Felix Salmon

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

Banks currently have $1.5 trillion in excess deposits at the Fed, earning 0.25% — a reasonably healthy amount, in a world where T-bills yield even less. So why would banks want to move money out of the Fed and lend it into the economy? It’s possible that even the latest rumblings of new Fed actions to boost the economy may not have much effect, because the real anchor holding down growth is sitting in the Fed’s own vault.

That’s the core of Bruce Bartlett‘s diagnosis. For Bartlett, with interest rates already so low, the remedy lies elsewhere:

The Fed can penalize banks for holding excess reserves by charging them interest rather than paying them interest. This has been done in other countries. From July 2009 to July 2010, the central bank of Sweden charged banks 0.25 percent on their reserves, and on July 5 the central bank of Denmark announced that it would begin charging an interest rate of 0.2 percent on reserves.

In effect, this reduces the real interest rate received by banks and thus, ironically, would ease monetary policy and encourage bank lending.

Bartlett is pushing banks to get excess capital out of the Fed and into the economy. If bankers are “traveling money salesman” and the Fed stops paying interest on their excess deposits, why not give them a new task: hit the road and start hawking loans to customers.

Mike Shedlock disagrees with Bartlett: penalties on excess reserves “sure would get banks to do something, but that something might not necessarily be lending! For example, banks might bet against the US dollar, bet on gold, plow into the stock market, etc.” For Peter Stella the argument boils down to a misguided beliefs that excess deposits and lack of credit are connected. Reducing excess deposits, he argues, would actually cause credit to contract. Michael Pento thinks Bartlett’s idea would lead to more lending, but the wrong kind. Banks would “[shove] loans out through the drive-up window with a lollipop… They will be forced to take a chance on loans to consumers, at the exact time when they should be getting rid of their existing debt”.

Allen Binder thinks the British are on the right track in tackling a lack of lending from a different angle: Instead of penalizing excess reserves, “the more a bank lends, the more it saves on funding costs [from the Bank of England]… no bank is forced to lend, nor told what loans to make”. – Ben Walsh

On to today’s links:

EU Mess
Greece is on the brink of bankruptcy, with “cash reserves [at] almost zero” according to finance minister – Reuters

New Normal
Just 54% of Americans 18-24 were employed last year, the lowest level since data has been kept – FT
Bill Gross: The “cult of equity is dying”. Lenders, labor and the government will get returns – Pimco

Plutocracy Now
There’s just no place like America to be a billionaire – Mother Jones

When Regulators Stop Being Polite
Geithner: Fannie and Freddie’s refusal to use targeted principal reductions is not “the best decision for the country” – Treasury Department
DeMarco: Principal reductions do not improve foreclosure avoidance or reduce taxpayer costs – Federal Housing Finance Agency
DeMarco has “a deep aversion to reducing principal” that is common among bankers and lenders, and he should step aside – Jared Bernstein

Alpha
Shares of companies with women on their boards outperform similar companies with all-male boards by 26% – Bloomberg

Oxpeckers
“We have no patience for mystery. We want the deciphering of gods. We want oracles … right now” – Ta-Nehisi Coates

Ouch
The “linchpin of [Romney's] economic strategy is to further enrich the richest 1%” – American Progress

It’s Ed DeMarco vs Tim Geithner today, on the subject of principal reductions, and the fight is getting ugly.

DeMarco, in a letter to Congress, explains that the Treasury has put a lot of effort, and is willing to put very large sums of money, into something with the rather unwieldy name of HAMP PRA, where PRA stands for Principal Reduction Alternative. But here’s the thing: PRA is going to get nowhere unless Fannie and Freddie sign up for it. And they can’t sign up for it until DeMarco signs off on it. And DeMarco is refusing to sign off on it.

DeMarco has released a 15-page paper explaining his decision, although in reality his letter, and the reasoning in it, is much clearer. He basically says that principal reductions would be costly to implement, and he doesn’t have a lot of time for Treasury’s offer to pick up the tab: “although principal forgiveness may provide some financial benefit to Fannie Mae and Freddie Mac,” he writes, “it presents operational challenges for them and their servicers as well as a risk of loss to the taxpayer”. It’s not his job to worry about costs to Treasury or taxpayers generally — but he’s making it his job.

But the main thrust of DeMarco’s argument is less financial than it is moral. Any kind of principal-reduction strategy risks encouraging strategic default, and DeMarco hates the very idea of strategic default. And even if there’s no strategic default at all — and the letter from Geithner makes a very strong case that strategic defaults as a result of this plan would be de minimis — DeMarco still hates principal reductions on, well, principle:

Perhaps the greatest risk of the Enterprises’ allowing principal forgiveness is one with far more significant long-term consequences for mortgage credit availability. Fundamentally, principal forgiveness rewrites a contract in a way that other loan modification programs do not. Forgiving debt owed pursuant to a lawful, valid contract risks creating a longer-term view by investors that the mortgage contract is less secure than ever before. Longer-term, this view could lead to higher mortgage rates, a constriction in mortgage credit lending or both, outcomes that would be inconsistent with FHFA’s mandate to promote stability and liquidity in mortgage markets and access to mortgage credit.

This is a classic “parade of horribles” argument, and it’s not a particularly strong one, either. As Jared Bernstein says, “in unusual times, like the aftermath of the worst housing bubble implosion in decades with 30+% price declines, guess what? Write downs happen.”

But the weirdest thing about this argument is that the horribles aren’t particularly horrible. Higher mortgage rates? Um, fine: no one is exactly complaining that mortgage rates are too high right now. A constriction in mortgage credit lending? That’s fine too: it was too-lax credit lending that caused this whole problem in the first place. Both together? Even that’s fine: it would help bring homeownership rates down from their current too-high levels, and encourage more people to rent rather than own, creating a more flexible national labor force.

The fact is that while it’s imperative that we fix the problem of broken mortgages issued at the height of the credit bubble, the last thing we want to do is return to those days and tell anybody who wants a house that they can just go out and buy one, whatever their creditworthiness or cash position. If you want to make mortgages safer, you should ensure that homeowners have large amounts of positive equity in their homes. That means significant down-payment requirements for people buying houses. And it also means significant principal reductions for those who are currently underwater.

There’s an anonymous troll on the internet who doesn’t like my latest Pimco post. And frankly it’s really hard to take any post seriously when it’s tagged “born last night, clown questions, gmafb, horseshit, STFU”. This kind of macho bullying posturing is everything I hate about Wall Street — a place which is still home to far too many overconfident frat boys with overstuffed paychecks.

So, why am I rising to the bait? Mainly because some people I respect are taking the post seriously. And also because, hidden behind the sophomoric grandstanding, there are actually a couple of substantive points being made.

To take them in order, then:

Firstly, does Bill Gross pay himself, or is he “paid by the parent company that bought his firm”? I haven’t seen a lot of reporting on this, but everything I know about Pimco says that it’s a very arm’s-length, largely independent unit of Allianz. It certainly dividends profits up to its parent, but I don’t actually believe nor have I ever seen it reported that Allianz executives make granular decisions on how much Bill Gross, or any other Pimco employee, gets paid on a year-to-year basis.

Is there a formula governing Gross’s remuneration, based on some combination of Pimco revenues, Pimco profits, and the performance of the funds he manages? I’m sure there is. And if you want to reverse-engineer a way for Gross to have been paid $200 million in 2011 despite massively underperforming that year, then that’s surely the way to get there. Pimco doesn’t want to encourage short-term gambling among its employees, and so its pay is based on long-term performance rather than year-to-year fluctuations; Gross’s long-term performance remains excellent, and he manages an astonishing amount of money. And on top of that, Pimco is attracting spectacular inflows these days.

