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

It’s now five years since August 2007, which means that the US is now halfway into its very own lost decade. There is, however, a bit of good news coming from the housing market, as the WSJ’s Nick Timiraos reports:

Prices rose by their largest percentage in at least seven years during the second quarter, propelled by low inventories of properties for sale and high demand for bargain-priced foreclosures… Prices rose by 2.5% in June from a year ago, and by 6% from the previous quarter, said CoreLogic Inc., a Santa Ana, Calif., data firm. The quarterly jump was the largest since 2005… Separately, Freddie Mac, which uses a different methodology, said home prices during the second quarter jumped by 4.8% from the previous quarter. That was the largest jump since 2004.

It’s been long enough since we last saw this kind of rise in home prices that Bill McBride of Calculated Risk thinks it’s worth remembering the economic effects even modest gains in home prices can have. There’s increased profitability at Fannie and Freddie, fewer homeowners with negative equity, lower mortgage delinquency rates, fewer fear-driven sellers adding to excess inventory, and increased private residential investment. That last data point, McBride says, is the “the best leading indicator for the economy”.

Still, that doesn’t mean that younger Americans are going to become home buyers en masse anytime soon. Not only does student debt loom over many first time buyers, but as Bloomberg’s Caroline Fairchild notes, median wages for college graduates fell 10% from 2009-2011 compared to 2007. As a result of this decreased cash flow, the workforce’s newest entrants prefer to rent; they’re delaying making other large purchasing decisions like cars, too.

That isn’t necessarily a bad thing. A less-indebted and more mobile population should be a source of economic strength. But if, as Felix thinks it will, the housing crisis lasts a full decade, those benefits will largely be wasted in a sputtering economy. We really need a housing recovery: let’s hope Calculated Risk is right, and Felix is wrong. – Ben Walsh

On to today’s links:

Tax arcarna
“Should I be preparing to leave the country?”: France’s wealthy react to proposed 75% top marginal tax rate – NYT

Alpha
The market is one step ahead: as earnings growth slows, stock returns increase – Market Watch

Wonks
Popular tax break silly, possible sign of national failure – Matt Yglesias

Good Ideas
Forget congestion pricing. Instead, pay commuters to drive outside rush hour – Arstechnica

Light Touch
Morgan Stanley pays $4.8 million to settle electricity price-fixing that cost consumers an estimated $300 million – Reuters
Treasury and the Fed would prefer “public shaming kept to a minimum” re allegations of banking rogue states – Reuters

China
Report: 16% of China’s wealthy have already left the country and 44% intend to soon – Economist

New Normal
Extended unemployment benefits weren’t “designed to deal with a stagnating labor market of the sort the US” now has – WaPo

The Fed
Bernanke’s “prolonged low interest rate environment has been hurting US households” – Credit Writedowns

At the beginning of January, Simon Lack published The Hedge Fund Mirage: The Illusion of Big Money and Why It’s Too Good to Be True. It basically does for hedge funds what the Kauffman Foundation did for private equity, and shows that while fund managers can do extremely well for themselves, fund investors would be better off avoiding the asset class entirely.

The book was well received (see reviews by Jonathan Ford and Jonathan Davis, in the FT, and James Pressley, for Bloomberg), and even Andrew Baker, the chief executive of the Alternative Investment Management Association, said that “much of the book is sensible advice for investors in hedge funds about the need to be well-educated about the industry”. Baker did quibble with the message of the book, saying that it revealed “more about investor behaviour than manager performance”. But if managers really cared about their investors, they would surely take that message to heart, rather than simply keep on trying to maximize their own performance and pay. Baker concluded with figures showing capital flowing back into hedge funds, and concluded not that those investors were being foolish, but rather that “many investors consider hedge funds not a mirage, but an oasis.”

Fast forward to this week, however, and now Baker is singing a very different tune:

Many of us in the industry looked at the arguments in the book with initial interest, and then growing scepticism. Many of the most sensational claims appeared not to be backed up by any figures. Where there were figures, the methodology was slapdash or flawed, and further undermined by simple errors. We, in the Alternative Investment Management Association, began to wonder if The Hedge Fund Mirage was itself an illusion.

Baker and the AIMA have in fact now published a 24-page paper entitled “Methodological, mathematical and factual errors in ‘The Hedge Fund Mirage’”, seeking to debunk the book. But a close reading of the paper reveals that there’s much less there than meets the eye.

In fact, the AIMA paper has convinced me of the deep truth of Lack’s book in a way that the book itself never could. Reading a book, it’s often very hard to judge just how reliable the author is, or how cherry-picked the data might be. But if a high-profile hedge-fund industry association spends months putting forward a point-by-point rebuttal, and that rebuttal is utterly underwhelming, then at that point you have to believe that the book has pretty much got things right.

AIMA kicks off by responding to the first sentence of Lack’s book: “If all the money that’s ever been invested in hedge funds had been put in Treasury bills instead, the results would have been twice as good”. They come out fighting, saying that “extraordinary as it may seem, nowhere in the subsequent 174 pages is this central claim supported by clear evidence”. And of course they say that the claim is not in fact true:

What our own calculations, using the same core data and time period as the book, in fact show is that investors allocated $1.24 trillion into hedge funds between 1998 and 2010 and have $1.78 trillion to show for it, a 44% return, while the same amount invested in T-bills over the same period would have produced $1.52 trillion, a 23% return. So to paraphrase the book’s opening line, if all the money that had been invested in hedge funds had been put in T-bills, the results would only have been half as good.

Read on a little bit, however, and it turns out that AIMA can — and did — replicate Lack’s results. The group publishes two tables (Table 1 and Table 4): the first one, which attempts to reproduce Lack’s methodology, concludes that between 1998 and 2010, hedge fund investors lost $6 billion, while T-bill investors made $309 billion. That’s even worse than what Lack says! The second table, using AIMA’s own methodology, does indeed show hedge funds outperforming T-bills between 1998 and 2010. But, it’s worth noting that even the AIMA-methodology table shows T-bills outperforming hedge funds between 1998 and 2009.

After having replicated Lack’s results, AIMA then attempts to explain that there are “five fundamental flaws” needed in order to obtain them. But all those “flaws” seem like very sensible assumptions to me.

Firstly, AIMA takes much umbrage at the fact that Lack is looking at the returns to investors, rather than at internal hedge-fund returns. In the jargon, Lack’s figures are “dollar-weighted”, which means that he looks at what happens to actual dollars as they are actually invested in hedge funds. AIMA’s preferred figures are “time-weighted”, which is much less helpful. If a tiny unheard-of fund has a couple of spectacular years, attracts lots of money, and then sees only mediocre performance, then the dollar-weighted returns will be low while the time-weighted returns will be high.

AIMA’s argument is that it’s not up to the fund manager when external investors choose to invest their money in a fund, and that therefore if you’re measuring the performance of fund managers, you should use a time-weighted series rather than a dollar-weighted series. That’s reasonable. But Lack isn’t trying to measure the performance of fund managers, here. He has no interest in trying to work out how good John Paulson is, for instance. Instead, he’s attempting to measure the performance of hedge funds, in aggregate, and is trying to work out whether investing in hedge funds is a good idea. And for that purpose, a dollar-weighted series is absolutely the right one to use.

