforting to think that today’s euros are somehow real and that tomorrow’s hypothetical Deutschmarks are not real, and that therefore if tomorrow those euros ceased to exist and were replaced by Deutschmarks, that there would be a loss of hundreds of billions of euros. But that’s not how fiat currencies work. Tomorrow’s Deutschmark is no more or less real than today’s euro, and in fact the most likely problem with the Deutschmark is not that it would be weakened when the Bundesbank printed lots of it, but rather that it would be such a popular currency that it would soar in value, making German exports uncompetitive.

There’s no doubt that there would be absolutely massive costs associated with a breakup of the euro. But let’s not exaggerate matters by including Target2 balances in those costs. They’re little more than accounting conventions, really: they’re a way of making sure that the eurosystem always sums to zero. If you’re the kind of person who thinks that the Target2 balances are real liabilities, then you’re also the kind of person who thinks that a bank run in Spain, where deposits flee for Germany, is bad for Germany and good for Spain — since it only serves to exacerbate those Target2 imbalances.

By Sinn’s logic, it would be good for Spain or Italy to leave the euro, since they would default on their Target2 obligations and thereby find themselves incredibly rich — they would have borrowed hundreds of billions of euros from the eurosystem, and then would have no need to ever repay that loan. If you believe that, then feel free to take Sinn seriously. But it seems clear to me that if those euros cease to exist, then all that matters are the bilateral relationship which the national central banks have with all the banks in their country. And those bilateral relationships, built on fully-collateralized loans, wouldn’t be affected by Target2 accounting conventions at all.


Felix seems to have lost the debate, but isn’t Felix of the same mind as the ECB and cooperating EU banks in this mess? So where do we stand? I don’t like that accounting definitions are so debatable.

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Counterparties: A guide to Jamie Dimon’s stroll on Capitol Hill

Ben Walsh
Jun 13, 2012 22:09 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

Heading into Jamie Dimon’s testimony before the Senate Banking Committee, Andrew Ross Sorkin, Bloomberg View, Occupy the SEC and many others offered up the questions they would ask JPMorgan’s chairman and CEO. But this was, after all, the Senate Banking Committee, whose members are no strangers to JPMorgan’s campaign donations.

The Senators by and large met our low expectations, delivering performances that Brian Beutler said “turned the cross-examination into a coronation, and exposed the extent to which elected officials still feel compelled to genuflect to powerful financial interests”. Dimon decidedly got the best of his questioners, so much so that David Weidner said he came “off too much like a know-it-all. His inner confidence and cockiness have come to the surface”.

Senators Menendez and Merkley were the exceptions. Menendez reminded Dimon that his company’s vaunted fortress balance sheet has a moat built by taxpayers. Dimon bristled when Merkley suggested JPMorgan had benefited from TARP, Federal Reserve borrowing and AIG’s bailout. Dimon said that view was “factually wrong”. (It’s not.)

Neil Barofsky, the former TARP inspector-general, condensed the proceedings:

Dimon did say that JPMorgan was “likely” to claw back pay from those involved in the CIO losses. Even as he repeatedly said he had been “dead wrong” about the CIO’s trades, he came closest to a gaffe when explaining his own involvement: “I was aware of it, but I didn’t approve it”. It’s unclear whether that distinction will exempt his own pay from a clawback.

Dimon continued to get the better of the senators – at one point he was asked to expound on the fiscal health of the US government – and important questions remained unanswered. Were the bulk of the CIO’s operations located in London to avoid the view of regulators? Why were the firm’s risk models changed, and how reliable is the better model, if, as Christine Harper tweeted, it still massively underestimated the size of the losses? And what about risk management?

But the most eloquent thing that Dimon said was not verbal at all: He appeared before the senators wearing POTUS cufflinks. You couldn’t get more Wall Street alpha male if you tried. – Ben Walsh

On to today’s links:

The simple problem with the US economy – Americans can’t spend like they used to – Robert Reich

Must Read
What it’s like to live and work in one of America’s poorest counties – The American Prospect

Of course passing healthcare reform slowed the recovery – Jonathan Chait

“Hypothetical, illustrative example of the orderly liquidation of JPMorgan Chase” – FT Alphaville

Popular Myths
Five persistent myths of the financial crisis – Fortune

EU Mess
A reminder that Spanish taxpayers are on the hook for their country’s bailout – NYT
Greeks are already withdrawing cash and stockpiling food – Reuters