Still, Pimco told me that the numbers in the original NYT article were “seriously inaccurate”, and I’m quite sure that Gross, given his position in the company, does have a certain amount of discretion when it comes to divvying up the remuneration pool. He might not “have to answer to congress or a goofball parade of Occupy Wall Streeters”, but he’s still a leader — and even if we don’t know for sure how much he got paid last year, a lot of big-time money managers in the company know exactly what example he is setting. If they would risk getting fired after turning in such dismal performance, then it would be downright hypocritical — and bad for the cohesion of the senior management team — were Gross to accept a $200 million paycheck in such a bad year.

And how about the people whose money Pimco is managing? Yes, it’s easy to say that they’re sophisticated investors who “pay an agreed upon and transparent management fee up front” — but that doesn’t mean they’re happy with the fees they’re paying, especially not if they start reading about $200 million paychecks. And in a world moving swiftly away from the fund model and toward the lower-fee ETF model, it behooves any long-only money manager to keep a very close eye on fees and costs. The level of money-skimming which maximizes your payday this year is not necessarily the best way to keep on building your company’s franchise over the long term, especially in a world where index investing is becoming increasingly popular.

As for the assertion that long-only “buy siders that actually run portfolios north of 200 billion are paid at this level” — well, name some names. It’s a very short list, of course. But if you can find one or two other people who were paid $200 million a year for managing funds, and who weren’t hedge-fund managers collecting 2-and-20, then I’d be much more likely to believe that Gross is paid that much, too.

Next up comes a question about Mohamed El-Erian’s tenure at Harvard Management Company. I quoted an article about how “Mohamed was having a heart attack” while he was there, because Larry Summers insisted on taking Harvard’s spare cash and investing it in an endowment which was designed to have a virtually infinite time horizon. As a result, El-Erian’s job when it came to liquidity management was made extremely difficult. But now I’m told “this isn’t true”, on the grounds that all El-Erian needed to do was “explain” to Summers and others “that their allocation was inappropriate”, and then sleep well at night since the “allocation was made by Harvard officials not by Harvard Management.”

Maybe anonymous Wall Street trolls think that way, and wouldn’t worry about Harvard’s liquidity needs even if Harvard was effectively using them as a checking account. But a responsible money manager worries about liquidity every day, especially in a situation where Harvard can and will ask for large sums of cash on a regular basis. In any case, my larger point was that El-Erian can’t be blamed for liquidity problems after he left HMC, and there doesn’t seem to be any disagreement on that front.

Then there’s the question of the degree to which El-Erian’s ubiquity in the media is a Pimco marketing strategy, responsible for the large increase in assets that Pimco is seeing these days. I’m informed that the answer is a simple yes — but if that’s the case, that has interesting implications. A large chunk of Fabrikant’s article was based on the premise that Pimco’s investors wanted Gross’s bond-trading expertise, rather than El-Erian’s technocratic global-macro insights. But if indeed El-Erian’s regular TV appearances and various op-eds are responsible for the hundreds of billions of dollars which continue to flow into Pimco, then it seems that there’s a lot of appetite out there for a macro-led, rather than a trading-led, strategy.

On top of that, it’s notable that Gross, the great bond trader, has started to underperform Pimco as a whole, where investments are based very much on the global macroeconomic outlook. Pimco’s more than big enough for both Gross and El-Erian, of course. But the idea, in Fabrikant’s piece, that Pimco is effectively still Gross’s shop, and risks withering away were he ever to leave — that idea is pretty effectively demolished if in fact El-Erian’s media strategy is responsible for bringing in enormous amounts of new money. Certainly El-Erian never talks about trading strategies in such appearances.

Finally, there’s the question of Blackrock, a much bigger fund manager than Pimco, where, incidentally, the CEO, Larry Fink, was paid $21 million in 2011. How did Blackrock grow so big? In large part by buying a lot of index funds, thereby diversifying into one of the fastest-growing investment strategies in the world. And also, in part, by being a public company. And so I asked a question, and received an answer:

In order for Pimco to effectively compete with Blackrock, will it too have to go public?

No. How is that even a question? They are a wholly owned subsidiary of a firm that is significantly larger than Blackrock which allows them tremendously cheap financing if they need it. Allianz’s insurance assets also provides them with 23% of their AUM. Does JP Morgan Asset Management, SSgA, or Deutsche Bank Asset Management (all well over a trillion in AUM) need to spin off and IPO to compete with Blackrock?

I wasn’t suggesting that Pimco spin off from Allianz. But Pimco already has “shadow equity” which is traded among Pimco employees; there’s no reason that it couldn’t get listed as some kind of tracking stock. And that tracking stock could be a very valuable acquisition currency as Pimco seeks to diversify away from its historical core competence of actively-managed bond funds. There are many reasons why Pimco might well prefer to do things that way, rather than asking Allianz for “tremendously cheap financing” for an acquisition.

I’m sure that Pimco gets lots of value from having Allianz assets at its core. But Pimco is also reported to be “seeking more independence from its parent”, and in any case I don’t think it’s true that Pimco is wholly owned by Allianz, which bought only 70% of the company back in 1999.

My point about Blackrock is that by having its own stock and being master of its own strategy, it has managed to diversify, and grow, more quickly and effectively than Pimco has. Here’s a germane quote, from last year:

“The history of the asset-management business demonstrates time and time again that the most successful asset-management firms are those who are dedicated to investing rather than subsidiaries of banks and insurance companies where there can be lots of tension,” Burton Greenwald, a fund-consultant based in Philadelphia, said in an interview. “Fund companies tend to be entrepreneurial, while banks and insurance companies tend to be bureaucratic.”

There’s a case to be made that Pimco has in fact thrived under Allianz’s ownership — but it’s unclear whether that’s a function of Allianz being a great owner, or whether it’s a function of the fact that those years saw the greatest fixed-income bull market of all time. That bull market is going to come to an end at some point. And when it does, Pimco wants to be positioned much more evenly across various different asset classes and strategies than it is now. In order to do that, it’s not a completely horseshit clown question to ask whether it might want to take a leaf or two out of Blackrock’s book.

Update: David Merkel adds some very useful facts to the debate.

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

After Sandy Weill had his say on breaking up big banks last week, backlash to his reversal was inevitable. It turns out Bank of America and Citi had already considered his idea: Execs at BofA studied breaking out troubled Countrywide Mortgage, which has been called the worst deal in finance history, as well Merrill Lynch’s securities business. Citi, apparently at the behest of regulators, did a similar analysis and even employed Bain to conduct it. The bank concluded that tax inefficiencies precluded a breakup; they have yet to pursue changing the tax code with the same vigor they applied to abolishing Glass-Steagall.

Somewhat paradoxically, BofA decided Countrywide was too bad to let go and that Merrill was too profitable to part with. The latter is just wrong, according to their own filings, as Jonathan Weil smartly points out: “Last quarter Merrill reported a net loss of $1.6 billion. It posted a $1.7 billion net loss for all of 2011″.

Before Weill made his comments, Jamie Dimon had already said that he doesn’t think any of JPMorgan’s business would be better off independently. He’s probably unlikely to take advice from a guy who once fired him said. Former JPMorgan Chairman and CEO William Harrison chimed in on the merits of Dimon’s firm with this faintest of praise: “you can screw [management and risk-taking] up at a small bank or a large bank”.

The WSJ reports that Dodd-Frank’s two eponymous lawmakers don’t agree with Weill: Former Senator Chris Dodd thinks Weill is “frankly too simplistic”; Representative Barney Frank says doing “something drastic to a major part of the economy isn’t a very good idea” right now.