This is actually AIMA’s fourth beef as well: they don’t like the fact that Lack is using the HFRX Global Hedge Fund Index to measure hedge-fund returns, as opposed to other indices which show higher returns. But what they don’t say is that there’s a reason HFRX returns are lower than other indices — which is that HFRX is dollar-weighted and the other ones aren’t.

The next two flaws that AIMA complains about surround Lack’s idea of what exactly is meant by “profit”, from the point of view of a hedge-fund investor. Obviously, it doesn’t include fees paid to the fund manager. But according to Lack, the sensible measure of profit to use is “profits in excess of treasury bills, the riskless alternative”. After all, if you can take no risk and make more money than a hedge fund, it’s a trivially easy decision to do just that.

AIMA doesn’t like this:

This is mistaken because it replaces real dollars going to investors (hedge fund returns figures are post- fees) and replaces them with an arbitrary and flawed definition of what is “real”. For example, if an investor earned $10 from hedge funds when he could have earned $2 from Treasuries, the “real” money he received was still $10, not $8 ($10-$2).

I’m with Lack on this one: hedge funds should not be taking credit for risk-free returns that an investor could have gotten by investing in Treasury bills. The value added by hedge funds is excess return, and T-bills are a very good proxy for the risk-free rate.

AIMA also dislikes the way that Lack corrects for survivorship and backfill bias in published hedge-fund returns. These are huge, well-known problems: survivor bias is the way that funds stop reporting their returns — and eventually fizzle out entirely — when they perform badly, while backfill bias is the way that funds often only get included in indices once they have a string of decent returns, which then get added in to the index retroactively. Put the two together, and you find that hedge-fund indices are generally overstated by about three percentage points; it’s entirely reasonable to account for that when working out the actual returns to investors.

But here’s the thing: Lack only includes survivor and backfill bias in his calculations once in his book, in the table on page 64. All of the other tables and calculations exclude it, and they still show utterly pathetic returns to investors, compared to enormous profits for fund managers. Now to be fair to AIMA, those utterly pathetic returns are still positive. So for instance, here’s one of Lack’s main sum-it-all-up charts:

The main thing that you’re looking at here is the final line. If you look at the money that investors made by investing in hedge funds, it comes to $70 billion — a number substantially smaller than the $379 billion that the hedge funds managed to skim off in fees. Now the $70 billion is profit over and above the risk-free rate of return on Treasury bills. But it’s not the end of the story. Because funds-of-funds were very popular for most of this period, investors also paid some $61 billion to them. Which left them with the grand total of $9 billion in profits, compared to the $440 billion that the hedge-fund industry took in fees.

And even that overstates the amount of money that hedge-fund investors wound up with. There are lots of other fees, too, going to hedge fund consultants, family offices, and the like. On top of that, the fees in this table are actually understated, by some unknowable amount. I’ll let Lack explain, from his book:

Estimating fees on the industry as if it’s one enormous hedge fund does include one simplification, in that it excludes any netting of positive with negative results. To use a simple example, if an investor’s portfolio included two hedge funds whose results cancelled out (one manager was +10 percent while the other was −10 percent) the investor’s total return would be 0 percent and for our purposes here we’ll assume that no incentive fee was paid on the 0 percent return. However, in reality the profitable manager would still charge an incentive fee. It’s not possible with the available data to break down the returns to that level of detail, so the fee estimates derived are understated, in that it’s assumed incentive fees are charged only on the indus try’s aggregate profits, whereas in fact all the profitable managers would have charged incentive fees with no offset from the losing managers.

On top of that, Lack assumes that all hedge funds were below their high-water mark for the entire post-2008 period, and charged only management fees with no performance fees at all. It’s a very conservative assumption: of course some hedge funds were charging a performance fee as well as their management fees. So total fees are surely higher than Lack calculates here.

In any event, while AIMA tries to reverse-engineer Lack’s comparison of hedge-fund returns to T-bill returns by looking at his chapter on fees, that’s not actually what Lack was doing when he wrote his opening sentence. Instead, if you look at page 7 of his book, he explains that over the time period in question, T-bills returned 3% annualized, while hedge fund investments returned 2.1%. That calculation isn’t based on fees at all: it’s simply based on assets-under-management figures from BarclayHedge. It’s hardly surprising that there’s a very wide range of reported returns and assets for hedge funds: the industry is secretive and there’s no central clearinghouse for such figures. So no one can know for sure what total investor returns for the asset class have been. But there’s certainly no reason to believe that higher figures are more reliable than lower figures, as AIMA seems to do.

AIMA concentrates very much on Lack’s fee calculations, which doesn’t serve it well. Its complaints on that front are decidedly niggling: the worry, for example, about the fact that the fees that hedge funds charge should not be considered to be profits. But AIMA doesn’t actually look at the biggest costs of hedge funds — things like rent, or Bloomberg terminals — to see whether such things are taken out of headline returns, or whether they’re paid entirely by the fund manager. Maybe because they wouldn’t like the results.

AIMA also complains that average fees in the industry “are closer to 1.75% and 17.5%” than they are to 2-and-20. I’d take that complaint a bit more seriously if they weren’t at the same time trying to make the opposite point, that Lack’s survivor-bias and backfill-bias calculations should be offset by the fact that “some of the largest and most successful hedge funds choose not to report to databases for a variety of reasons”. Those large and successful hedge funds, of course, are the ones most likely to be charging more than 2-and-20. (Renaissance, for instance, charges 5-and-44.)

AIMA’s complaints aren’t only about fees. It also tries to say that Lack isn’t being realistic about how hedge funds are used in reality: they’re not designed to replace stocks and bonds, they say. Indeed, they say, “a hedge fund (a market-neutral fund, in particular) is not designed as a stand-alone investment but as a diversifier for an equity portfolio”. As such, the proper thing to look at is not hedge-fund returns versus various combinations of stocks and bonds, but rather various combinations of stocks and bonds, on the one hand, versus various combinations of stocks-and-bonds-and-hedge-funds, on the other. They then trot out familiar charts showing that hedge funds give you lovely diversification benefits, even if they underperform the stock and/or bond markets.

This argument is directly addressed on page 159 of Lack’s book. He points out that diversification benefits are generally calculated using the most generous hedge-fund index that can be found, using returns going back as far as possible — since hedge-fund returns in the 1990s, when the hedge fund industry was much smaller than it is today, were significantly higher than what we’ve seen of late. On top of that, the returns used are the returns of the average fund, not of the average investor. If small funds outperform large funds, on average — and they do — then average investor returns will be significantly lower than average fund returns. AIMA’s pretty chart showing a portfolio with hedge funds outperforming a portfolio without hedge funds — that’s not based on actual returns to actual investors, it’s all based on theoretical returns to theoretical investors.

Of course, some hedge-fund investors do manage to do quite well. That’s a statistical inevitability. But we’re not talking about the art of picking outperforming hedge funds, here, we’re talking about whether it makes sense, in general, to invest in hedge funds at all. Which is why AIMA’s epilogue is so annoying:

Consider the following quotes:

“Some of the most talented investors in history run hedge funds.”

“There are plenty of investors that are happy with their hedge fund investments.”

Those are not taken from an AIMA document, but from ‘The Hedge Fund Mirage’. The book, at times, is prepared to acknowledge that certain investors in hedge funds have done very well from their investments – a conclusion that is seemingly at odds with the claims made elsewhere in the book.

