Felix Salmon

Counterparties: ‘More foolish than wicked’ but still self-dealing

Ben Walsh
Jul 18, 2012 21:45 UTC

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The structured and synthetic credit markets just can’t seem to catch a break. Monday was the first day of the civil fraud case against former Citi banker Brian Stoker. The SEC’s case sounds a lot like Goldman’s infamous Abacus deal – Citi sold $1 billion of CDOs to clients without disclosing to investors that it put a $500 million short position on those same securities. Japan’s Mizuho may soon face similar charges.

Stoker’s attorney offered the standard “sophisticated investor” defense, with this additional flourish: ”The synthetic CDO market is high-stakes, high-level gambling… However you feel about gambling… this was legal gambling”. As a result, Stoker’s attorney argued, disclosure of conflicts to clients was moot.

As Steven Davidoff writes, the Stoker case threatens to reveal mass incompetence on Wall Street. Instead of your classic stereotype of a greedy trader, Davidoff says the Stoker case reveals something “more banal, merely showing how clueless financiers can be”. The standard sins of conflicted interest, misaligned incentives and an ecosystem of law firms and accountants to condone bad practice will be on display in the trial. Few people, save some hedge funds, thought deeply about the risks: “The likelihood is that this trial will show that many on Wall Street were more foolish than wicked”.

Stoker, a mid-level employee, may fit that bill. Citi, on the other hand, seems to have considered the risks quite specifically and decided to short the deal.

That kind of self-dealing is far from rare. Jesse Eisinger delves into the opacity of the credit default swap markets, where such “high stakes gambling” is the norm. Basic questions, Eisinger writes – like whether Greece’s EU-led bailout constituted a default under CDS documentation – are decided by a “committee [that] operates as a quasi-Star Chamber”. Ten of its 15 members are credit default dealers, and “there’s no prohibition against committee members deciding cases” where they have a financial interest. Eisinger thinks the CDS market is just another case of bad practices becoming “so routine on Wall Street as to almost be unremarkable”. – Ben Walsh

On to today’s links:

Implausible Deniability
HSBC: Banker to drug cartels and Iran – DealBook
HSBC compliance head steps down – FT

New Normal
States’ fiscal crises will last long after the economy recovers – NYT

Peregrine CEO: Sorry, but I spent all the money I embezzled – WSJ

Geithner defends himself against King defending himself against Geithner – Reuters
The Libor scandal “doesn’t illuminate anything very flattering for anyone involved” – All About Alpha

Measuring every inch of the fiscal cliff and its impact on the US economy – WaPo
Democrats propose a plan to sidestep the anti-tax pledge – NYT
Anti-tax crusader Grover Norquist calls Senator Tom Coburn a liar – The Hill

The economic downside of summer: Kids get fatter and dumber – Peter Orzag
How the US fought the summertime unemployment blues during the Depression – Bloomberg

Good News
Why the US labor market is doing a lot better than you think – Conversable Economist

Ups and Downs
Reminder: Historical stock market returns are not the same as one decade’s returns – Business Insider
Bernanke: Do we have a “sustained recovery going on in the labor market, or are we stuck in the mud?” – NYT

Niche Markets
Duane Reade, where cereal is always on sale – The Billfold

Louis Brandeis slams too big to fail…in 1913 – Pedro da Costa

Will the New Yorker “change the Borowitz Report, which is composed entirely of lies?” – Andy Borowitz

Welcome to Adulthood
Cheer up, depressed teens, you’ll make less money later – The Atlantic

“84 Things That Aren’t On an Everything Bagel” and other suggested Buzzfeed listicles – McSweeney’s

In Case You Were Wondering
Lloyd Blankfein likes America. A lot – Politico

Stuff We’re Not Linking To
For Yahoo CEO, two new roles – WSJ


The revelations here -

“Implausible Deniability
HSBC: Banker to drug cartels and Iran – DealBook”

are appallingly hard to believe. This company engaged in a premeditated plan to violate the law in a flagrant and repeated manner. How can this firm be permitted to escape the corporate death penalty? The shareholders and creditors deserve to be financially destroyed along with the executives – who belong in cells.

If the bank’s General Counsel has already been disbarred, that should be first and automatic.

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What’s driving the Total Return ETF?

Felix Salmon
Jul 18, 2012 16:13 UTC

When Pimco’s Total Return ETF launched earlier this year, it was clear what the biggest risk was:

The inability of the PIMCO Total Return ETF to use derivatives will prevent a perfect correlation and affect performance. The size of that difference will be watched closely and will play a role in the format’s acceptance by investors.

Peter Lewis, executive director of liquid markets at Nomura Securities International in New York, said while some deviation will not have a big effect on the acceptance of active ETFs, a wide gulf would be a point of objection.