Had Weill spoken up a few years ago, Frank says he would have been all ears. And there are also who think Weill hasn’t even started to address his past mistakes. Here’s the Roosevelt Institute’s Jeff Madrick in the NYT: ”What was most eye-catching was Mr. Weill’s claim that the conglomerate model ‘was right for that time.’ Nothing could be further from the truth”.

What we haven’t seen is a defense of big banks not just as the status quo or too complex to tamper with, but as better, more valuable businesses which are more socially useful than the alternative. Maybe that’s another legacy of the financial crisis: even their staunchest supporters have defined the benefits of big banks down. – Ben Walsh

On to today’s links:

Reversals
Say goodbye to 10 consecutive quarters of US corporate profit growth – WSJ

Politicking
Big government is gone, and what’s left keeps shrinking – NYT

Munis
America loves its cops and firefighters. Their pensions, less so – Reuters

Doubts
New Fed action “will not increase the supply of, or demand for, credit” – The Big Picture

New Normal
A billionaire’s fear: Inequality is creating an impoverished underclass that threatens social stability – NY Mag

Mistakes Were Made
“We apologize”: HSBC sets aside $2 billion for failure to stop money laundering – FT
Why big banks have scandals – The Atlantic

EU Mess
The next make-or-break moment of the euro crisis: after everyone gets back from August vacation – Reuters
Germany and France endorse Draghi’s pledge to save the euro with decisive action – WSJ
The Bundesbank: still opposed to the ECB buying sovereign bonds – FT

Oxpeckers
Jonah Lehrer resigns from the New Yorker after admitting to lying about Dylan quotes – NYT

I’m Confused
Headline: “Stocks Continue to Defy Investors’ Sour Mood” – WSJ

Primary Sources
Dallas Fed’s manufacturing index hits 10-month low – Dallas Fed

Corrections
“He was Isambard Kingdom Brunel, a prominent British engineer in the 19th century, not ‘a Dickens character.’” – NYT

Tim Harford is a fan of the clear way in which Alex Tabarrok has couched the debate — which started with a Tyler Cowen post back in January — about the desirability of intergenerational economic mobility. Or, in English, is it a good thing if quite a lot of poor people become rich?

The Marginal Revolution guys say that looking at economic mobility is overrated; Cowen, also in January, linked to a bunch of critics of that position, including John Quiggin, Brad DeLong, and Paul Krugman. Recently, DeLong resuscitated the discussion, and Krugman came back for a second go-round as well, all of which resulted in Cowen being rude about Krugman, and Tabarrok trying to clear things up.

Tabarrok’s post is indeed clear, but it’s clear in an invidious way. He basically starts with his conclusion, saying that if a high-mobility society has no better outcome, in general, than low-mobility society, then there’s not very much to choose between them. And similarly, he says, if both a high-mobility society and a low-mobility society have the same very good outcome, then again there’s not much to choose between them.

But this obtusely misses the fundamental reason why high mobility is a good thing: that it improves outcomes. A sclerotic society where no rich people become poor and where no poor people become rich is never going to be a hive of creative destruction. Cowen even comes close to admitting this, when he says that “if the general standard of living is rising, mobility takes care of itself over time” — except he has the causality largely backwards. If you have lots of social mobility, then the general standard of living is going to go up: you’ll have lots of poor people becoming richer, and you’ll also have the rich protecting their downside, in the likely event that they become poorer, by doing their best to improve the lot of the poor.

So when Cowen talks about economic mobility not mattering much “for a given level of income”, or when Tabarrok talks about “some simple societies” with fixed levels of income, they’re taking the variable in the equation and they’re turning it into a constant. What they should be doing is looking at two societies, equal in all respects except that one is high-stasis and the other is high-churn, then fast-forwarding to see which one turns out better. The answer, of course, is the high-churn society — which means, working backwards, that if you want growth, you also want social mobility.

As a result, it’s reasonable to conclude that anything which impedes social mobility — like rising inequality, say — also impedes growth. The effect might not be huge, but it’s there. And the only way not to see it is to effectively assume your conclusions.

What kind of person confesses to a crime he didn’t commit? Omer Rosen, it would seem, for one. His piece in the Boston Review today is headlined “I, Too, Have Messed with LIBOR”, and after a lot of throat-clearing he finally utters the fateful words:

I was not setting the official LIBOR—no one would borrow money or otherwise make or receive payments based on my LIBORs. However, for the purposes of this particular deal, I was ‘setting’ LIBOR.

The scare quotes are doing a huge amount of work, there, because in fact Rosen not only wasn’t setting Libor; he really wasn’t even “setting” Libor, either. Here’s the tl;dr version of Rosen’s 1,700-word piece: Rosen was working at Citigroup, on a deal which would save a client millions of dollars in taxes. But banks know better than to put things in writing saying “you should do this deal because you’ll save a shedload of money in taxes”. So instead they concoct an ersatz financial justification for the deal which allows everybody to sit around a table gravely nodding their heads and saying “yes of course it makes perfect financial sense, in and of itself, for us to borrow at a high fixed rate instead of a low floating rate, and wow, look at that, there are tax benefits too, that’s just icing on the cake”.

In this case, the ersatz financial justification was about as simple as it could get: Rosen basically just said “hey, if you borrowed at a floating rate, then if interest rates went up, you’d end up paying more money than if you borrowed at a fixed rate”. And that, apparently, was all the wispy gauze of a financial justification needed for the deal to go through.

There was no setting-of-Libor going on here: there was just a possible future path for interest rates generally, combined with a willful ignorance of, say, the existence of interest-rate swaps. According to Rosen, he was told by his managing director that “tax transactions are illegal” — if that’s true, then the real scandal here has nothing to do with Libor, and everything to do with the fact that Citigroup put together an illegal transaction. But frankly I doubt that the transaction was illegal; I think the people structuring it just didn’t want to raise unnecessary red flags with the IRS.

But that’s the problem with things like the Libor scandal, I guess. Once a top-tier bank like Barclays cops to lying about Libor, everybody else wants to inflate their importance by joining their ranks. Even if what they did really had nothing to do with Libor manipulation at all.

When Geraldine Fabrikant decided to write a rather odd and meandering profile of Mohamed El-Erian for the NYT, she made sure to bury the lede, deep in the article’s sixth paragraph. But Clusterstock knew where the news value was (“KA-CHING: PIMCO’s Mohamed El-Erian Got Paid $100 Million Last Year”), while Bloomberg led with the revelation about El-Erian’s co-CIO: “Pimco’s Bill Gross Paid $200 Million Last Year, N.Y. Times Says”.

Fabrikant’s source for both numbers is a single individual, “a person with knowledge of Pimco’s finances”. The whole thing was rather reminiscent, to me, of what happened last February, when Reuters reported that Pimco’s top partners are making an average of $33 million each, and Pimco responded by calling those numbers “wildly inaccurate”. So I asked Pimco what it thought of Fabrikant’s reporting, and got this back from a spokesperson:

The article contains numbers that are seriously inaccurate, as well as other factual errors.

Fabrikant spent a lot of time on this article — she says that her joint interview with El-Erian and Gross took place “earlier this year” — and so I suspect that she’s pretty confident in printing those numbers. That said, however, Gross, who’s already a multibillionaire and really doesn’t need the money, would have had to be utterly tone-deaf to pay himself $200 million in 2011.

2011 was the year, remember, in which he published a 3-page note entitled “Mea Culpa”: “I’m just having a bad year,” he said. “This year is a stinker.” He continued:

This is big league ball, where your ticketholders come to the park expecting not a circus Willie Mays catch but more wins than losses and a yearend performance that places your bond assets near the top of the standings.