The DOJ is starting an anti-trust investigation into cable companies’ disdain for web video – WSJ
The Feds’ cable probe means web video is about to get more expensive for you – All Things D

How Silicon Valley got the next big thing (widgets) spectacularly wrong – Pando Daily

New Normal
The state of the nation in four datapoints – The Awl
“It’s fair to say that the median US household is no richer now than it was 30 years ago” – Felix

NYC may be about to repeat Chicago’s disastrous parking meter mistake – Rolling Stone

The frightening lessons of a decade spent playing Civilization 2 – Andrew Sullivan

Study: Corporate political giving doesn’t pay – except for highly regulated industries – WashPo

How HuffPost co-founder Jonah Peretti got fed up with partisan journalism – The Atlantic Wire

Wall Street’s preference for low-priced stocks

Felix Salmon
Jun 13, 2012 14:12 UTC

Three weeks ago, Alex Tabarrok found an intriguing post by high-frequency trader Chris Stuccio. The idea is very elegant: if you want to stop high-frequency traders extracting rents from the market, there’s an easy way to do so — you just allow stocks to trade in increments of much less than a penny. Matt Levine puts it well: right now, he says, “because you can’t be outbid by another bidder within the same penny increment, you get free money by just getting there first”. If high-frequency traders could compete on price rather than just on speed, then a lot of the silly arms-race stuff would be replaced by better prices for investors.

It’s a serious proposal, so I was glad to see that Matthew Philips wrote it up for Businessweek. But after starting off well, Philips ends up joking about it, and refusing to adjudicate between Stucchio and his on-the-other-hand trader, Ben Van Vliet.

The fact is that on the face of things, Stuccio is undeniably correct. Here’s the chart, from Credit Suisse via Cardiff Garcia:


The y-axis shows the bid-offer spread on any given stock, in basis points; the x-axis shows the price of the stock, in dollars. Clearly, there’s an artificial clustering around that curve. For a lot of stocks trading at less than $50 a share, the market would happily provide bid-offer spreads of less than a penny if it could; but it can’t. And when stocks get really cheap, the bid-offer spread becomes enormous. For instance, an eye-popping 3.766 billion shares of Citigroup were traded on December 17, 2009, when the stock fell 7.25% to $3.20. At that level, a one-penny bid-offer spread is equivalent to a whopping 31 basis points; if Apple traded at a 31bp spread, then its bid-offer spread would be almost $2.

Clearly, the traders were the big winners when Citi was trading at a very low dollar price — if you make the assumption that traders capture half the bid-offer spread on each trade, then the traders made almost $20 million trading Citigroup alone, in one day.

On the other hand, it seems that the market almost never trades stocks at a bid-offer spread much below 2bp. Which in turn means that for stocks over $50 per share, we’re pretty much already living in Stuccio’s ideal world, where the spread is determined by traders, rather than by an artificial rule barring increments of less than a penny.

Which brings me to my theory: that companies deliberately price their shares at less than $50, as a way of greasing their relationship with Wall Street a little bit. Back at the end of 2010, I was very confused by the fact that Facebook had done a 5-for-1 stock split, reducing its share price from about $75 to about $15. But in hindsight, maybe it was all part of its IPO preparations: you almost never see stocks go public at more than $50 per share.

Here’s a question for the data geeks out there: did nominal share prices decline after the stock market moved to penny pricing in 2000? If so, that would support my argument: that Wall Street manages to engineer stock prices so that it makes good money trading shares. And companies are generally happy to go along with Wall Street on this: most stocks trade at $50 per share or less.

It’s true that a lot of the rents from the sub-penny rule and low nominal share prices are captured not by Wall Street proper but rather by HFT shops. But all Wall Street banks have some kind of HFT operation of their own, and in general it’s probably fair to say that the lower the nominal share price, the more money that Wall Street makes. And conversely, the higher a company’s nominal share price, the less beholden it feels towards Wall Street.

To put it another way: the sub-penny rule is a way of allowing companies to price their stock so that Wall Street can make good money trading it. And we don’t need Stuccio’s rule, since it can effectively be implemented just by pricing your stock above $50 per share. If the companies don’t want to subsidize Wall Street, all they need to do is price their stock higher. And if companies do want to provide this hidden subsidy to Wall Street, maybe they should be allowed to do so.