The total return ETF is supposed to mimic the performance of Bill Gross’s flagship Total Return Fund. And the bad news is that it has failed to do so, by an enormous margin: there’s a whopping 350bp gap between the two already, and that’s just performance since March 1. Oops.

But here’s where things get interesting: the Total Return ETF has actually outperformed its namesake fund, rising 7.7% during a period when the older fund rose just 4.2%. And suddenly the investors who were worried about basis risk don’t seem to be nearly as worried any more:

Bill Gross’s Total Return Exchange Traded Fund has doubled its assets in less than two months, as performance trumped that of the world’s largest mutual fund, whose strategy it mimics…

Pimco Total Return ETF (BOND) reached $1 billion in net assets on May 21. Because the ETF is still much smaller than the mutual fund version, it can snap up notes with the biggest potential returns.

This is worrying on three different levels. First of all, it shows that investors still haven’t learned one of the first lessons of financial markets, which is that anything which can outperform substantially is also at risk of underperforming substantially. If the ETF is doing much better than the bond fund it’s meant to mimic, that’s not some happy reason to pile in, it’s a big red flag.

Secondly, this shows that sophisticated, actively-managed ETFs simply can’t do what they’re designed to do. Pimco is deliberately vague on the question of whether the ETF is meant to replicate the larger fund, or whether it’s just meant to follow the same strategy. But either way, a 350bp difference between the two, in the space of just four months, is pretty definitive proof that they’re very different animals indeed.

And finally, it’s evidence that the $263 billion Total Return mutual fund is simply too big at this point. Here’s the theory:

“It’s very difficult to beat the market when you are the market,” said Bonnie Baha, head of global developed credit at Los Angeles-based DoubleLine Capital LP, which oversees $38 billion. “Any choices you make will have an outsized impact when you’re smaller and more nimble. It stands to reason that there will be more opportunities that you can take and fly below the radar”.

I’m not completely convinced: the Total Return Fund can move very fast, when Bill Gross is so inclined. On the other hand, while there are good reasons why you might want to be invested in a $2 billion fund rather than a $20 million fund, it’s much less clear why an investor is better off in a $200 billion fund than in a $2 billion fund. Economies of scale, at some point, become diseconomies of scale.

And then there’s the simple question of Bill Gross’s finite attention budget: if he’s picking out smaller opportunities for his baby ETF, does that mean that at the margin he’s neglecting his main charge?

On top of all that is the fact that it seems to be decidedly non-trivial to work out the difference in performance between the ETF and the main fund. On July 6, for instance, Yahoo Finance reported that the ETF was up 6.2% since March 1, while the Total Return Fund was up 3.2% — a difference of 300bp. The same day, Bloomberg had the same 3.2% return for the fund, but said the ETF was up 6.8%, for a difference of 360bp.

All of which says to me that it’s very early days to be investing in the young and decidedly untested asset class of actively-managed ETFs. Pimco’s big institutional clients, with their billions of dollars invested in the main Total Return Fund, certainly aren’t moving their money over to the ETF just yet. If and when they do, it might be time to revisit. But for the time being, it’s probably best to just observe BOND’s nascence from the sidelines. Like all babies, it’s pretty much impossible to tell how it’s going to grow up.


Two things – there is no mention of the BarCap Agg’s performance during this time period, which both fund and ETF have dominated. Also, getting a quote from Doubleline, arguably PIMCO’s biggest up and coming competitor in the core bond space, on how PIMCO is too big seems a bit biased, no?

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Counterparties: King vs Geithner vs Barclays

Ben Walsh
Jul 17, 2012 21:56 UTC

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Testifying before Members of Parliament today, governor of the Bank of England Mervyn King added another layer of uncertainty to the “Liebor” scandal. BoE deputy governor Paul Tucker already strongly rejected Barclays’ indirect but unmistakable assertion that he asked the bank to lowball Libor submissions. On Monday, Jerry Del Messier, Barclays former COO, testified that he thought he was an instruction from Bob Diamond to lowering Libor submissions. That, Del Messier said, “did not seem an inappropriate action given this was coming from the Bank of England”. King hit back at Del Messier’s interpretation of events, saying Barclays execs were in a “state of denial” about the true nature of their conversations with regulators.

King then went further, addressing documents released by the New York Fed last week showing that Tim Geithner, then President of the NY Fed, had been aware of potentially improper Libor submissions and emailed a set of reform recommendations to King in 2008. (And it turns out that these were basically carbon copies of banking industry recommendations.)

The NYT’s Mark Scott writes that King rejected the notion that the BoE had been tipped off to rate rigging:

Mr King said the correspondence with Mr. Geithner, who is now the United States Treasury secretary, did not represent a warning about potential illegal activity related to Libor.

“At no stage did he or anyone else at the New York Fed raise any concerns with the Bank that they had seen any wrongdoing,” Mr King told the parliamentary committee on Tuesday. “There was no suggestion of fraudulent behavior”.