This is just silly. Of course there’s no conflict between saying that some hedge fund managers have done very well, and even that some hedge fund investors have done very well, but that in aggregate the managers have done much better than the investors, to the point at which the investors would have been better off not investing in hedge funds at all.

Indeed, if AIMA has been reduced to this rather pathetic game of “gotcha”, that says to me that there really is no robust refutation of Lack’s book. There are huge risks involved in investing in any hedge fund: they’re illiquid investments, and can blow up through bad luck or bad faith or old-fashioned bad investing at any time. In order to compensate for those risks, investors should be getting substantial excess returns. They’re not. So they should stay away.

Dennis Kelleher of Better Markets has responded to my post in which I said, inter alia, that he was wrong about high-frequency trading. He, of course, says that I’m wrong — indeed, that I’m “over the top and just plain wrong in many ways”, and that the post is “self-discrediting”. Blogfight! So, fair warning: this post is my response to his response to my post; if you’re not into that kind of thing I fully understand, and you’re probably much more grown-up than either of us. Anyway.

First, Felix totally overlooks the fact that some of the biggest banks in the world knowingly committed multiple very serious crimes by rigging the Libor rate.

It’s true I didn’t dwell on this, because it really wasn’t the subject of my post. My point was that whenever something scandalous or unacceptable happens in the financial markets, it’s not enough that the activity is scandalous or unacceptable: the financial press also feels the need to demonstrate that the little guy was being ripped off somehow. Even if he wasn’t. In this case, I’m perfectly happy to agree with Kelleher that rigging Libor was a very serious crime.

Kelleher accuses me of ignoring other things, too, like the difference between the two separate parts of the Libor-rigging scandal. Again, yes, I didn’t mention that. I also didn’t mention Standard Chartered, or HSBC money-laundering, or, for that matter, the Olympics badminton scandal. Kelleher has made it his life’s work to rail against such things, so maybe he feels that I should mention them in every post I write. But I can hardly be wrong about something if I didn’t even mention it.

He does, however, say that I’m “dead wrong that no one was harmed by the banks rigging the Libor rate”. This is a bit of a nasty accusation, because if I’d said that no one was harmed by the Libor rigging, then indeed he would be quite right to call me wrong. But I never said anything like that. He also says that I don’t understand interest-rate swaps, and proceeds to give a perfectly accurate explanation of how they work. And again, his explanation doesn’t contradict anything I said. But I do think he misses my point, so let me try again.

Kelleher uses an example of a municipality which has entered into an interest rate swap and is paying a fixed rate while receiving a floating rate linked to Libor. Such swaps are designed to protect borrowers from rising interest rates; the flipside of the deal is that if rates fall, then the borrower will end up losing money. And as it happened, rates fell, and the borrowers ended up losing money.

Now here’s the thing: the municipalities didn’t insist on linking the interest-rate swap to Libor because their borrowing costs are particularly bank-like. They just used Libor because it was the market standard, a proxy for interest rates more generally. The Libor scandal — and, yes, it is a scandal — is that the banks ended up printing a rate for Libor which was closer to prevailing interest rates than it should have been. Because Libor is tied to the interest rate on unsecured bank debt, it can actually rise when interest rates are falling, if the credit spread on bank debt rises fast enough. From the point of view of borrowers engaging in interest-rate swaps, that’s a bug, not a feature. What they want is a simple proxy for interest rates; they don’t want a proxy for interest-rates-plus-financial-sector-credit-spreads.

So Kelleher is right, in a narrow sense, when he says that if you were receiving floating-rate interest payments linked to Libor, then you got less money than you should have got. Because according to the contract, your payments should have included that extra bank-credit-spread component, on top of the interest-rate component. But my point is that no one ever entered into an interest-rate swap because they were making a bet on bank credit spreads rising. As a result, the losses here are losses of windfall, unexpected revenues. And of course there are just as many borrowers who entered into floating-to-fixed interest-rate swaps: they ended up winning just as much as the fixed-to-floating borrowers ended up losing.

It’s worth taking a step backwards here. In the grand scheme of things, borrowers gained rather than lost from the Libor manipulation, because it meant that they paid less interest on floating-rate debt. The real losers here are investors who bought floating-rate debt, and who should have been paid more than they were. My point is that if you’ve found someone claiming to have lost money as a result of the Libor manipulation, and they’re a borrower rather than an investor, you’re pretty much scraping the barrel. The Libor scandal is scandalous for many reasons, first and foremost that it involved banks lying in order to manipulate a hugely important interest rate. You don’t need to show borrowers losing money in order for there to be a scandal here: there would be a huge scandal even if no borrowers lost any money at all.

Kelleher then moves on to the main subject of my post, which was high-frequency trading. I said he was wrong when he said on a TV show we were on that shops like Knight rip off small investors. He replies:

Mr. Kelleher distinguished between high speed trading (really high speed market making) and predatory high frequency trading (HFT). Maybe not the most precise way to talk about these activities, but not too far off the mark for a general audience. It was the later practice not the former that Mr. Kelleher said rips off small investors, frequently referred to in the market as dumb money. (Not mentioned was that, because shops like Knight pay for order flow from retail brokers and pick off what they want, there are fewer natural buyers and sellers in the market and only professional or toxic retail flow actually gets to the market.)

OK, let’s make a distinction between high-speed market-making, on the one hand, and HFT, on the other. If you’re making that distinction, then Knight absolutely falls into the former category: it’s one of the helpful market-makers, rather than one of the predatory algobots. This part of the show hasn’t made it onto the internet, but I can assure you that Kelleher never explained that his distinction, at the margin, actually makes Knight look better rather than worse.

But in any case, the high-frequency algobots don’t rip off small investors, because the two never come into contact with each other. If a small investor puts in a stock trade, it ends up being filled by Knight, or one of the other high-speed market-makers. The algobots are whale-hunting: they’re looking for big orders from institutional investors, which they can game and front-run and otherwise prey upon. If small investors ever found themselves naked in the open oceans of the markets, the same thing might happen to them, but they don’t: they’re protected from those waters by companies like Knight, which will give them exactly what they want at the national best bid/offer price.

You’d think that Kelleher, having made the distinction, would be happy that small investors don’t end up being picked off by predators, but he’s not: he reckons that because they’re not out in the open ocean, that means “there are fewer natural buyers and sellers in the market”. Well, you can’t have it both ways. And frankly if retail investors did return to the market, it wouldn’t help matters: there wouldn’t be more volume or more liquidity or any visible positive effect.

So why did Kelleher even make his distinction in the first place? Just so that he could then come out and say that “HFT is a liquidity taker, not a liquidity provider”. In order to say that, he needs to exclude high-speed market-makers like Knight, who clearly do provide liquidity to retail investors. When I said that high-frequency shops provide liquidity to the market, I was very much talking about Knight, and I can assure Kelleher that everybody who was watching TV on Monday night thought that he was talking about Knight as well. After all, it’s Knight that’s in the news right now.

Finally, Kelleher pushes back against my “anti-regulation stance”, which is quite hilarious; he also informs his readers that “Felix also sees HFT as nothing but a force for good.” Maybe he didn’t see my post on Monday, where I talked about how HFT is “quite literally out of control”. I concluded that post by saying that “the potential cost is huge; the short-term benefits are minuscule. Let’s give HFT the funeral it deserves.” So obviously I don’t consider HFT to be “nothing but a force for good”.