That didn’t happen. Instead, Gross placed in the bottom 10% of bond-fund managers for 2011. Given that, it’s hard to see how he could justify extracting $200 million from Pimco’s investors, or three times the record $68.5 million that Lloyd Blankfein was paid in 2007.

Certainly that kind of payday is within the realms of possibility, given that his firm manages $1.8 trillion, and his Total Return Fund has $263 billion under management: $200 million is just 0.01% of the former, or 0.08% of the latter. On the long-only buy side, the way you get paid for performance is that your performance attracts new money, and the new money pays management fees. And so long as Pimco’s assets under management are going up rather than down, I can see how Gross’s pay might do likewise. But still.

I can’t say that the rest of the article makes it seem particularly reliable, either. Fabrikant lays out the case against El-Erian on two fronts: firstly that he isn’t much of a bond trader; and secondly that his tenure running Harvard’s endowment was “somewhat controversial”. Overall, she says, “his track record for managing money is mixed”.

But I can’t work out how Fabrikant comes to that conclusion. El-Erian has managed money at two places: Pimco (twice), and Harvard. In his first stint at Pimco, between 1999 and 2005, he managed emerging-market bonds through the Russian and Brazilian crises and the Argentine sovereign default; he ended up making an annualized return of 18.4%, which was very much, in Gross’s words, “near the top of the standings”. What’s more, he amassed a much larger emerging-market bond portfolio than any of his competitors: he was just as good at attracting funds as he was at generating alpha.

At Harvard, El-Erian also did well, at least in terms of published returns. Of course, there’s more to managing an endowment than maximizing annual returns: you also need to be assiduous about liquidity management. And after El-Erian left Harvard, the endowment ran into massive liquidity problems. Fabrikant says that “several experts on endowments”, none of whom are named, blame El-Erian’s investment strategy for those problems, along with his abrupt departure. But I see things differently: I think the real problem at Harvard was leadership, or rather the lack thereof.

El-Erian’s departure was indeed abrupt — but I suspect that had he been managed better by the university’s grandees, including Larry Summers and Robert Rubin, they could have done a better job of persuading El-Erian to put in place a considered succession strategy. And then, after El-Erian left, the endowment was left effectively headless for the best part of a year before Jane Mendillo was hired in July 2008. That’s not his fault.

Asset allocation is something endowments do on a very long timeframe: once El-Erian had worked out where he wanted the endowment’s money to be invested, it was probably OK to keep that same allocation until a new head could be found. But liquidity management is another thing entirely: that kind of thing can’t be run on autopilot, and has to be actively managed. Especially when Summers is busy losing $1 billion of the university’s money elsewhere. Remember this?

Through the first half of this decade, Meyer repeatedly warned Summers and other Harvard officials that the school was being too aggressive with billions of dollars in cash, according to people present for the discussions, investing almost all of it with the endowment’s risky mix of stocks, bonds, hedge funds, and private equity. Meyer’s successor, Mohamed El-Erian, would later sound the same warnings to Summers, and to Harvard financial staff and board members.

“Mohamed was having a heart attack,’’ said one former financial executive, who spoke on the condition of anonymity for fear of angering Harvard and Summers.

In other words, El-Erian was having a hard enough time on the liquidity-management front when he was in the office every day, thanks to the internal politics of the university; he can’t really be blamed for failures after he left.

Finally, El-Erian started managing money directly at Pimco again in 2009; since then, his funds’ returns, in Fabrikant’s words, have been “relatively lackluster”. But these are small funds, with just $10 billion between them — a rounding error, at Pimco. As CEO and co-CIO of the whole company, El-Erian should be properly judged on the whole company’s performance, and Pimco seems to show no deceleration whatsoever when it comes to the pace at which it is accumulating assets under management. Not that you’d learn that from Fabrikant’s story.

Instead, we get very silly stuff like this:

Mr. El-Erian was headed east and people were buzzing. Some wondered if he was taking the job to cultivate a relationship with Lawrence H. Summers, a former Treasury secretary who was then Harvard’s president, in the hope of finally landing atop the I.M.F.

Who are these “some”? We’re never told, of course. But since when has the president of Harvard had any say at all in who becomes the next head of the IMF? Summers did return to government eventually, but that was by no means a foregone conclusion, or even likely, in 2007. What’s more, even once he was in government, I don’t think that Summers played any real role in selecting the next head of the IMF — a choice which is made by Europeans, not Americans.

And what we don’t get, from Fabrikant’s article, is any real substance on the task facing El-Erian. If you’re writing a profile of him, here are some questions I look forward to you trying to answer:

To what degree is El-Erian in the process of replacing Gross, and to what degree is he doing something completely different? What will happen to the Total Return Fund when Gross retires? Does Pimco need to replace Gross with another great bond trader, or is it now a very different animal to the company that Gross founded, in need of someone who thinks on a more macroeconomic level? And how is El-Erian, who is CEO as well as CIO, as a manager?

How much time does El-Erian spend appearing on television, writing op-eds, and otherwise cultivating the media? Is that all part of some Pimco marketing push? To what degree does it distract from his day job? Same questions for Gross, too.

Finally, and most interestingly, how did Larry Fink manage to amass twice Pimco’s assets under management despite the fact that Bill Gross, the greatest bond investor of all time, had a more than 15-year headstart on him? What is the story of Blackrock vs Pimco, and how is it likely to play out in future? In order for Pimco to effectively compete with Blackrock, will it too have to go public? (Incidentally, Fink was paid $21.9 million in 2011.)

El-Erian is an interesting character, but it seems to me that the most daunting job facing him is the fact that he is being asked to run an enormous buy-side institution which he didn’t found. Many people have been asked to do that; very few of them have ever succeeded. What will it take to buck the trend? And will the world’s institutional investors stick around long enough to find out? Or will El-Erian finally get that IMF job, and move to Washington, before it comes to that?

But yeah, it would also be fascinating to find out how much he’s really being paid.

Is a bubble bursting in Web 2.0 stocks? The NYT says there is, and says indeed that this implosion is even more dramatic than the one we saw in 2000. In reality, of course, it isn’t.* In 2000, trillions of dollars of wealth evaporated as the share prices of thousands of companies plunged to earth; in 2012, by contrast, we’re talking about a mere handful of companies, including Facebook, which, with its $65 billion market cap, still looks pretty well valued to me.

That said, most of the public self-described “social” companies — with the prominent exception of LinkedIn — have indeed seen their share prices hit hard of late, to the point at which many recent private rounds look decidedly rich. The result is that there’s a pretty strong case to be made that we have what you might call a steep inversion in the valuation curve.

In general and in aggregate, corporate valuations are meant to rise over time. There’s a lot of volatility in the process, of course, and individual companies go bust all the time. But in the Silicon Valley model, companies begin as startups at relatively low valuations, and then as they raise more money in successive rounds, their valuation steadily rises. Eventually, if and when they go public, they’re worth so much that anybody who bought in during one of the private rounds will be sitting on a nice profit.

That’s not just a matter of growth over time, either: it’s also a matter of a much larger investor base. There are only a relative handful of individuals and institutions who buy into private rounds; in contrast, there are millions of investors around the world who can buy stocks listed on public markets. If the number of people bidding against each other to buy equity in any given company suddenly rises by many orders of magnitude, it stands to reason that the price is going to rise as well.

With the latest crop of tech stocks which have gone public, however, that hasn’t been the case — despite what seemed to be enormous appetite, for Facebook stock in particular, from investors all over the world. Instead, even if valuations are still getting steadily richer from round to successive round in the private markets, there’s no a significant drop at the end of the curve — the point where private markets go public.