Nor, according to King, did the Fed share the documents suggesting improper rate submissions with the BoE. Nor, according to King, was there ever a suggestion that Libor itself had been impacted. Despite King’s comment that he “doesn’t like firearm analogies”, his testimony today was a direct shot at Tim Geithner. – Ben Walsh

On to today’s links:

New Normal
“Everyone Only Wants Temps”: Inside America’s new perma-temp labor boom – Mother Jones

Goldman Sachs is about to launch a bank (for rich people and corporations) – WSJ
Goldman’s earnings: Success is doing less worse than expected – Reuters
Goldman’s 2nd quarter earnings release – Goldman Sachs

One day before announcing earnings, JPMorgan told regulators that its traders might have hidden losses – Reuters

Romney is freaking out about the Bain attacks; the US public not so much – NYT
What’s Romney hiding in his tax returns? – Businessweek

12% of Chesapeake’s employees have golden parachutes that kick in if the company changes hands – Reuters

Plutocracy Now
Sheldon Adelson investigated for violations of the Federal Corrupt Practices Act – ProPublica

Not-So-Small Government
US economic data is now guarded with “launch-code secrecy” – NYT

Financial Arcana
You can mitigate liquidity risk or credit risk, but you can’t do both – Deus Ex Macchiato

Data Points
5-year Treasury yields hit record lows – Sober Look

Stuff We’re Not Linking To
“A mini-industry of blogs, Web sites, books and consultants now helps them prepare for sorority recruitment” – NYT


Using Occam’s razor, the most logical conclusion is that every banking regulator and banking executive is a lying liar.
But I am a fear that it is actually worse. These people are so divorced from reality that they jump in front of WHATever happens and reimagine it (Subprime is contained, QE is a success, things will be all right…)
Its bad when they drop bombs on you – it is worse when they believe they are dropping flowers.

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Why going public sucks: it’s not governance issues

Felix Salmon
Jul 17, 2012 18:14 UTC

Marc Andreessen agrees with me that it sucks to be a public company. But he disagrees on the reasons why:

Basically, it was very easy to be a public company in the ’90s. Then the dot-com crash hits, then Enron and WorldCom hit. Then there’s this huge amount of retaliation against public companies in the form of Sarbanes-Oxley and RegFD and ISS and all these sort of bizarre governance things that have all added up to make it just be incredibly difficult to be public today.

Andreessen, of course, as the lead independent director at Hewlett-Packard, knows all about “bizarre governance things”. But Sarbanes-Oxley and RegFD and ISS don’t even make it into the top ten. And as for the idea that they’re “retaliation against public companies”, that’s just bonkers; in fact, it’s really rather worrying that we have directors of big public companies talking that way.

The three things mentioned by Andreessen come from three different places: Sarbanes-Oxley came from Congress; RegFD came from the SEC; and ISS is a wholly private-sector company which allows shareholders to outsource the job of ensuring that governance at the companies they own is up to par. If there wasn’t significant buy-side demand for such services, ISS wouldn’t exist.

It’s directors’ job to care deeply about governance, rather than to dismiss serious concerns from legislators, regulators, and shareholders as “bizarre governance things”. And for all that companies love to bellyache about the costs of Sarbox compliance, the fact is that if you’re looking to governance issues as a reason why it sucks to be public, you’re looking in entirely the wrong place.

The real reasons it sucks to be public are right there in the name. Being public means being open to permanent scrutiny: you need to be very open about exactly how you’re doing at all times, and the market is giving you a second-by-second verdict on what it thinks of your performance. What’s more, while the glare of shareholder attention on the company can be discomfiting, it tends to pale in comparison to the glare of public attention on the company’s share price. I was on a panel last week talking about IPOs in general and Facebook in particular, and I was struck by the degree to which Mark Zuckerberg’s enormous achievements in building Facebook have already been eclipsed by a laser focus on his company’s share price.

Zuckerberg — or any other CEO — has very little control over his company’s share price, but once a company is public, that’s all the public really cares about. If Facebook’s share price falls, all that means is that external investors today feel less bullish about the company than they did yesterday; if it falls from a high level, that probably just says that there was a lot of hype surrounding the Facebook IPO, and that the hype allowed Facebook to go public at a very high price. Facebook could change the world — Facebook has already changed the world, and did so as a private company — but at this point people don’t care about that any more. All they care about is the first derivative of the share price. And maybe the second.

When companies go public, people stop thinking about them as companies, and start thinking about them as stocks: it’s the equivalent of judging people only by looking at their reflection in one specific mirror, while at the same time having no idea how distorting that mirror actually is. Many traders, especially in the high-frequency and algorithmic spaces, don’t even stop to think about what the company might actually do: they just buy and sell ticker symbols, and help to drive correlations up to unhelpful levels. As a result, CEOs get judged in large part by what the stock market in general is doing, rather than what they are doing.