You are so right. No one in the media, not Felix, no one, understands this. It’s criminal how bad it is. Only when you trade stocks and pay $1000s per year in “tolls” to the hft, then you understand.

There is simply no escaping. You can’t use limit orders any more than you can use market orders, despite the bull$— the hft promoters peddle. The best you can do is use a limit that reaches across a one penny spread and hope you get filled for a $0.0049 fee per share to the hft on every trade. (half of the spread, minus $0.0001)

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Chart of the day: Median net worth, 1962-2010

Felix Salmon
Jun 12, 2012 21:36 UTC

The big news from the Fed this week is, in the words of the NYT headline, that Family Net Worth Drops to Level of Early ’90s. But if you look at the actual report, there isn’t any data in there on family net worth before 2001. So many thanks to Peter Coy, who actually went ahead and ran the numbers.

Now these are Coy’s numbers, not the Fed’s. But Coy uses the Fed’s data, and here’s what he comes up with:


According to these numbers, the median family net worth in 2010, $77,300, is lower than it was in 1989, when it was $79,600. And it might well even be lower than in 1983, when, according to a different methodology, it was $88,000.

The 1962 and 1983 numbers can be compared to each other but not directly to the rest, because the methodology changed. But the fact is that they’re just as likely to be too low as they are to be too high. And as a general guide to household net worth, I think it’s fair to say that the median US household is no richer now than it was 30 years ago.

And in case you’re wondering whether things might have gotten better since 2010, the answer is almost certainly no. In 2007, median household net worth was $126,400, while the median amount of home equity was $110,000; in 2010 net worth had dropped to $77,300, while home equity had dropped to $75,000. These days, home equity is net worth. And since house prices haven’t recovered since 2010, it’s safe to assume that net worth hasn’t recovered either.

The fact is that household net worth was pretty inadequate even at the top of the housing bubble in 2007. Families need a place to live, and if you strip out the housing component of the net-worth calculation, the median US family has barely any net worth at all. Certainly nothing they can retire on. This of course is why Social Security is so important: with the recent drop in net worth, there’s no realistic chance that the median US family will ever save up enough to live on when they’re no longer earning money.


It just doesn’t get any

better than seeing the gorgeous “Mrs. Anita Pelaez” over at her and her

husband “Captain Kutchie’s” place..Some Folks Also Call Him..”The

KutchMan!”….(Anita and Kutchie’s Key West, Key Lime Pie Factory and

Grill)…Just watching the lovely couple baking together all those Yummy

Key Lime Pies at their Key Lime Pie Factory and Grill in Asheville.

…It’s always worth the trip to visit them in they’re Historic Key Lime

Pie Factory and Grill…It should be on everyone’s bucket list for

sure..And The World’s Best Key Lime Pies!..YUM-YUM-YUM…..”Talk About

World Class” What An Understatement!…….AAHHHHH!….The Magic Of The

Lovely..”Mrs. Anita Pelaez” And Her Delicious Key Lime Pies Baked With

Pure Love…Always……40 Years And They’re Still Going Strong….

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Smiles Are Always Warm And Inviting. “Kutcharitaville” We Love You!…..

…Now You Know Who Is The Hottest!…And Baby Let Me Tell You, Mrs. Anita Is No Act…She’s The Real Thing Baby!…

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Counterparties: The knives come out for Jamie Dimon

Jun 12, 2012 21:25 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

If Jamie Dimon is worried about being attacked by Congress tomorrow over JPMorgan’s spectacularly failed hedges, he should be equally concerned about his relationship with current and former bank employees. Bloomberg and the WSJ both have pieces this morning that detail how the bank spent years dismissing internal warnings about the riskiness of its risk management division.

Bloomberg’s sources are so critical of Dimon that the piece can either be read as palace intrigue, with JPM’ers gunning for Dimon, or as post hoc ass-covering. Dimon received warnings about the chief investment office’s increasingly risky behavior from “some of his most senior advisers, including the heads of the investment bank.”

Bloomberg buries the names, but the “We warned you, Jamie” camp now reportedly includes: Bill Winters and Steven Black, the former co-heads of the investment bank; James “Jes” Staley, who ran asset management and now leads the investment bank; and the current chief risk officer, John Hogan. (JPMorgan denied that any of them complained about specific CIO risks.)