The fact is, however, that I don’t need to go back to Monday’s post to demonstrate my anti-HFT bona fides. In the very post that Kelleher’s responding to, I write this:

I do think that the amount of HFT we’re seeing today is excessive, and I do think that we’ve created a large-scale, highly-complex system which is out of anybody’s control and therefore extremely dangerous.

Kelleher, then, is a man who, immediately after reading those words, can turn around and describe me as someone who sees HFT as nothing but a force for good. It’s very hard to know how to respond to such a person, but I guess that does at least explain why he thinks I said so many things I never said. He might think he’s responding to me, but in fact he’s just creating a straw man and putting my name on it. Which, frankly, is a little bit annoying.

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

Five days after Businessweek gave him the Bob Dylan treatment on its cover, Ben Bernanke has gotten existential. Or at least relatively so for a former academic economist and current central banker. On Monday, he supported including well-being and quality of life in “economic measurement“:

Economics as the study of the allocation of scarce resources… may indeed be the “what,” but it certainly is not the “why.” The ultimate purpose of economics, of course, is to understand and promote the enhancement of well-being. Economic measurement accordingly must encompass measures of well-being and its determinants…

Aggregate statistics can sometimes mask important information. For example, even though some key aggregate metrics – including consumer spending, disposable income, household net worth, and debt service payments – have moved in the direction of recovery, it is clear that many individuals and households continue to struggle with difficult economic and financial conditions.

Bernanke isn’t necessarily covering new ground here, and admitted as much, citing Bhutan’s National Happiness Index and the work of Nobel laureate Daniel Kahneman, along with current research in the field of the “economics of happiness”.

Mark Thoma thinks Bernanke’s speech only deepens this question: why isn’t the Fed chairman “pushing the Fed to do more at every opportunity?” Conflicting comments from the presidents of the Boston and Dallas Fed over the need for new action  ”underscore the extent of divisions among Fed officials that have been obscured by the central bank’s efforts to maintain a united public face”, Binyamin Appelbaum writes in the NYT. Tim Duy sees public comments from proponents of new action as “[signals of] the strength of the resistance to further easing” within the Fed.

The minutiae of Fed-watching aside, David Leonhardt points out that Bernanke’s comments on happiness and well-being come in the context of the “slowest 10-year average growth rates since the Commerce Department began keeping statistics in 1947 … In addition to slow growth, the bounty from the economy’s growth has largely flowed to a small slice of the population: the affluent”.

Brendan Greeley thinks Bernanke is adapting to a post-crisis reality, in the pattern of John Stuart Mill and Karl Marx. Greeley notes Bernanke would be joining esteemed current company: Robert Shiller a year ago wrote that economics has at its core a “broad moral purpose of improving human welfare”. Bernanke’s policies are already seemingly in disagreement with his former academic self. With the economy stalling, if he agrees with Shiller but takes no further action, he’ll be in disagreement with himself as a “moral scientist”. How many conundrums can we afford in one central banker? – Ben Walsh

On to today’s links:

Bold Rationality
SHOCKING: The monthly jobs report is “overhyped, overanalyzed, and overvalued by the markets” – Barron’s

Rebuttals
“Standard Chartered strongly rejects the position and portrayal of facts made by the New York Department of Financial Services” – Standard Chartered

Charts
Say hello to the lowest level of US public-sector employment in more than 30 years – Hamilton Project

Disturbing
Hospital chain performed unnecessary, dangerous, and profitable cardiac procedures – NYT

Liebor
Gary Gensler: It’s time to replace Libor with a “new or revised benchmark” – NYT

Data Points
Papa John’s CEO says the price of Obamacare is an extra 11 cents to 14 cents per pizza – Politico

Plutocracy Now
“Twice a week, 6- to 11-year-old scions of wealthy families take classes on being rich” – Bloomberg

Welcome to Adulthood
“Please explain your rationale for the rainbow” – a job applicant’s confused attempt to “[add] color to the message” – Business Insider

Right On
Americans, increase national and personal productivity by leaving the office asap – The Atlantic

Stuff We’re Not Linking To
Another person who is not Bill Gates is now richer than Warren Buffett – Bloomberg

I feel for Peter Maass and Megha Rajagopalan of ProPublica, who have spent 3,700 words and some enormous amount of time trying to track down the source of dubious cybercrime statistics. I went through something similar in 2005, looking at counterfeiting statistics: I can attest to how frustrating and thankless it is trying to follow footnote after footnote in a futile attempt to find something substantive amidst the exaggerated rhetoric.

The short story here: the US government loves to say that the cost of cybercrime in the US is $250 billion per year, while the cost of cybercrime globally is $1 trillion per year. The government loves to say that because it’s in the business of fighting cybercrime, and it loves to feel important. But in reality, those figures are more or less picked out of thin air, and have very little in the way of solid scientific basis. What’s more, they’re all sourced from for-profit companies with a lot of skin in the game: Symantec and McAfee, manufacturers of anti-cybercrime software.

The most interesting thing, to me, about the ProPublica report is that the $1 trillion number ostensibly comes from a scientific survey, but in fact comes from a press release which accompanied that survey. The survey itself never said anything of the sort. In that, it’s just like the $5 trillion which hedge funds are supposed to be managing in five years’ time. (Thanks, Citigroup, for inventing that figure and placing it in the WSJ and elsewhere.)

Is this something they teach at PR school? Commission a scholarly report, and then distribute it with a press release featuring eye-popping assertions to be found nowhere in the report? I suspect that it happens much more than most journalists would like to admit.

What’s worse, once public institutions have officially cited these bogus stats, they feel that it would be shameful to ever distance themselves from them — hence the unedifying responses in the ProPublica piece from US spokespeople, which basically amount to “hey, it’s not our job to check facts, if McAfee puts something in a press release, that’s good enough for us”.

The reason that PR types do this, of course, is that it works. They know that most journalists are much more comfortable working off a press release than putting the work into reading and understanding a long report; they also know that even if most journalists do read the report and steer clear of the story, that doesn’t matter so long as some journalists wind up falling for the bogus numbers. And most importantly, they know that they’ll never get punished in any way for putting out false or misleading information: while journalists are expected to check facts, PR people are shameless.

Which means that the conclusion to my 2005 piece is as true today as it was back then: if you ever see seemingly authoritative statistics being bandied around by journalists or politicians, always bear in mind that there’s a good chance they’re utter bullshit. Especially if they’re particularly striking, or don’t pass the smell test.

One of the problems with financial journalism is its rather kludgy attempts to appeal to a general audience. If something bad happens, for instance, it has to be presented as being bad for the little guy. This was a huge problem with the Libor scandal, since anybody with a mortgage or other loan tied to Libor ended up saving money as a result of it being marked too low.

But don’t underestimate the imagination of the financial press. For instance, what if there was a New York county which put on Libor-linked interest rate swaps to hedge its bond issuance? In that case, if Libor was understated, then the hedges would have paid out less money than they should have done — and presto, the Libor scandal is directly responsible for municipal layoffs and cuts in “programs for some of the needy”.