And meanwhile, CEOs of public companies have to spend an enormous amount of time on outward-facing issues, dealing with investors and analysts and journalists and generally being accountable to their shareholders. That’s as it should be — but it isn’t pleasant. When Andreessen says that it was very easy to be a public company in the 90s, he’s right — but he’s wrong if he thinks the 90s were some kind of halcyon era to which we should return. They were good for Andreessen, of course, who took Netscape public in a blaze of publicity and more or less invented the dot-com stock in the process. But they were bad for shareholders, who saw their brokerage statements implode when the bubble burst. And, as Andreessen rightly says, they were bad for the broader institution of the public stock market, which has never really recovered from the dot-com bust.

As a venture capitalist, Andreessen has a fiduciary responsibility to his LPs, and he needs to give them returns on their investment, in cash, after five or ten years. It’s a lot easier to do that when you can exit via an IPO. But the way to make IPOs easier and more common is not to gut the governance that’s in place right now. Instead it’s to embrace it, and make public companies more like private companies: places where management and shareholders work constructively together and help each other out as and when they can. Mark Andreessen is a very active and helpful shareholder of the companies that Andreessen Horowitz invests in — and he has a level of access to management and corporate information that most public shareholders can only dream of. If he likes that system, maybe he should start thinking about how to port it over to public companies, as well.

Update: See also this great post from Alex Paidas, who’s found a quote from Andreessen saying that all of his companies should have a dual-class share structure. Despite the fact that I can’t ever imagine Andreessen himself being happy with non-voting shares.


I heard Andreessen speak at the Stanford Directors’ College a few weeks ago. In addition to the type of rhetoric you describe he also said that if there was a way to get his money out of startups without going public he’l do it and if he has to go public he’ll only do it going forward the “controlled company” exemption the very specific exemption to exchange rules on corporate governance rules that gave Mark Zuckerberg all the power one his company and his board. Basically the board at Facebook serves at his pleasure.

Reed Hastings, a Facebook board member, said at the same event that he was still trying to decide of that made sense for him, given his philosophy that a board’s most important job was to hire and fire the CEO. If a board member can not take a position adverse to the CEO without the risk of being removed, what’s the point?

I’ve decided Andreessen is good for Andreessen but not so much for the rest of the capital markets.

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Counterparties: The largest antitrust settlement in US history?

Ben Walsh
Jul 16, 2012 21:36 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

In a week full of scandals and financial restatements, MasterCard, Visa and a handful of the country’s biggest banks nonetheless managed to stand out: in the largest antitrust settlement in US history, they have agreed to pay $7.25 billion.

The case centered on the “swipe fees” charged by card companies each time consumers pay with credit or debit. Those fees had been fixed, and passed along by stores to consumers. Now, retailers will get to negotiate the fees. The settlement is a coup for retailers.

For consumers, the result is much more ambiguous. Swipe fees may come down, but retailers can now add surcharges for paying with plastic. That practice was previously banned by Visa and MasterCard. A discount could be given for cash, as some gas stations did, but up-charging to cover the swipe fee wasn’t allowed. However, Karen Weise notes that surcharges could help consumers by giving retailers newfound leverage: The “threat of the extra fee could be a new weapon for big retailers as they negotiate” with the card companies.

Kevin Drum isn’t too excited about those negotiations. “Frankly,” he writes, “in a war between Visa and Walmart, I can’t get very excited about who wins”. He is, however, enthused by what we might learn from retailers’ experience implementing surcharges:

If they end up doing it, it’s pretty good evidence that fees were too high and were being paid at least partly by unwitting consumers, many of whom prefer the option of switching to cash once they realize the real price of using plastic. If they don’t, and things stay pretty much the same as they are today, it’s pretty good implicit evidence that everyone was getting a tolerably reasonable deal already.

And that’s how the largest antitrust settlement in US history turns into a massive microeconomics study. – Ben Walsh

On to today’s links:

Google’s Marissa Mayer named CEO of Yahoo – Dealbook

Data Points
“Increasingly clear that the US economy is slowing” – retail sales drop for third month in a row – Reuters

Mapping stop-and-frisks and gun seizures in New York City – WNYC

A tour of the magical mystery behind Mitt Romney’s IRA – Bloomberg
Did Romney put Bain Capital shares in his IRA? – Felix
And now the Democrats are threatening to push the US economy over the “fiscal cliff” – WaPo

Level Playing Fields
The nation’s biggest brokerage firms give hedge funds an early look at analysts’ stock views – NYT

Plutocracy Now
196 Americans – 0.000063% of the population – have given more than 80% of super PAC dollars spent on the presidential election – Lawrence Lessig

Austerity Bites
Madrid’s “shoestring Olympics” proposal calls for using bullrings as basketball courts for the 2020 games – WSJ

EU Mess
ECB now open to imposing haircuts on senior creditors of European banks – WSJ
IMF lowers global growth forecast – IMF