So what’s going on? The answer, I think, can be found in the psychology of the dot-com bubble. Back then, there were a lot of people making enormous amounts of money by investing in technology stocks. You’d put together a portfolio of tech stocks, the portfolio would rise in value, and you would conclude that you were doing very well, and therefore buy ever more tech stocks. After all, your brokerage statements were proof positive that you knew exactly what you were doing, and were very successful at it. A bull market, especially a soaring bull market, creates confidence and momentum and inflows.

Turn that story on its head, and you wind up where we are today. There are still dedicated technology investors and funds in the public markets, but all the top technology investors have moved, at this point, to the private markets. If you’re in the public markets, your performance has been mediocre for over a decade, and you’re liable to take any brief buzz-induced inflow of funds into the sector as an opportunity to cash out and make a rare and precious profit.

In theory, the fact that the public markets are so much bigger than the private markets should be great for any tech company going public which cares mostly about its valuation. There’s a finite number of shares out there, and the demand for those shares is now vastly bigger than it was. Therefore, price must go up.

In practice, however, it doesn’t work like that. Instead, we have a very small pond of private investors, where valuation momentum can pick up incredibly quickly. But the minute the gates come down and the company’s valuation wave spills into the ocean of the public markets, it just gets absorbed into the broader tech-valuation sluggishness, and disappears.

Yes, Facebook had a very large IPO, but it was always a bit ridiculous to hope that a single offering could change the psychology and momentum of the entire technology sector — even if it had gone well, which of course it didn’t. Stock markets are moody animals, and they don’t like being told how to behave by Sand Hill Road types with an eye to a big payday. The tech sector might turn around and begin a rally at some point. But chances are, that point won’t come until after Silicon Valley’s VCs have been properly chastened.

*Update: I apologize for mischaracterizing the NYT article; it did not say that the current pop was as loud as the one we all heard so loudly in 2000. I misread the article, or read it too quickly. Sorry.

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

First, Apple released decidedly “meh” earnings this week for the second quarter. Then, Netflix did, too. Then Zynga. Then Facebook. Not all of these companies are in the same boat: Apple reported strong growth but missed analysts’ lofty expectations; Netflix topped analysts’ estimates but experienced a big slowdown in growth. Still, the stocks of all four companies ended the week down: Apple’s shares fell around 3% on the week; Netflix’s were down 28%; Zynga’s were down 36%; and Facebook’s fell 17%.

Apple’s case is probably the most instructive. Part of what’s going on is the continuation of the trend that Larry Summers picked up on at Fortune’s BrainTech conference last year: that the earnings of tech companies are undervalued relative to the earnings of industrial companies. As he pointed out then, once you subtract Apple’s Scrooge McDuck-size pile of cash, Apple’s price-earnings ratio is only about two-thirds of GE’s. But another part of what’s happening is what Peter Thiel highlighted at this year’s BrainTech conference and that we blogged about last week: big tech companies like Apple, Microsoft and Google have excess cash and a shortage of scalable, innovative ideas worth a chunk of it.

Take Apple’s cash hoard in particular (now over $117 billion). Apple may have just plunked down $356 million in cash in its bid for AuthenTec, but that’s only 5% of the $7.04 billion in cash that Apple accrued since the end of June alone. What Matt Yglesias wrote this week about Microsoft could apply to Apple as well: “Innovation is really hard. Staying on top once your core business has saturated the market is really hard”.

Adam Lashinsky made an observation during Peter Thiel’s panel that there is a notable exception to this trend: “Amazon is the only one, in my mind, of the big tech companies that’s actually reinvesting all its money, that has enough of a vision of the future that they’re actually able to reinvest all their profits”. He was almost spot-on: With heavy investments in its business Amazon was able to eke out a profit of a penny per share this quarter. Barney Jopson had a great piece in the FT earlier this month that detailed Amazon’s capital investments, from its own “digital market place with millions of customers, to petabytes of server space and to state-of-the-art warehouse facilities serving myriad forms of commerce”. Investors don’t seem to mind Amazon’s paltry income for the time being. Although its profit, like Apple’s, came in below analysts’ estimates for the second quarter, Amazon’s shares finished up 4% on the week. – Peter Rudegeair

On to today’s links:

Facebook
What investors saw and didn’t like in Facebook’s first public earnings release – DealBook

Economy
GDP growth slows to 1.5%: The US recovery is now the second slowest since World War Two – WSJ

EU Mess
Yields of 7+ percent too much to bear – Spain discussing full-scale, $366 billion bailout with Germany – Reuters
Draghi made his statement, now he has to back it up – Bloomberg
“Convertibility” and the ECB’s monster challenges – FT Alphaville
The irreversible euro: Did Draghi pull a “the crisis is contained to subprime”? – Tim Duy

TBTF
“Millions have suffered needlessly” because of the structure of the bailouts – Kevin Drum
Not the strongest argument: “you can screw [management and risk-taking] up at a small bank or a large bank” – Reuters

Liebor
How one trader tried to blow the whistle on Libor manipulation – and was ignored – FT
How not to rig Libor: the Barclays instructional video – John Carney

Think of the Children
The birthrate is at a 25-year low as Americans put off procreating – USA Today

Good Ideas
Geithner supports the Merkley mortgage refinance plan – Housing Wire
“In many ways … this is functionally equivalent to a principal reduction” – Felix

PR Pushes
What the financial industry needs now: A cheesy promo video with terribly low production values – The Partnership for a Secure Financial Future

Awesome
“Like Finnegans Wake as drafted by the unicorn debate team … atavistically beautiful, like middle school cave art” – Brian Philips

New Normal
The majority of Americans getting jobs have had to switch industries – WSJ

Data Points
Compared with the Super Bowl, the RNC quadruples earnings for strips clubs – NYT

Oxpeckers
The NYT is now supported more by readers than by advertisers – NY Mag

Are crowdfunding statistics the new counterfeiting statistics? Certainly they seem to have become a meme. If you know that crowdfunding is a big deal, it’s probably because you read all about it in TechCrunch, in May (“these portals raised $1.5 billion and successfully funded more than 1 million campaigns in 2011″), USA Today, a few weeks later (“About $1.5 billion was raised in 2011 by about 450 crowd-sourcing Internet sites worldwide”), or maybe the Economist, a week after that (“$2.8 billion will be raised worldwide this year, up from $1.5 billion in 2011″). More recently, Forbes upped the ante even further: “This year alone, an estimated $3.2 billion dollars is expected to be raised through donation-based crowdfunding platforms like Kickstarter”.

All of these statistics, you won’t be surprised to hear, come from the same place: a May report from Crowdfunding.org and its research arm, Massolution. The report lists — by placing their logos on five successive pages of the report, so that their names can’t be searched — 135 different “participating companies”, starting with Lending Club and Kiva, and ending with… um, hang on a sec. Lending Club and Kiva? Since when are they “crowdfunding platforms”?

It turns out, if you look at the definition of a “crowdfunding platform” that the report uses, it’s incredibly broad: “an operator of a funding platform that facilitates monetary exchange between funders and fundraisers.” Which turns out to include not only peer-to-peer lenders but also FirstGiving, a website which non-profits use to accept donations, and which claims to have moved $1 billion of funds through its system. For that matter, the definition doesn’t even say that the crowdfunding platform needs to be online: I reckon that if anybody hosting a political fundraiser probably counts as a crowdfunding platform under this definition. Hell, the New York Stock Exchange would even qualify.