This is all a bit silly. The Libor understatements actually brought it closer to prevailing interest rates; the fudging basically just served to minimize the degree to which the unsecured credit risk of international banks was embedded in the rate. And in any case, the whole point of a hedge is that it offsets risks elsewhere: it’s intellectually dishonest to talk about losses on the hedge without talking about the lower rates that the municipality was paying on its debt program as a whole.

We’re seeing the same thing with the fiasco at Knight Capital, where a highly-sophisticated high-frequency stock-trading shop lost an enormous amount of money in a very small amount of time, and small investors lost absolutely nothing. On the grounds that we can’t present this as news without somehow determining that it’s bad for the little guy, it took no time at all for grandees to weigh in explaining why this really was bad for the little guy after all, and/or demonstrates the need for strong new regulation, in order to protect, um, someone, or something. It’s never really spelled out.

The markets version of the Confidence Fairy certainly gets invoked: Arthur Levitt, for instance, said that recent events “have scared the hell out of investors”. And Dennis Kelleher of Better Markets goes even further: I was on a TV show with him last night, where he tried to make a distinction between “high-frequency trading” and “high-speed trading”, and said that shops like Knight rip off small investors. He’s wrong about that: they absolutely do not. Yes, Knight and its ilk pay good money for the opportunity to take the other side of the trade from small investors. But those investors always get filled at NBBO — the best possible price in the market — and they do so immediately. Small retail investors literally get the best execution in the markets right now, thanks to Knight and other HFTs. And those investors want companies like Knight to compete with each other to fill their trades as quickly and cheaply as possible. If Knight loses money while doing so, that’s no skin off their nose.

So Andrew Ross Sorkin is right to treat such pronouncements with skepticism. The argument that “investors are worried about high-frequency trading, therefore they’re leaving the market, therefore stocks are lower than they would otherwise be, therefore we all have less wealth than we should have” just doesn’t hold water at all. Sorkin has his own theories for why the stock market doesn’t seem to be particularly popular these days, which are better ones, but the fact is — he doesn’t mention this — that the market is approaching new post-crash highs, and that if investors follow standard personal-finance advice and rebalance their portfolios every so often, they should probably be rotating out of stocks right now, just to keep their equity holdings at the desired percentage of their total holdings.

The calls for more regulation are a bit silly, too. Bloomberg View says that “if any good comes out of the Knight episode, it will be a commitment by Wall Street’s trading firms to help regulators design systems that can track lightning-speed transactions” — but regulators will always be one step behind state-of-the-art traders, and shouldn’t try to get into some kind of arms race with them. More regulation of HFT is not going to do any good, especially since no one can agree on the goals the increased regulation would be trying to achieve. If what we want is less HFT, then a financial-transactions tax, rather than a regulatory response, is the way to go.

I do think that the amount of HFT we’re seeing today is excessive, and I do think that we’ve created a large-scale, highly-complex system which is out of anybody’s control and therefore extremely dangerous. Making it simpler and dumber would be a good thing. But you can’t do that with regulation. And let’s not kid ourselves that up until now, small investors have been damaged by HFT. They haven’t. The reasons to rein it in are systemic; they’re nothing to do with individuals being ripped off. Sad as that might be for the financial press.

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

Just over a month ago, Standard Chartered’s CEO urged bankers to regain their “social legitimacy” and asserted that “good banking is never needed more than now”. That message was in line with the bank’s image as “boring but good“, as one FT headline put it.

Standard Chartered now stands accused of helping Iranian banks – including the central bank – circumvent US sanctions by concealing roughly 60,000 transactions involving at least $250 billion from US regulators, and having reaped “hundreds of millions of dollars in fees” for itself over a decade. The whole damning complaint is here, and Business Insider pulled the choicest bits here.

In this section, a StanChart Group Executive Director provides a great example of banker braggadocio, now destined to rank among the industry’s all-time PR lows:

In short, SCB [Standard Chartered Bank] operated as a rogue institution. By 2006, even the New York branch was acutely concerned about the bank’s Iran dollar-clearing program. In October 2006, SCB’s CEO for the Americas sent a panicked message to the Group Executive Director in London. “Firstly,” he wrote, “we believe [the Iranian business] needs urgent reviewing at the Group level to evaluate if its returns and strategic benefits are … still commensurate with the potential to cause very serious or even catastrophic reputational damage to the Group.” His plea to the home office continued: “[s]econdly, there is equally importantly potential of risk of subjecting management in US and London (e.g. you and I) and elsewhere to personal reputational damages and/or serious criminal liability.”

Lest there be any doubt, SCB’s obvious contempt for U.S. banking regulations was succinctly and unambiguously communicated by SCB’s Group Executive Director in response. As quoted by an SCB New York branch officer, the Group Director caustically replied: “You f—ing Americans. Who are you to tell us, the rest of the world, that we’re not going to deal with Iranians.”

The complaint also alleges that Deloitte & Touche aided StanChart, saying the consultancy “intentionally omitted critical information in its ‘independent report’ to regulators”. And a footnote reveals further investigations into whether StanChart was involved in similar schemes with other countries under US sanctions, such as Libya, Myanmar and Sudan.

If nothing else, perhaps this episode will make bank executives think twice before signing off on sanctimonious ad campaigns while they’re allegedly simultaneously leaving the “US financial system vulnerable to terrorists, weapons dealers, drug kingpins and corrupt regimes”. The voice-over from this 2010 Standard Chartered commercial has now been pushed painfully beyond absurdity:

Can a bank really stand for something?
Can it balance its ambition with its conscience?
To do what it must. Not what it can.
As not everything in life that counts can be counted.
Can it look not only at the profit it makes but how it makes that profit?
And stand beside people, not above them.
Where every solution depends on each person.
Simply by doing good, can a bank in fact be great?
In the many places we call home, our purpose remains the same.
To be here for people. Here for progress. Here for the long run.
Here for good.

– Peter Rudegeair

On to today’s links:

Good Points
Should hospitals be more like the Cheesecake Factory? – New Yorker

Knightmare
Knight Capital raises $400 million in preferred shares, convertible into a 70% stake in the company – CNBC

Old Normal
Lack of copyright may have powered Germany’s 19th-century industrialization – Der Spiegel

Contrarian
Study finds that the revolving door actually toughens enforcement results at the SEC – NYT and American Accounting Association

EU Mess
Spain’s prime minister would ask for an economy-wide bailout, but first the ECB has to let him know what he’d be asking for – WSJ
Consumer austerity hits Europe: Even the French aren’t going to Disneyland Paris – WSJ

Politicking
After Bain made $1 billion there, Mitt Romney isn’t too popular in Italy – Bloomberg

LIEBOR
To minimize settlements, banks compete to show regulators they’re “not as bad as the next guy” – Dealbook

China
Golden Elephant No. 38, yielding 7.2% annually, “not fundamentally different from a Ponzi scheme” – Reuters

Love Equity, Hate Disclosure
Little known, marginally successful Manchester United to use start-up disclosure exemptions in IPO – ESPN

Oxpeckers
Time Warner buys Bleacher Report for less than $200 million – Bloomberg

Stuff We’re Not Linking To
Trend: increased Botox use on Wall St – Bloomberg TV

In the run-up to Facebook’s IPO in May, Henry Blodget explained just what it was that made Mark Zuckerberg a great CEO: his ultra-long-term time horizon. “It often takes decades to build the sort of companies that the best executives and entrepreneurs hope to create,” wrote Blodget, explaining that Facebook’s dual-class share structure, and Zuckerberg’s control of the company, would allow the young CEO to build a company for the ages, rather than one which hurt itself by chasing short-term profits.