Treasury’s 2008 recommendations for fixing Libor were basically verbatim banking industry suggestions - Huffington Post
“As a company, we now avoid London. It’s tarnished” – Bloomberg

US banks sitting on three times more cash globally than the Fed reports – David Cay Johnston

Good News
Africa’s mobile banking boom – CFR

Odd But True
“If it looks like a duck and smells like a duck, it could well be a delicious peanut butter sandwich” – Gary King and Margaret Roberts

Margaret Sullivan is the new NYT public editor – NYT

Be Afraid
The “best hope for an egalitarian future may well be a democratising, skill-premium-erasing technological revolution” – Economist

Ed Ruschas, the last artist on the board of MOCA, leaves – LAT


mfw13, They said the same thing in 2004 but Bush won anyways. Thank you for the reply. :-) “Some of the issues described above have created problems for voters generally. Others, however, by accident or (it is charged) by design, have disproportionately affected racial minorities. For example, the U.S. Commission on Civil Rights determined that, in Florida in 2000, 54 percent of the ballots discarded as “spoiled” were cast by African Americans, who were only 11 percent of the voters” From Wiki. Money does talk.

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Did Romney put Bain Capital shares in his IRA?

Felix Salmon
Jul 16, 2012 17:59 UTC

Bill Cohan is the latest columnist to wonder how on earth Mitt Romney’s retirement account got so incredibly large — as much as $102 million — given the limits on the amount of money employees can put in such things each year. Nicholas Shaxson asked similar questions in Vanity Fair this month, and both of them cited the work of the WSJ’s Mark Maremont to help explain what might be going on; Cohan might want to update his link, since the Maremont article he links to is not the one with the real juice.

Maremont explains that when Bain bought a company, it wouldn’t just create debt and equity. Instead, there would be debt, equity, which was known as A shares, and then a kind of preferred equity called L shares. As far as the debt holders were concerned, the A and L shares together were the equity holders. And anybody with equity in the company received the same ratio of A shares to L shares. But A shares were much riskier, and had much more upside than L shares: holders of equity in Sealy, for instance, got a total gain of roughly 4X, where the L shares doubled in value and and A shares wound up worth 34 times what they were originally valued at.

So up until now, the theory has been that Mitt Romney pumped his retirement accounts full of A shares, which often had aggressively low valuations when they were first issued. If those valuations turn out to have been unreasonably low, that could create issues in an IRS audit.

But the recent controversy over when exactly Romney left Bain raises another possibility, which is hinted at in a Maremont article from January:

Several estate-planning experts said they know of others with IRAs of more than $100 million, but they are rare. Typically, they said, that occurs when founders of companies invest in their own shares, which then take off.

We now know that Mitt Romney, individually, was the sole shareholder of Bain Capital when he took leave of all day-to-day responsibilities in 1999 to concentrate on running the Salt Lake City Olympics. And he remained the sole shareholder of Bain Capital through 2002. So here’s the thesis, taken directly from Henry Blodget: that Romney filled up his retirement account with shares of Bain Capital itself, rather than shares in its funds, or in its portfolio companies.

This would also help explain why it took Romney three years to disentangle himself from Bain Capital:

Romney legally remained the CEO and sole owner of Bain Capital until 2002, Conard added, because he was intensively negotiating his exit deal with the partners at the firm. Conard summed up Romney’s position this way: “‘I created an incredibly valuable firm that’s making all you guys rich. You owe me.’ That’s the negotiation”.

Blodget has some very good questions about how Romney managed to set things up so that he was the sole owner of the company: one would imagine that other Bain Capital partners would also have had an ownership stake, not to mention Bain Consulting. But it seems that Bain Capital was a Romney entity, and that he then just handed out fees and carry to various stakeholders, while retaining all of the equity in Bain Capital for himself. When he left, then, he wasn’t just retiring from Bain Capital, he was actually selling the company to its partners. And you can see how that negotiation might have taken a while, given that those partners were picked precisely for their skill in buying companies for a low price.

What’s more, Romney would have had every incentive to keep the official valuation of Bain Capital low for many years, since the lower Bain Capital was worth, the more of it he could put into his retirement accounts every year. Again, the IRS might well be interested in the valuation techniques Romney used for the purposes of his retirement account contributions. And then, of course, suddenly, when Romney left Bain, he would have switched from minimizing Bain Capital’s official value to maximizing it.

I wouldn’t be at all surprised were we to learn that a huge amount of the gain in Romney’s retirement accounts came in 2002, when he finally sold Bain Capital back to its partners. Of course, Romney doesn’t seem remotely inclined to tell us. But if he started Bain Capital from scratch, and put a bunch of the company into his retirement account, and it’s now worth some ten-digit sum, then maybe it makes sense that his retirement account now is ridiculously enormous.