While Jamie Dimon tackles apparent dissent from inside his own company, David Cay Johnston laments JPMorgan’s “hedginess”. Reuters suggests the SEC could build its case around the bank’s failure to disclose changes to its risk-measuring methods. And Daniel Indiviglio has a solution: JPMorgan bonuses should be tied to a synthetic bond “linked to the fate of the bad hedges.”

Here’s Jamie Dimon’s full prepared remarks for tomorrow’s testimony. For everything else you need to know about the JPMorgan scandal, check out our JPMorgan link collection. – Ryan McCarthy

On to today’s links:

A “short-time” work-sharing program for the unemployed could pay for itself – Barry Eichengreen
Data shows “profound uncertainty” of the death penalty’s effect on murder rates – Bloomberg View
The size of the Nobel Prize is shrinking – Nobel
Milton Friedman, master of the aphorism – Conversable Economist

Have we arrived at a financial singularity? – Finance Addict

Financial Arcana
Insured intangible collateral: How banks can reduce capital requirements for loans backed by patents, logos and recipes – FT Alphaville

11 wonky questions for Dimon – Occupy the SEC
Once a favorite of the Obama White House, Jamie Dimon is now reliant on Republican goodwill – Bloomberg

Brooklyn is getting way whiter – Daily Intel

The Wire: The Musical – Funny or Die

EU Mess
German bonds are risk-free, but its CDS are riskier than Verizon and Pfizer – Sober Look


Johnny Damon got taken to the cleaners by Madoff. Had all of his lifetime savings invested in the Ponzi scheme. Not wise, but he doesn’t merit additional criticism for it.

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You can’t blame legislation for inequality

Felix Salmon
Jun 12, 2012 19:36 UTC

In the NYT today, I review the new books from Paul Krugman and Tim Noah. Short version: these are both really smart people, whom you should pay attention to. But neither has produced a great read, a book which works really well qua book. Krugman and Noah have good reason to be upset at me for this, because the fact is that the overwhelming majority of the nonfiction books which pile up around me every day are just as dull as theirs are. To say that these books are a bit of a slog is not to say something mean about Krugman and Noah in particular, so much as it is to say a simple truth about virtually every popular book about economics. But these are the books I was asked to review, and if anybody asked me whether they should read either one of them, I would reply by pointing that person to Krugman and Noah’s online writing instead. Because that is much more digestible, and even fun to read.

I didn’t have a huge amount of space to go into the substance of the books’ arguments, but on Twitter today, Noah took exception to my characterization of how he presents the importance of the Taft-Hartley Act of 1947. In the review, I say that after giving us chapter and verse on the act, Noah’s ultimate point is that the act wasn’t actually all that important in terms of rising inequality. Noah responds that I’m wrong: Taft-Hartley was very important, he says, and that was actually “kind of the chapter’s point”.

Now I’m not one of those post-modernists who thinks that an author has no privileged access to his own work, and that my reading of the chapter is just as valid as Noah’s. If he says that he was saying that Taft-Hartley was very important, then I’ll take him at his word. But that’s not the impression I got, either from the chapter in particular or from the book as a whole.

The chapter in question is called “The Fall of Detroit”, and covers the decline of unions in the US. In terms of the number of union members, the decline began in 1979; in terms of the percentage of the population, it began much earlier, in 1954. And it’s possible to blame some amount of the rise in inequality to the decline in unions. Noah cites Berkeley’s David Card, who reckons that somewhere between 15% and 20% of the growth in male income inequality between 1973 and 1993 was attributable to the decline of unions, while among women the impact was minimal. Noah, of course, is talking about a divergence in inequality from 1979 to the present day, most of which took place after 1993, and it’s fair to assume that if unions had already pretty much declined by 1993, the effect of their further decline over the past 20 years is slim. So if you’re looking for causes of the Great Divergence, I don’t think you can reasonably make a case that the decline of unions is responsible for more than 10% of it.

And if the decline of unions as a secular trend is a minor but still important part of the reason why inequality has increased so much, the next question is the degree to which the Taft-Hartley Act was responsible for that decline.

Noah’s argument here is subtle. It has to be, because the 1950 Treaty of Detroit, a high point in the history of unions, came three years after the Taft-Hartley Act became law. Still, writes Noah, Taft-Hartley was a kind of ticking time-bomb:

Another reason unions fell fast and hard was that the Treaty of Detroit, formidable though it was when constructed in 1950, lay atop the fault line of an antilabor law whose passage big labor had been unable to prevent three years earlier. If the 1935 Wagner Act was labor’s Magna Carta, the Taft-Hartley Act was its Little Bighorn.