When talking about Zuckerberg’s most valuable personality trait, a colleague jokingly invokes the famous Stanford marshmallow tests, in which researchers found a correlation between a young child’s ability to delay gratification—devour one treat right away, or wait and be rewarded with two—with high achievement later in life. If Zuckerberg had been one of the Stanford scientists’ subjects, the colleague jokes, Facebook would never have been created: He’d still be sitting in a room somewhere, not eating marshmallows…

Companies are a lot more than ticker symbols. They create jobs that employ people. They create products that help people. They devote resources to ensure that they’ll keep creating this value for decades, despite the fact that these investments reduce their near-term profits. In other words, these companies create societal value. As Warren Buffett and a handful of other investors have often observed, this balanced approach allows such companies to create huge value for some shareholders: the ones who stay put for the long term.

But where are we now, just three months after Facebook went public? Dalton Caldwell’s blog post about Facebook has gone viral this week because it seems to depict a company which, having gone public, is doing the exact opposite of the kind of things that Blodget so admires. Caldwell built a Facebook app, but was then told by Facebook that because it had embarked upon a similar project internally, he basically had two choices: be taken over and shut down by Facebook, or just be shut down by Facebook. Dalton wrote, in an open letter to Zuckerberg:

Mark, I don’t believe that the humans working at Facebook or Twitter want to do the wrong thing. The problem is, employees at Facebook and Twitter are watching your stock price fall, and that is causing them to freak out. Your company, and Twitter, have demonstrably proven that they are willing to screw with users and 3rd-party developer ecosystems, all in the name of ad-revenue. Once you start down the slippery-slope of messing with developers and users, I don’t have any confidence you will stop.

The point here is that although Facebook might be controlled by Zuckerberg individually, it’s still nothing without its thousands of employees. And those thousands of employees have entered into a bargain with Zuckerberg: they’ll accept relatively modest salaries, and work hard, because Zuckerberg is giving them substantial amounts of equity in the company. Once Facebook went public, every single Facebook employee became acutely aware of the company’s share price, what direction it was going in, what that move was doing to their net worth, and what public investors wanted to see from the company (revenues, and profits, rising sharply).

As such, despite his voting control at board level, it’s actually really hard for Zuckerberg to keep his employees focused on long-term platform-building, rather than short-term obsession over the share price. For one thing, they don’t own the company; many of them are going to leave, at some point, and so their time horizon is necessarily going to be shorter than Zuckerberg’s. And at any company with broad share ownership and a public share price, employees are always going to pay a huge amount of attention to whether it’s going up or going down.

On top of that is the classic Silicon Valley problem — which is that employees are always searching for the new new thing, the company where they can get early-stage equity and make themselves a fortune. Or, at the very least, join a mature company like Apple where the stock can still rise enormously. If Facebook’s stock is going down rather than up, its employees will start looking for other opportunities, and the company will find it much harder to attract talent.

Facebook has a lot of money and a lot of great employees, and so should by rights have the luxury of spending both money and its employees’ time in the service of building a platform for the ages. In practice, however, now that Facebook has gone public, it doesn’t work like that. The markets want to see quarterly results — and the employees’ incentives are aligned more with the markets than they are with Zuckerberg. He might have been a very good CEO of a private company. But trying to run a public company, as he’s discovering, is very different.

>

This astonishing GIF comes from Nanex, and shows the amount of high-frequency trading in the stock market from January 2007 to January 2012. (Which means that the Knightmare craziness of last week is not included.)

The various colors, as identified in the legend on the right, are all the different US stock exchanges. You might think there are only two stock exchanges in the US, but you’d be wrong: there are only two exchanges where stocks are listed. There are many, many more exchanges where stocks are traded.

What we see here is relatively low levels of high-frequency trading through all of 2007. Then, in 2008, a pattern starts to emerge: a big spike right at the close, at 4pm, which is soon mirrored by another spike at the open. This is the era of traders going off to play golf in the middle of the day, because nothing interesting happens except at the beginning and the end of the trading day. But it doesn’t last long.

By the end of 2008, odd spikes in trading activity show up in the middle of the day, and of course there’s a huge flurry of activity around the time of the financial crisis. And then, after that, things just become completely unpredictable. There’s still a morning spike for most of 2009, but even that goes away eventually, to be replaced with sheer noise. Sometimes, like at the end of 2010, high-frequency trading activity is very low. At other times, like at the end of 2011, it’s incredibly high. Intraday spikes can happen at any time of day, and volumes can surge and fall back in pretty much random fashion.

It’s certainly fair to say that if you take a long, five-year view, then you can see a clear rise in trading activity. But it’s also fair to say that there’s something quite literally out of control going on here. Just as the quants at Knight found themselves unable to turn off their machines for 30 long minutes last week, the HFT world in aggregate seemingly has a mind of its own when it comes to trading patterns. Or, to put it another way, if there’s a pattern here, it’s one incomprehensible to human minds.

Back in 2007, I wasn’t a fan of a financial-transactions tax; today, I am. And this chart shows better than anything why my opinion has changed. The stock market is clearly more dangerous than it was in 2007, with much greater tail risk; meanwhile, in return for facing that danger, society as a whole has received precious little utility. Are spreads a tiny bit tighter than they might be otherwise? Perhaps. But that has no effect on stock-market returns for long-term or even medium-term investors.

The stock market today is a war zone, where algobots fight each other over pennies, millions of times a second. Sometimes, the casualties are merely companies like Knight, and few people have much sympathy for them. But inevitably, at some point in the future, significant losses will end up being borne by investors with no direct connection to the HFT world, which is so complex that its potential systemic repercussions are literally unknowable. The potential cost is huge; the short-term benefits are minuscule. Let’s give HFT the funeral it deserves.

Remember how there’s a very good chance that Treasury’s new floating-rate notes are going to be linked to some kind of repo benchmark? Well, here’s another reason that’s a bad idea: the repo market is shrinking fast, at least in Europe — and if it can shrink in Europe, it can do so in the US, as well.

What’s more, we want the repo market to shrink. Gillian Tett, in her latest column, explains that as rules about collateral tighten up, they create what Manmohan Singh calls a “second deleveraging”. But weirdly, Tett thinks that an increased focus and reliance on the repo markets is a good thing in the long term: “a financial system in which transactions are secured on assets is likely to be a healthier system than one which is largely – or patchily – unsecured,” she says, “particularly if that collateral is valued in a regular, disciplined basis”.

This is exactly wrong. Repos are a form of informationally-insensitive asset: they epitomize the paradoxical and ultimately destructive desire on the part of people with money to lend out money but to take no credit risk while doing so. Informationally-insensitive assets are a bad idea in general, for reasons which are probably familiar at this point to most readers of this blog: they breed complacency, tail risk, and deluded, magical thinking. But repos are a particularly bad species of the genus, because they are a direct replacement for old-fashioned unsecured credit.