Update: My colleague Lynnley Browning reminds me that she covered this issue in January as well, and had her own theory:

Romney may have made use of an Internal Revenue Service loophole that allows investors to undervalue interests in investment partnerships when first putting them into an IRA…

An investor could even set an initial value for a partnership interest at zero dollars, because under tax regulations an interest in a partnership represents future income, not current value.

This seems conceptually extremely dubious to me: all securities, after all, represent future income. But if Romney had an aggressive tax lawyer, anything is possible.


I just can’t see how Romney has made people believe his etchasketch lies. People say that in his first debate that Romney proved that he was a worthy challenger. I don’t believe that all of the lies he told were worth the time to listen to him. If people google what he says on his stump speeches then they wouldn’t need a light to see through him and his lies. Then there are the people that know better like Elisabeth Hasselbsck, Michael sateel and Amy Holmes. They are always in the news and always have something to say. If you watch anything but Fox, you have to know that the man is a liar! He also shows nothing that remotly explains how what he is saying will work.
I wouldn’t be surprised to see him led away in handcuffs for tax evasion.
He says he will be tough on China while he is at this moment through Bain that he owns part of is sending a company from Freeport Illinois to China costing 170 jobs even though the company made its biggest net profit last year.
I can fill up page after page. All I can say is if Romney says anything, just google it and you will find that he has been on the other side of whatever he says now.

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When Zuckerberg fired Morgan Stanley, mortgage edition

Felix Salmon
Jul 16, 2012 15:28 UTC

Mark Zuckerberg has a reputation as a geek who’s focused mainly on technology; the finance stuff he’s outsourced to his COO, Sheryl Sandberg, and his CFO, David Ebersman. When anonymous griping about the Facebook CFO started appearing in the press attributed to senior Facebook executives, I didn’t think those executives would be as senior as Zuckerberg himself.

Still, the timing of Zuckerberg’s marriage was interesting, coming as it did the weekend of the IPO. And today we learn, in the 23rd paragraph of a Bloomberg story, that Zuckerberg was annoyed enough at Morgan Stanley after the IPO that he severed his mortgage relationship with the bank, paying off his loan in full and moving his mortgage to a rival bank, First Republic.

When you’re rich enough to buy any number of homes you want for cash, a mortgage isn’t the same kind of financial product as it is for we mere mortals. Instead, it’s part of a suite of financial services and wealth management, which can cover everything from big-picture investment strategies to providing someone who’ll make sure your electricity bill is paid.

According to Bloomberg, by moving his mortgage from Morgan Stanley to First Republic, Zuckerberg managed to reduce his monthly loan payments from $21,256 to $19,275. His new bank explains how the game works:

First Republic Bank, which provided Zuckerberg’s mortgage, doesn’t comment on specific loans or clients, said Greg Berardi, a spokesman for the San Francisco-based company.

“First Republic, like most banks, prices its credit products based on the strength and totality of the entire client relationship,” he said in an e-mailed statement. “This is our approach with all of our clients.”

The story here, then, isn’t the 1.05% initial rate that Zuckerberg was paying on his mortgage, or even the Libor +80bp rate that he’s been paying since June. Rather, the story is that Zuckerberg has decided that he wants to have his wide-ranging client relationship with First Republic, rather than Morgan Stanley — and that he made that decision in May, within a couple of weeks of the Facebook IPO. The new mortgage is the only publicly-visible part of the change, since it needs to be recorded in public records, but you can bet that First Republic is taking over much more than just Zuckerberg’s home loan here.

Which puts into focus just one of the many risks, to a bank like Morgan Stanley, of messing up a high-profile IPO like Facebook’s. If things go wrong, you don’t just take a hit to your reputation. You can also lose a lifetime relationship with Silicon Valley royalty. And those relationships are worth many millions of dollars.


@MrRFox, if blogs are “not at all to serve the commenters”, then why do they permit commenting? As a public service?

As with any ecology, the blog system must serve all participants to remain healthy. Traditional press serves the readers and authors, if that is your preference.

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Counterparties: What the Fed knew

Ben Walsh
Jul 13, 2012 20:12 UTC

We now know what the New York Fed knew about Barclays fudging its Libor submissions. Included in the NY Fed’s vast document dump in response to a congressional request is this confidence-deflating exchange from Apr. 11, 2008:

Barclays: So, we know that we’re not posting um, an honest Libor.

NYFR: Okay.

B: And yet and yet we are doing it, because, um, if we didn’t do it

FR: Mm hmm.

B: It draws, um, unwanted attention on ourselves.

The NYT reports that after that and other exchanges between members of the NY Fed and Barclays, Tim Geithner, then head of the NY Fed, called and emailed the head of the Bank of England with his concerns and suggestions for how to improve oversight of Libor. The governor of the BoE, Mervyn King, called those suggestions “sensible”, but as the NYT’s Marc Scott writes, none of them were actually implemented.