Oh, and guess what: if you add up all the money raised in 2011 from all 135 companies listed, it doesn’t come to $1.47 billion at all. It comes to just $575 million. Where does the other $895 million come from? The report basically pulls it out of thin air, reckoning that since it didn’t manage to get numbers from all of the crowdfunding companies in the world, it would try to extrapolate, somehow. Or, in the language of the report:

Each CFP was modelled individually based on key metrics, market growth dynamics and other characteristics for a number of large CFPs that did not provide data in order to estimate the total funds.

It’s very hard to know what this means, but when it comes to crowdfunding platforms, all of the big ones, including Kickstarter, are already on the list. It beggars belief to assert that there’s a whole bunch of other platforms out there which together raise more money than those 135 companies put together.

In any case, you won’t find it in the abridged version of the report, but the key chart is this one:

According to this chart, of the $575 million that Massolution managed to total up, fully 49% is “donation based”, from companies like FirstGiving. And another 22% is “lending-based”, from companies like Lending Club. (I don’t know which bucket Kiva is in; I suspect it’s lending, but it’s certainly one or the other.) I don’t consider peer-to-peer lending to be crowdfunding, and I don’t think that giving money to charity online counts as crowdfunding either. So what happens if you exclude those two categories? You get $63 million in reward-based crowdfunding (think Kickstarter, which is now up to $247 million in total funds raised), and another $103 million in equity-based crowdfunding, all of which comes from outside the US.

Recently, SecondMarket has been moving into the business of raising money for fund managers of various descriptions — this too counts as crowdfunding under the Massolution definition, even if it’s just a couple of high net worth individuals putting their money into an art fund. And SecondMarket is adamant that it does not want to get into the crowdfunding game.

All of which is to say that Massolution has done a very good job of taking the relatively small amount of genuine crowdfunding which is going on out there, throwing it into a bucket with a lot of stuff which is not crowdfunding, and persuading the media that crowdfunding has already become a billion-dollar business, even before all the new activity legalized by the JOBS Act kicks in.

So what are the real numbers? Well, if you take only the “reward-based” and “equity-based” slices from the Massolution pie, they come to $165 million for 2011. That’s more or less in line with the $123 million number which the Daily Crowdsource came up with earlier this year. It’s not chump change, but it makes the entire global crowdsourcing space roughly half as big, in revenue terms, as, say, the Fifth Avenue Apple Store.

The lesson of this story is that we shouldn’t be getting ahead of ourselves, and we certainly shouldn’t be accepting uncritically any statistics which come from Massolution. Carl Esposti, Massolution’s CEO, is on the executive board of the Crowdfunding Professionals Association — which is to say he very much has a dog in this fight. Next time he starts throwing out statistics on the size of the crowdfunding market, it would behoove any journalist to double-check exactly what he means by that. And whether he thinks it includes things like online donations to the Red Cross.

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

It was a comment that launched a thousand strained attempts to capture its essential absurdity. Sandy Weill, the man who broke the wall between commercial and investment banking, the architect and former chief executive of Citigroup, has decided the whole thing is now a bad idea:

What we should probably do is go and split up investment banking from banking, have banks be deposit takers, have banks make commercial loans and real estate loans, have banks do something that’s not going to risk the taxpayer dollars, that’s not too big to fail.

That’s a massive reversal for a man who two years ago hung a “hunk of wood – at least 4 feet wide – etched with his portrait and the words ‘The Shatterer of Glass-Steagall’” in his office. Even then things had changed: Citi was in a shambles, and Weill had gone from the pioneer of an economic boom to an early harbinger of the dangerous financialization of the American economy.

Weill, it turns out, is not the only now-retired finance chief to have second thoughts. The American Banker has a list of other prominent proponents of breaking up the big banks. Phil Purcell, former CEO of Morgan Stanley; John Reed, former chairman of Citi; David Komansky, former CEO of Merrill Lynch — each one is on the list. Dick Parsons, another former Citi chairman, isn’t on American Banker’s list, but he should be.

The public mood toward finance has shifted dramatically, but so has the employment status of each of these men. Parsons’s post-retirement alacrity was particularly bold: It took him just three days away from Citi’s board to have second thoughts. It seems that once you receive the banking chieftain’s version of an AARP card, repressed doubts about the value of your life’s work emerge. Or perhaps your incentives (and ego inflation) now come from public plaudits and not compensation.

Lining up against Weill et al to defend big banks is former senator Phil Gramm, the co-author of the bill that retroactively legalized the merger that created Citigroup. He’s joined by Rodge Cohen, the Sullivan & Cromwell rainmaker famous for advising numerous bank CEOs through the financial crisis. Wells Fargo Chairman and CEO Richard Kovacevich disagrees based on Rumsfeldian existentialism: “Investment bankers are risky, not investment banking”. Other big-bank CEOs have been silent, but they might say they’ve already addressed the matter – they’re not too big to fail, because they have filed a piece of paper with the Fed saying they can fail.

It will take more than armchair advice from former titans, it seems, to persuade current big-bank executives that Weill is on to something. It will take demonstration of real economic gain: Even if Jamie Dimon “can’t imagine” that any unit of JPMorgan would be more profitable alone, the idea of more than doubling shareholder value could, one suspects, catch James Gorman’s eye. – Ben Walsh

On to today’s links:

EU Mess
Germany’s finance minister declares that markets are wrong, then goes on vacation – Bloomberg
Draghi’s bazooka: The ECB will “do whatever it takes to preserve the euro … believe me, it will be enough” – Bloomberg

Charts
The “Garbage Indicator” has something very grim to say about US GDP – Business Insider

Alpha
“Brokers are being paid 12% to put your money into these private vehicles that are opaque, illiquid and frankly, unnecessary” – Josh Brown

Politicking
Ron Paul’s “audit the Fed” bill passes the House, paving the way for certain death in the Senate – Yahoo News

‘Liebor’
BlackRock, Fidelity and Vanguard considering legal action against banks – Bloomberg

Surprisingly Difficult
Pop quiz: British Olympian or London Tube stop? – Slate

Takedown of a Takedown
Jason Linkins rips the dismissive review of Bailout by the NYT‘s Jackie Calmes – Huffington Post

That Better Get Better Fast
In 29 states, companies can still legally fire a worker for being gay – WSJ

Bloomberg News has been run, since inception, along the lines laid out very clearly by its editor-in-chief, Matt Winkler, in The Bloomberg Way. But you don’t need to buy a copy of the book to know what the Bloomberg Way means: if you spend any time at all reading Bloomberg articles, you’ll know exactly how it feels to read them.

Of late, however, Bloomberg has started injecting some serious attitude into various parts of the empire which are close to — if not strictly part of — the central news organization. Look at Richard Turley’s covers for Bloomberg Businessweek, for instance: “Most of my work involves trying to turn the capitalist system against itself,” he told AdAge, “but try not to tell anyone that”. Or look at @bobivry’s balls-out Twitter feed (sample tweet, from yesterday: “Sandy Weill just made me throw up.”)

Now a Bloomberg View columnist, Bill Cohan, has delivered an entire column devoted to fisking Loren Feldman’s long NYT piece about the court case currently pending against Goldman Sachs brought by James and Janet Baker, a couple who sold their company for $580 million in worthless stock.

I remember thinking, when I read Feldman’s story, that it felt like it wasn’t telling the whole story. For one thing, how was it that this lawsuit has managed to drag on for over a decade? (Although Feldman never actually says when the suit was filed, so that bit was always a bit fuzzy.) And secondly, what kind of M&A banker blithely goes on vacation when his client is having a hugely important meeting with the acquiring company, saying that he would be unable to call in “and that it was pointless to send anybody else from Goldman because there wasn’t time to catch up on the deal”?