Lending money in return for interest on that money is a form of investing: one entity, with money to spare, invests that money in a venture which can put it to good use and profit from it. If all goes according to plan, both win. The borrower might be poor but has ideas, and the ability to make money in the future; the investor makes such profits possible.

When you move from a credit-based system to a repo-based system, however, all that changes. At that point, future profitability isn’t enough to get you cash: instead, you need to be rich already, and you need to be able to hypothecate your existing assets to some lender. If we’re talking about the banking system, here, we’re talking about a world in which banks simply cease to trust each other at all, and the answer to all interbank credit questions is “no”. The only way for banks to lend to each other is to either go through some central counterparty, hub-and-spoke style, or else to retreat to the world of repo, where banking prowess counts for nothing and all that matters is collateral quality.

The implications of such a world are already being seen: Tett says that “collateral arbitrage” has now become a profit center at some banks. Far from trying to lend out money to creditworthy borrowers, banks are beginning to make money by gaming inconsistent repo rules. No good can come of this.

And in times of crisis, a reliance on repo markets makes all banks incredibly fragile, and vastly increases the risk to taxpayers should a bank fail. Once upon a time, banks had equity, they had debt, and then they had deposits. If a bank failed, the bank’s equity would be wiped out first, and then its debt. The depositors were senior, which meant there was relatively little chance that the FDIC would have to bail them out.

Now, however, bank debts are shrinking, replaced with repo operations. As a result, when a bank fails, the equity gets wiped out first — and then there’s no cushion any more before the depositors start losing money and need to be bailed out. The rest of the finance world is senior to depositors: they have repo collateral, which makes them secured creditors, and secured creditors are senior to unsecured creditors, even when the unsecured creditors are just mom-and-pop depositors.

The more that the world of finance relies upon repo, the less it relies upon relationships and trust and underwriting and all the other ties which bind. The financial sector can’t afford those ties to be severed: the cost of breaking them, in terms of foregone growth and profit, is far too great. But we seem to be doing exactly that.

Update: See also Carolyn Sissoko, from February,  a great post. h/t Waldman.

Randy Cohen, the NYT’s former Ethicist columnist, has now attempted an ethical defense of running red lights on his bicycle. “I flout the law when I’m on my bike,” he writes; “you do it when you are on foot, at least if you are like most New Yorkers.”

This, of course, is one of the weakest ethical defenses imaginable: if lots of other people are flouting the law, that doesn’t give anybody else the ethical right to do so, let alone the legal right. But Cohen continues:

I roll through a red light if and only if no pedestrian is in the crosswalk and no car is in the intersection — that is, if it will not endanger myself or anybody else. To put it another way, I treat red lights and stop signs as if they were yield signs. A fundamental concern of ethics is the effect of our actions on others. My actions harm no one. This moral reasoning may not sway the police officer writing me a ticket, but it would pass the test of Kant’s categorical imperative: I think all cyclists could — and should — ride like me.

The “should” at the end of this passage is utterly indefensible. At best, Cohen has demonstrated that he’s causing no harm to others (although I’ll take issue with that in a moment). But if Cohen is doing something illegal — which, by his own admission he is — then he needs something much stronger than “no harm to others” before he urges such behavior on all other cyclists.

There are cases where flouting the law can be the ethical thing to do, but those are generally cases where following the law, or standing idly by in the face of something which is clearly wrong, cannot be ethically justified. In this case, stopping at a red light and waiting for it to turn green does no harm to anybody, and there’s no morality I know of which would frown on such behavior.

It is important to cyclists that we get the full respect of drivers as fellow road users, with just as much right to be riding down the street as they have. The biggest danger facing cyclists is when drivers get annoyed if we slow them down, or drive as though we’re simply not there. Developing a relationship of mutual respect between drivers and cyclists is the most important thing we can do to improve cyclists’ safety, and to reduce the number of injuries and fatalities on the streets. And cyclists will find it much harder to earn that respect if they visibly flout the law every time they reach a red light.

Do pedestrians flout red-light laws all the time? Yes, of course they do. But they also fear cars, and respect the fact that the roadway is built for the purposes of cars and not for themselves. No pedestrian insists on the right to walk down the middle of the road at any time of day or night, and to be respected by drivers while doing so.

Similarly, Cohen — quite rightly — saying that cyclists “are a third thing, a distinct mode of transportation, requiring different practices and different rules”. I wrote as much myself, in my unified theory of New York biking. But that theory was based on the idea that the tragedy of New York cycling is that everybody — pedestrians, drivers, and cyclists — treat cyclists too much like pedestrians. Cohen, by contrast, says that “most of the resentment of rule-breaking riders like me, I suspect, derives from a false analogy: conceiving of bicycles as akin to cars”. I wish that New Yorkers would conceive of bicycles as akin to cars: pedestrians would look first before stepping out in front of us; cars would respect our right to be on the road; and fellow cyclists wouldn’t endanger everybody by riding the wrong way down the street.

One of the weirder parts of Cohen’s essay is that he extols Amsterdam and Copenhagen, which are cities where, to a first approximation, all cyclists always stop at all red lights, and don’t go again until the light turns green. Doesn’t he understand that in order for New York to work as a cycling city, cyclists will have to stop taking the law into their own hands? “Uninterrupted motion,” he writes, “gliding silently and swiftly, is a joy.” Well, yes, it is. Uninterrupted motion is quite nice for car drivers, too, but they stop at red lights. And even pedestrians generally wait until the way is clear before they cross the street.

More to the point, I simply don’t believe Cohen when he writes that he only breaks the red-light rule “if and only if no pedestrian is in the crosswalk and no car is in the intersection”. What about when there’s a pedestrian in the crosswalk who’s walking away from the bike? I’ll bet he does it then, too. The point is, when you can make up your own rules, you can also make up when to bend them. I can understand that Cohen would prefer it if New York had rules like Idaho’s. But whatever the rules are, we should obey them. If Cohen wants to agitate for a change in the rules, I’ll join him and support him. But I’m not going to pretend that it’s OK to break the rules just because you think the rules should be changed.

It’s quite common for pedestrians to thank me when I stop at a red light behind the crosswalk. That’s nice of them, I guess — but it’s also a bit depressing: it shows that most pedestrians expect most cyclists to flout the law. And that makes them afraid and resentful of cyclists in general. That’s the last thing anybody wants. And so for the time being it behooves all cyclists to adhere to the law as it stands, even if they’re convinced that they’re doing no harm. Running red lights is highly visible behavior, and every time a pedestrian or a driver seen Cohen do it, that only confirms in them their prejudice that cyclists are lawless people with no respect for the rules of the road. They can’t see the counterfactual case where Cohen would have stopped had there been a pedestrian in the way: all they see is the law-flouter.

I’m no angel on this front: I’ve done, on my bike, everything Cohen has done on his. I just don’t kid myself that I’m behaving ethically when I do so. And I’m trying to set a good example, even if I don’t always succeed. If you ever see me run a red light on my bike, feel free to tell me off. I’ll deserve it.

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

Over the last decade, Amtrak has lost $834 million selling food and drinks, its president and CEO admitted Thursday in front of the House Transportation and Infrastructure Committee. The NYT reports that those losses were “largely because of waste, employee theft and lack of proper oversight”.