And that leads back to the post-scandal explanation offered by Barclays: that England’s central bank tacitly encouraged Barclays to continue its improper Libor submissions. Deputy BoE governor Tucker forcefully argued before members of Parliament on Monday that he was acting precisely as he should have, questioning what Barclays was doing to lower its borrowing rates in the aftermath of its rejection of government capital.

To Matt Levine, the real question for regulators in Barclays’ Libor fixing is intent. The latest emails, he writes, actually make Barclays seem more diligent:

The earlier Barclays emails, in which derivatives traders asked Libor submitters to change their rates to help the swap book, sound terrible: market manipulation for high-fives and profit. Mis-marking within a reasonable range is not necessarily a scandal; in some sense it’s most of what most traders do most of the time. It only becomes a scandal when you do your mis-marking for nefarious purposes, with “hiding trading losses” and “screwing derivatives counterparties” being reasonably obvious nefarious purposes. “Keeping our name out of the FT and our stock price out of the crapper” is a gray area…

During the financial crisis interbank lending all but dried up and, Levine writes, Libor was widely known to be a fiction: ”I think these Fed documents make it hard to share the collective amnesia of thinking that Libor was the most important and trusted thing in the world until it was broken by a secretive coterie of bankers and nobody knew about it. Everybody knew about it”. – Ben Walsh

On to today’s links:

Public-sector cuts have likely cost the US economy 751,000 private-sector jobs – Jared Bernstein

To counter super PAC influence, Soros’s son launches super-duper PAC – WaPO

Long Reads
A mega-mall isn’t all – the multibillion-dollar business of the Mormon Church – Businessweek

JPMorgan reports $5.8 billion loss on failed CIO trades, quarterly profit drops 9% – DealBook
The complete JPMorgan earnings release – JPMorgan
JPMorgan’s 8K: CIO traders mis-marked securities – JPMorgan
Former-CIO head Ina Drew cedes two years’ pay over trading losses – Bloomberg

China’s economic growth is slowing  – and likely at a faster rate than official GDP data suggests – Also Sprach Analyst
China’s “M&A is driven more by politics than the domestic economy” – Bloomberg

In a few years the federal government will face a trillion dollars of student loan credit risk – Sober Look

Welcome to Adulthood
Youth unemployment is double the national average – Young Invincibles

Far-right party wants to create Greeks-only blood bank – Foreign Policy

Bankruptcy-seeking San Bernardino has “no legitimate financial filings” – Cate Long

Nothing to See Here
Wells Fargo pays $175 million to settle discrimination claims it denies – WaPo


“B: It draws, um, unwanted attention on ourselves.”

Ourselves? He of course means “…on us.” For some reason there is a growing collection of, mostly younger, people in the UK who have no idea when or where to use the reflexive. It’s just so wrong. And if they can’t get simple English right, perhaps it is no wonder that other rules are broken without much thought – just avoid getting caught, take no responsibility, just take the money – even if you don’t deserve it.

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JP Morgan: The clawback narratives

Felix Salmon
Jul 13, 2012 18:35 UTC

Two weeks ago, Bloomberg’s Dawn Kopecki reported that Ina Drew would be allowed to keep all of the money she was paid over the past two years — more than $20 million in all. Today, Kopecki’s headline is very different: “JPMorgan’s Drew Forfeits 2 Years’ Pay as Managers Ousted”.

What happened in the interim? There are three possibilities, as I see it, all of which can overlap:

The first is the official story: that Drew unilaterally approached Dimon, offering to return two years’ pay.

“She has acted with integrity and tried to do what was right for the company at all times, even though she was part of this mistake,” Chief Executive Officer Jamie Dimon said today during a meeting with analysts. “In that spirit, Ina came forward and offered to give up a very significant amount of her past compensation.”

This is actually entirely consistent with everything I’ve read about Drew’s conscientiousness and professionalism, and although returning $20 million surely hurts, Drew isn’t exactly impoverishing herself by doing so: Kopecki estimates that she retired with about $57.5 million in stock, pension and other pay.

The second possibility is that Drew was always going to give back her pay, and that Kopecki’s initial story was simply wrong. There was no JP Morgan source for that story, which was based on the idea that if Drew was subject to any kind of clawback, that would have been reflected in an SEC filing; Kopecki had no JP Morgan source for her article, and JP Morgan had no particular reason to scoop itself with a formal denial, if it had long planned to announce the clawback today.

Finally, there’s the other bit of new news today: the way that JP Morgan has started pointing fingers at its now-departed traders:

Traders in CIO were expected to mark their positions where they would expect to be able to execute in the market. In this instance, while the positions were within thresholds established by an independent valuation control group within CIO, the firm has recently discovered information that raises questions about the integrity of the trader marks and suggests that certain individuals may have been seeking to avoid showing the full amount of the losses in the portfolio during the first quarter. As a result, we are no longer confident that the trader marks reflected good faith estimates of fair value at quarter end.