Cohan doesn’t answer either of those questions, but he does reveal other germane information which Feldman either missed or chose to ignore. For instance: Goldman advised the Bakers consider hedging the stock they received in the transaction; the Bakers rejected that advice. And: the Bakers’ suit against Goldman is just one of many different lawsuits they have brought against more than 30 separate defendants, including KPMG and SG Cowen; so far those suits have resulted in the Bakers being awarded more than $70 million. And: in those suits, at least according to Goldman, the Bakers swore under oath that their company had done due diligence on its acquirer; that the due diligence was not Goldman’s job; and that in any case “no amount of due diligence could have detected the fraud”.

Cohan concludes by describing Feldman’s story as a “one-sided potshot” — and I have to say I love it when I see that kind of say-what-you-mean language coming from any part of the Bloomberg empire. Winkler is notoriously allergic to ad hominem attacks, and media organizations in general tend to be very shy when it comes to criticizing each other, especially outside clearly-labeled media-criticism ghettoes. No one wants to throw the first stone.

The fact is, however, that Cohan’s column does a good job of placing Feldman’s story in a bigger perspective. I don’t sign on to Cohan’s opinions, either in this piece or elsewhere: I think his sympathy with Goldman’s argument that it was only advising the company and not its shareholders, for instance, is misplaced. And while I’m OK with opening sentences which liken Goldman Sachs to a deep-sea cephalopod, Cohan’s decision to compare the company to Jerry Sandusky seems unnecessarily vile.

But when it comes to the substance of Cohan’s column, I think he makes his case quite well: it can be dangerous to take NYT stories about Goldman Sachs at face value. I only wish that Feldman felt free to reply, and that we could have some real iterative journalism here about what really went on in this deal.

Most of all, though, I wish that one of Feldman and Cohan had seen fit to upload some or all of the legal source materials they reviewed. The NYT’s document viewer is great for such things, and Bloomberg is entirely capable of publishing primary documents too. Here’s the one place where Feldman and Cohan are saying exactly the same thing: Feldman talks about how his account “is based on a trove of legal filings”, and Cohan talks about how his piece is based on vague “court documents I reviewed”. Neither links to any of those documents, and neither gives much of a hint of what exactly those documents are, or where they might be found. It’s classic “trust me, I’m a journalist” reporting, and it’s offputting in both instances.

By all means tell us what certain documents are saying. But when you do so, show us those documents at the same time, so that if we’re so inclined, we can judge for ourselves. At the very least, if you don’t upload or point to the documents, explain why you’re failing to do so. Right now, we know that Feldman looked at a bunch of documents and came away thinking very little of Goldman; we also know that Cohan looked at a bunch of documents and came away much more sympathetic to the bank. But we don’t even know whether they were even looking at the same documents or not. And neither is letting us draw our own conclusions.

So while Bloomberg’s move into content-with-attitude is entirely welcome, I’d love to see it do more when it comes to linking to primary documents. The NYT, too, for that matter. Both of them are good at such things sometimes: Jonathan Weil, in particular, is great. But it doesn’t seem to have sunk in to the corporate DNA yet.

Update: Apparently Cohan did attach two documents to his column, but they initially showed up only on the Bloomberg terminal. They’re up online now; let’s hope for more!

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

The Consumer Financial Protection Bureau and the Department of Education released a great new report last week detailing how the market for private student loans ballooned from less than $5 billion in 2001 to more than $20 billion in 2008. In its arc, its reliance on securitization for rapid growth, and its push to lend superfluous amounts of money to individuals with relatively low credit scores, the boom and bust in this market very much resembled the subprime mortgage market. All told, the report points out that there’s more than $150 billion in outstanding private student loan debt, and that the poor outlook for jobs for recent grads is making defaults all the more likely:

In 2009, the unemployment rate for private student loan borrowers who started school in the 2003-2004 academic year was 16%. Ten percent of recent graduates of four-year colleges have monthly payments for all education loans in excess of 25% of their income. Default rates have spiked significantly since the financial crisis of 2008. Cumulative defaults on private student loans exceed $8 billion, and represent over 850,000 distinct loans.

And that’s just private loans. The New York Fed pegs total student loan debt outstanding in the United States at $902 billion as of the first quarter of this year. Dylan Matthews notes that the median amount of student debt last year was $12,800, or about 17% of median household wealth.

Rohit Chopra, the student loan chief at the CFPB, reckons that the links between the mortgage market and the student debt market aren’t just superficial – they’re causal, too: “Student debt may be more intertwined with the housing market than we realise and it may prove more important every day to understand that connection,” he told the FT’s Shahien Nasiripour and Robin Harding. That connection may already be having an impact: In June, first-time purchasers made up 32% of homebuyers, down 2% from May. In 2011, first-time buyers accounted for 37% of all purchasers, but that’s still the second-lowest level in the past decade, according to the National Association of Realtors. Regulators and realtors aren’t the only ones who are noticing or who are concerned by this macroeconomic relationship. Credit Suisse’s chief economist, Neil Soss, agrees with Chopra’s diagnosis:

“We are trying to migrate towards a much safer underwriting standard, with let’s say 20 percent down payments required,” Soss said today. “It takes a certain amount of time for people to save that up, and the more they’re burdened with student loans the less possible it is for them to accumulate that chunk of liquid capital that allows them to make that.”

If Chopra, NAR and Soss are on to something, then the proposed policy solutions that the CFPB and the Department of Education outline in their report – namely, allowing only private student debt to be discharged in bankruptcy, while federally issued student debt remains inviolable – are too anemic to have much of an effect on the broader economy. – Peter Rudegeair

On to today’s links:

Liebor
Not my bag – Geithner says it was “on [the British] to take responsibility to fix” Libor – WSJ

You Say That Now
Sandy Weill decides big banks aren’t that great after all – CNBC

Munis
No, unions did not bankrupt California’s cities (housing did) – LAT

The Fed
The Fed is closer to action than the last time it was close to action – WSJ
The Fed’s “monetary policy has little effect on a number of financial markets, let alone the wider economy” – NYT
Inflation: from threat or menace to friend and benefit? – LAT

New Normal
After arbitrage, arbitrary rage: Getting punched in the face is just like risk-taking on Wall Street – Bloomberg

Apple
Apple’s strangely mediocre quarter in charts – SplatF

EU Mess
More people in Spain are betting, but they’re wagering less – Phys Org

Oxpeckers
Unlike Gretchen Morgenson, the NYT’s fiscal policy reporter is no fan of Neil Barofsky’s book – NYT

Analytic Rigor
Dick Bove thinks Wells Fargo is smart enough to hate serving customers, himself included – Dealbreaker

Cephalopods
There really is something in the water at Goldman Sachs – DealBook

I’m a huge fan of Senator Jeff Merkley’s new plan to help out the 8 million American homeowners who are current on their mortgages but underwater and therefore unable to refinance. If you like to see such things in video form, the YouTube announcement is here; for the nerds among us, the full 31-page proposal is here.

I’ve been bellyaching for a while about one of the biggest and most obvious market failures out there: the fact that huge numbers of mortgages are trading well above par — at roughly 106 cents on the dollar, on average — just because the homeowners are locked in to high interest rates because they’re underwater. When investors made these loans, they made them in the knowledge and expectation that if rates fell sharply, the loans would be refinanced and prepaid. But that never happened, and now they’re reaping an undeserved windfall.

Merkley’s plan addresses that problem straight on, and because it only concerns homeowners who are current on their mortgages — and not the 3 million homeowners who are underwater — it doesn’t come with any moral hazard problems attached: indeed, at the margin, it encourages homeowners to stay current on their loans, rather than defaulting on them.