Are the unions represented by George Custer and the 7th Cavalry Regiment, in this metaphor? If so, it doesn’t really work: Custer died at Little Bighorn, while the unions’ best days — like the Treaty of Detroit — were still ahead of them when Taft-Hartley was passed. But in any case, Noah’s basically saying that Taft-Hartley allowed corporate management to undercut labor in the decades ahead, and that as a result the Treaty of Detroit was much less of a victory than it might otherwise have been:

The momentum enjoyed by the labor movement and the remarkable job-creating postwar prosperity that would emerge within a few years (and on which big labor would come to depend) obscured for a couple of decades what a powerful weapon Taft-Hartley placed in management’s hands. “After ten years of experience” with the law, the University of Buffalo economist Joseph Shister wrote in 1958, “this controversial piece of legislation can be viewed with considerably less emotion.” Shister concluded that while the law had made it somewhat more difficult for unions to organize, the power relationship between management and labor was essentially unchanged. That judgment was correct for 1958, but it didn’t remain so.

So Noah has to make the case that because of Taft-Hartley, a lot of bad things happened to unions in the decades after 1958 that wouldn’t have happened otherwise. And frankly it’s a hard case to make, because elsewhere in the chapter Noah quite convincingly explains that bad things were going to happen to unions no matter what:

Management and labor were more adversarial in the United States than elsewhere. Mechanisms for compromise, either public or private, were few, and there was little tradition of joint economic stewardship. The resultant conflict made old-line industrial unions appear, to much of the public, maddeningly intransigent as the Rust Belt fell into steep decline. Some unions, like the Teamsters, were blatantly corrupt, with extensive ties to organized crime. That didn’t help labor’s image either.

But an underlying reason for labor intransigence was that Reuther was never able to build on the Treaty of Detroit sufficiently to establish a partnership between labor, management, and government comparable to what western Europe achieved after the war. American management wouldn’t allow it. It was too socialistic, too impertinent. When a corporate leader believed that Reuther had an excellent idea about how to run his business, he still felt compelled to reject it, on principle.

That, it seems to me — and this was certainly the impression I got from reading Noah’s book — is the real heart of the reason why America’s unions declined. In Germany, union representatives were invited onto corporate boards; in the US, they were treated as the enemy.

More broadly, in the book, Noah explains that the ovewhelming majority of the rise in inequality cannot be attributed to any one cause, like the decline of unions: it’s a much broader and subtler political phenomenon. Here’s where Noah completely convinces me:

Economists and political scientists previously resisted blaming the Great Divergence on government mainly because it didn’t show up when they looked at the changing distribution of income taxes…

But recently a few prominent economists and political scientists have suggested looking at the question differently. Rather than consider only taxes and benefits, they recommend looking at what MIT’s Frank Levy and Peter Temin call “institutions and norms.” It’s a vague phrase, but in practice what it mostly means is “stuff the government did, or didn’t do, in more ways than we can count.” In Levy and Temin’s view, the Great Divergence was the product of “a shift in the political environment.” Great income inequality, they wrote, would be impossible to achieve “without government intervention and changes in private sector behavior.” The two were mutually reinforcing.

In his conclusion, Noah writes that:

Today it can feel as though we live in a society that’s the precise opposite of Rawls’s ideal. The first principle isn’t economic equality; it’s economic inequality. Any effort to minimize income differences is held politically suspect, an intrusion on individual liberty.

I think he’s right about this. If Taft-Hartley hadn’t already passed in 1947, it would have passed some time later: as we just learned again in Wisconsin, the anti-union sentiment that allowed Taft-Hartley to get a two-thirds majority in both houses, enough to override Harry Truman’s veto, never really went away. Taft-Hartley is a symptom of a much broader syndrome; it’s not a significant direct cause of today’s inequality. And that’s why repealing Taft-Hartley would be so ineffectual as a weapon in the war against inequality. The real problems are deeply embedded in American society, rather than being enshrined in some labor-relations law. Do what you like to Taft-Hartley: the rich still run this country. And will continue to extract as much as they can in the way of rents.


Wow, what a terrible review. It amounts to:

“Krugman and Noah’s books don’t answer some question they didn’t seek to answer, but that I want answered, so they stink.”

More Salmonian arrogant idiocy.

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