This is a very tricky tightrope that JP Morgan is trying to walk here: it’s basically saying that its traders were acting fraudulently, but not so fraudulently that they were doing anything actually illegal. Essentially, it’s saying that the bank itself can’t be blamed for reporting marks outside the market’s bid-offer spread, but that the traders can and should be severely disciplined for choosing marks towards one extreme of that spread, even as they knew they couldn’t realistically get those prices if they needed to unwind their position.

As a result, Drew was overseeing a group that wasn’t just losing money, which is something that all traders do from time to time, but was also behaving unethically. That’s something no traders should ever do, and is good reason to claw back bonuses from the traders and their bosses, all the way up to Drew and possibly even Dimon himself.

You can mix and match these different narratives however you like. For instance: Drew retired a respected executive of long standing, but then — possibly within the past two weeks — discovered that her employees had been behaving unethically. In response to that discovery, she offered up a payment equivalent to a two-year clawback. If that’s the case, then Kopecki’s initial story was correct, when it was published, and then the facts changed later on.

But there’s still something smelly here. The restatement to first-quarter earnings came to $459 million — that’s basically the amount by which the trading loss in that quarter was increased, as a result of re-marking positions. And notwithstanding the fact that the London Whale had extremely large positions, it’s still the case that $459 million is a huge amount of money. Which raises the question: is it credible that a difference of $459 million could be within JP Morgan’s internal thresholds? And if so, what does that tell us about JP Morgan’s internal thresholds?

What’s more, if you’re the CIO trading desk and your single biggest and most public position starts sliding away from you in a nasty manner, would you really try to massage those marks? I can see why traders can get a bit overoptimistic when they’re angling for a big bonus, or trying to make it look like they made money rather than lost money. But if you’re already ‘fessing up to a $2 billion loss, at that point you have precious little incentive to make it look like it’s “only” $2 billion rather than $2.5 billion. You’re almost certainly going to lose your job either way; the last thing you want to do is exacerbate matters by being less than fully honest about where you’re at.

So try this other narrative on for size: after the losses were first disclosed, the markets continued to move away from JP Morgan, and the bank’s losses grew, as Dimon always warned that they might. At this point, however, with the losses up to $5.8 billion in total, it became increasingly difficult to justify the idea that there wouldn’t be any clawbacks. At the same time, JP Morgan, for whatever reason, didn’t want to set an internal precedent saying that taking on risk and then losing money was sufficient reason to claw back funds. So instead it went back to the original marks and unilaterally determined that they were unethically self-serving. And at that point it could claw back bonuses not on the grounds that the traders lost money, but rather on the grounds that they were behaving unethically. And similarly, because Drew was now someone who had been in charge of unethical traders, it could ask her to return a lot of money as well.

This solution would allow Dimon and JP Morgan to be seen to be taking the ethical high road, sending a clear signal to the bank’s trading desks: we understand you’re in the risk business, and that sometimes people in the risk business lose money. That’s OK, especially when executives up to and including the CEO signed off on your trades. But what’s not OK is if you lie about your marks, or you try to hide how much money you’re losing.

The truth is in here somewhere, although we’ll probably never know where exactly. If I had to guess, I’d say that Dimon was in the first instance inclined not to claw back pay, especially since he had personally approved the trade in question — but then, as JP Morgan’s share price got out of hand and there was outrage about the lack of clawbacks, he changed his mind. All he really needed to do was make a couple of phone calls. The first would go to the people trying to clean up the mess in London, asking whether the first-quarter loss was really as small as the bank originally said, and implicitly encouraging them to do what mess-cleaner-uppers always do, which is put as much blame as possible on the people who created the mess being cleaned up. And then the second call would go to Drew, who would probably need very little prompting to do the right thing and volunteer a clawback equivalent.

The downside of this strategy is that JP Morgan was forced to restate its first-quarter earnings, and public companies hate doing that. Still, the bank’s share price is up more than 5% today, so the markets don’t seem to mind. The big write-off this quarter, along with the claw-backs, look as though they have drawn a line under the whole sorry story. Which means, I guess, that JP Morgan can now concentrate more of its attention on the ongoing Liebor scandal.


Soon enough the implicated will all draw their knives on one another. In that situation, I want to be Drew’s lawyer more than be counsel for any of the others. About this –

“If I had to guess, I’d say that Dimon was in the first instance inclined not to claw back pay, especially since he had personally approved the trade in question ….”

That last-quoted clause of yours is a real eye-opener, FS. Got a source for that confession? AIUI, JD continues to deny knowledge of the actual situation at the relevant times, however much the mass of circumstantial evidence says exactly the opposite.

But hey – if Corzine, Grubman, DSK and Spitzer can ‘walk’ on their offenses, why not JD on this? Who’s more kosher-elite than him?

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