The basic idea’s very simple: the government will buy, at par, any new underwater mortgage written on certain terms. So if you currently have a $240,000 mortgage on which you’re paying 8% interest, but your house is only worth $200,000 and you can’t refinance, then suddenly now you can refinance. In fact, you have three options. You can get a $240,000 15-year mortgage at 4%, which keeps your payments roughly the same, but which gets you paying down principal quickly, so that you should be above water in about three years. You can get a $240,000 30-year mortgage at 5%, which cuts your monthly payments substantially. And there’s a third option I don’t fully understand, which includes a $190,000 first mortgage at 5% and a $50,000 second mortgage with a five-year grace period; on that one, monthly payments, at least for the first five years, drop even further.

In many ways, if you don’t sell your house, this is functionally equivalent to a principal reduction. That $240,000 15-year mortgage at 4%, for instance, has exactly the same cashflow characteristics as a $198,000 15-year mortgage at 7%. And the $240,000 30-year mortgage at 5%, similarly, asks homeowners to pay exactly the same as they would if they had a $193,00 30-year mortgage at 7%.

Problems arise, of course, if and when you want to move, or sell your house. In that event, Merkley told me, “we have to be very aggressive in not accepting short sales that dump losses onto the taxpayer. They’re on the hook for the amount”. He suggested that instead of selling, homeowners simply rent out their home until they’re no longer underwater. That works for some people; it doesn’t work for others. But in any case, his proposal is clear: “the program would not entertain short sales during the first four years of a loan,” it says.

And bigger problems might well arise with banks and investors, who are not going to be happy to see the loans they’re carrying on their books at 106 cents on the dollar suddenly reduced to par. On top of that, the banks are going to be asked to pay a “risk transfer fee”: 15% of the first 20% that the loan is underwater, and 30% of the second 20% that the loan is underwater. Beyond a loan-to-value ratio of more than 140%, banks are going to be asked to write off everything.

For Merkley’s typical family in a $200,000 home with a $240,000 mortgage, the result is that the bank would have to pay the government $6,000 in risk transfer fees, on top of any losses it might take if it had been holding the loan on its balance sheet at more than par. In total, the bank losses could reach $20,000 — a substantial sum, and one which might well result in the banks dragging their feet quite a lot.

On the other hand, there’s upside for the banks, too. For one thing, all their default risk — which is non-negligible, on underwater mortgages — goes away. And for another thing, they get paid off on second mortgages as well as firsts: the Merkley plan will refinance everything, up to 140% of the value of the home. And the opportunity to exit an underwater second mortgage at or near par is one that few investors would pass up.

The Merkley scheme has been very carefully assembled, so that it should make money for the taxpayer even at higher-than-expected default rates. Nothing’s guaranteed, of course. But after all the bailouts of banks, if there’s a plan which will credibly make money while saving homeowners enormous amounts of money at the same time, the government really should adopt it — especially since the funding will come from the private sector.

If you’re not persuaded, maybe these numbers will help. If you have a 30-year $240,000 mortgage at a blended interest rate of 8% (between your first and your second), your monthly payment is $1,761, and over the course of those 30 years you’ll make a total of $633,967 in mortgage payments. On the other hand, if you have a 15-year $240,000 mortgage at 4%, your monthly payment is $1,775 — basically exactly the same — while your total mortgage payments, over the life of the loan, plunge to just $319,544. (For all these calculations I am as ever indebted to this wonderful mortgage calculator.) Your monthly payments stay the same; your aggregate payments fall by 50%. And your total interest payments fall by a whopping 80%.

If we can save homeowners 80% on their mortgage-interest bill, while still making a profit and while helping to stabilize the housing market at the same time, well, that’s a no-brainer. I don’t know whether this plan is going to get any traction. But it should.

There were lines out the door of 500 Pearl Street on Monday afternoon, as a surprisingly large crowd of jurists and hedgies and bankers and wonks — and even a few journalists — filed into the Ceremonial Coutroom of the Second Circuit Court of Appeals for an hour-long hearing about two sentences in old Argentine bond documentation. The case is huge in the world of sovereign debt, arguably the biggest that world has ever seen. And it was no surprise to see Treasury’s lawyer get up in front of the judges to make his case that they should overturn Thomas Griesa’s lower-court decision, which seeks to force Argentina to pay off its holdout bond creditors.

If you want some extremely smart analysis of what happened at the hearing, I’d point you to two pieces: Anna Gelpern’s, at Credit Slips, and Vladimir Werning’s, for JP Morgan. The two of them take different routes to arrive at much the same conclusion: although Argentina’s lawyer, Jonathan Blackman, got beaten up much more than Ted Olson, who was representing Elliott Associates, ultimately the chances are that Argentina will prevail.

If nothing else, the hearings made it clear that a decision to uphold Griesa, and to find in favor of Elliott, would have such enormous consequences, not only for Argentina but for the entire world of sovereign debt, that I can’t imagine it wouldn’t be appealed all the way to the Supreme Court. (Where, interestingly, Antonin Scalia wrote one of the more important precedents for this case, in Argentine litigation dating back to 1992.)

One key precedent that the Second Circuit would set, were it to find in favor of Elliott, would be a significant weakening of the Foreign Sovereign Immunities Act (FSIA). Sovereigns have sovereign immunity, and can basically do what they like, and all sovereign bondholders know this — but in order to uphold Griesa’s order, the New York court would essentially be constraining what Argentina can do with its own foreign exchange. Everybody in the court agreed that Argentina’s foreign reserves are immune from attachment, but if the order were upheld, then Argentina would find itself in one of two states. If it continued to pay existing bondholders who tendered into its bond exchange, it would have to pay holdout bondholders as well. Alternatively, if it continued to refuse to pay holdout bondholders, it would be barred from paying holders of the new bonds at the same time.

Under the FSIA — and the US government made this argument reasonably forcefully on Monday — it’s really hard to make the case that the US can or should force Argentina’s hand in either case: it can’t compel Argentina to pay holdout bondholders, and it can’t restrain Argentina from paying other bondholders. Which means that no matter what the pari passu clause means, the FSIA presents a formidable roadblock to Elliott Associates, and one which the Second Circuit is likely to be reluctant to dismantle. The way that one judge, Reena Raggi, put it, if Argentina was determined not to pay its holdouts, it could do anything it wanted with its money — even spend it on hookers and blow, if it wanted — except pay its other bondholders. And as Gelpern notes, the FSIA “does not provide for sliding scale immunities”.

What’s more, upholding Griesa’s decision would have significant waterfall effects: it would hit not only Argentina, but a lot of private-sector institutions in New York as well, not least Bank of New York, which is the trustee for Argentina’s new bondholders. Olson made it very clear that if the order was upheld, and Argentina kept on trying to pay its new bondholders while stiff-arming its holdouts, then Elliott would go after Bank of New York for “aiding and abetting” Argentina in flouting the order.

That would put Bank of New York in a very invidious position. On the one hand, it acts as a trustee for the new bondholders, and if it is given a coupon payment by Argentina, then that coupon payment belongs to the bondholders. BoNY has to pass the coupon payment on to them. On the other hand, if it does so, it might well be found in contempt of court. The Second Circuit is going to have to think long and hard about what exactly it would expect BoNY to do in such a situation — not least because that subsidiary case is very likely to come up in front of them if they find in favor of Elliott here.

Finding in favor of Argentina, then, is the easy way out, and as a result the appeals court is likely to hold its nose and find in favor of a defendant whom they really don’t like. That might explain why the justices were so hard on Argentina during oral argument: if they’re going to find in the country’s favor in their decision, they really ought to at least make the country’s lawyer squirm a bit in person. It’s — almost literally — the least they can do.