All of this comes on top of Amtrak’s complex status as perennial political football, anecdote fodder for pundits aiming to outdo their own previous attempts at self-parody, and of course vital national infrastructure. But never mind that: losing more than $80 million on food an beverage service a year is offensive to “anybody who’s ever boarded a train hungry and been forced to cough up the better part of $20 for a burger and a beer”.

Meanwhile, burgers have hidden costs of their own, among them greenhouse gas emissions, overuse of land, water and energy, environmental contamination, and health impacts. Consumers are protected from directly paying those costs by a myriad of agriculture, energy and health policies and subsidies. As a result, a quarter pounder at a fast food joint costs almost nothing, and in any case far less than its true cost to society.

An industrialized hamburger is a cruel combination of subsidies and externalities. By increasing the price to the individual and adding to the cost paid by society, Amtrak has remarkably managed to turn the hamburger into an even worse deal for us all. – Ben Walsh

On to today’s links:

Knightmare
Goldman unwinds Knight’s trades for $440 million – Knight is “scrambling for extra cash” to settle by Wednesday – CNBC
Knight is in talks to sell its futures brokerage unit with potential buyers – DealBook

Crisis Retro
US selling $4.5 billion in AIG stock… and AIG plans to buy $3 billion of it – Bloomberg

Primary Sources
US economy adds 163,000 jobs in July, beating expectations; unemployment “essentially unchanged” at 8.3% – BLS

New Normal
The scary depth and duration of the current jobs crisis in one, updated chart – Calculated Risk
“It was like we were in a funeral home”: unemployment workers get pink slips of their own – Huffington Post
“The true backdrop for Friday’s jobs report: an epic, decade-long stall in the national Jobs Machine.” – National Journal

Your Daily Outrage
“The existence of mass unemployment has stopped being something the economic powers that be even pretend to regard as a crisis.” – Jonathan Chait

JPMorgan
Bruno Iksil was pushed by the CIO’s head of credit trading to inflate the value of his positions – WSJ

Politicking
Ezra Klein: “I can describe Mitt Romney’s tax policy promises in two words: mathematically impossible”.  – Bloomberg

Banks
Iceland, pioneer in banking reform – Bloomberg

Data Points
Pimco’s Mohamed El-Erian literally (figuratively) wears the same thing after every (three) good jobs reports – Business Insider

One of the most interesting takes on l’affaire Jonah Lehrer comes in a book review which was almost certainly written before any of the latest revelations: Evgeny Morozov’s hilarious and masterful dismantling of Parag Khanna in particular and the whole TED mindset in general. Whatever else you do this weekend, make sure to read it: you won’t be sorry. But this part is directly relevant to Lehrer:

Today TED is an insatiable kingpin of international meme laundering—a place where ideas, regardless of their quality, go to seek celebrity, to live in the form of videos, tweets, and now e-books. In the world of TED—or, to use their argot, in the TED “ecosystem”—books become talks, talks become memes, memes become projects, projects become talks, talks become books—and so it goes ad infinitum in the sizzling Stakhanovite cycle of memetics, until any shade of depth or nuance disappears into the virtual void. Richard Dawkins, the father of memetics, should be very proud. Perhaps he can explain how “ideas worth spreading” become “ideas no footnotes can support.”

The TED “ecosystem” — the scare quotes are unavoidable — has what Nathan Heller, in his New Yorker profile, called a “closely governed editorial process”:

The conference’s “curators” feel out a speaker’s interests, looking for material that’s new and counterintuitive. They think about form. A TED talk tends to follow one of several narrative arcs (some have three acts, others are cast as detective stories, others are polemics)…

The real work of the curators, though, often comes down to emotional shading. When Cain first drafted her talk, it was thick with statistics and case-making data. Looking at other TED lectures, though, she decided to replace some of her data points with stories—an inclination that the conference’s curators pushed even further. A moving narrative about her grandfather’s bookish introversion now concluded the lecture. “I’ve had to stifle my appetite for nuance,” she said, about the lost statistics.

One of the less-remarked aspects of TED is that although it popularizes science, it features very few of the people whose job it is to popularize science: science journalists. Although the beneficient spirit of Malcom Gladwell hovers invisibly over most of the proceedings, these talks are far removed from any culture of journalistic ethics. The scientists don’t consider what they do at TED to be science, and the ones who make it onto the TED Talks site are the ones most willing to let TED’s curators guide them to a trite and facile narrative nirvana. They often don’t need much guiding, these days: the TED formula, perfectly celebrated/skewered here, is at this point ingrained in the mind of almost anybody who wants to give a talk there.

And here’s the thing: for all that Jonah Lehrer ultimately wound up blogging for the New Yorker, he has always been a creature of TED much more than he has been a creature of journalism.* Check out Seth Mnookin’s post, today, on Jonah Lehrer’s missing compass: the way that Lehrer remixed facts in service of narrative is very TED. Mnookin says that Lehrer had “the arrogance to believe that he has the right to rejigger reality to make things a little punchier, or a little neater”. A journalist would call that arrogance — would call it, indeed, the action of a man with no moral compass. On the other hand, a TED curator, or a monologuist, might see things very differently.

Which is something that Morozov doesn’t touch on in his review: that TED-think isn’t merely vapid, it’s downright dangerous in the way that it devalues intellectual rigor at the expense of tricksy emotional and narrative devices. TED is a hugely successful franchise; its stars, like Jonah Lehrer, are going to continue to percolate into the world of journalism. And when they get there, they’ll be deeply versed in the dark arts of manipulating facts in order to create something perfectly self-contained and compelling. Does any editor out there want to take it upon herself to try to unteach such arts, when bringing on a hot new star? I didn’t think so.

I don’t know how to solve this problem. TED isn’t going away: indeed, it’s so successful that it is spawning dozens of competitors, even as many publications, including the New Yorker as well as Wired, the NYT Magazine, the Atlantic, and many others, move aggressively into the “ideas” space. The cross-pollination between the conferences and the publications will continue, as will everybody’s desire to draw as big an audience as possible. Which says to me that Jonah Lehrer will not be the last person to trip up in this manner. In fact, he might turn out to be one of the first.

*Update: Clay Shirky informs me that Jonah Lehrer has never actually given a TED talk.

Update 2: A lot of people seem to think that it matters, for the purposes of this post, whether Lehrer has actually given a talk at TED (as opposed to PopTech, where he has spoken, or any of the other TED clones out there). Certainly the post would be a bit more elegant if Lehrer had been a genuine TED star, with millions of views for his TED talk. But I absolutely stand by my assertion that he’s a creature of TED, and that his writing is decidedly TED-esque in its prioritization of narratives over niceties.

It’s the first Friday of the month, which means there’s a new jobs report out, and an absolutely enormous number of people are puzzling over what it might mean. And this close to a general election, there’s also lots of politicians trying to make hay out of it. Both of which, for the intellectually honest, are largely futile exercises at the best of times, and especially so this month.

There are two components to the jobs report: the household survey, which polls households to measure how many people are unemployed; and the establishment survey, which polls employers to measure how many people have jobs. The establishment survey is the more accurate of the two; the household survey is the one politicians gravitate towards. Taken as a package, the two together sometimes convey substantive information on how the economy is doing, and the speed with which we are approaching — or moving away from — full employment.

This month, however, not so much. And in general, the amount of useful information in the monthly jobs report is much lower than the amount of attention paid towards it would imply. Every month, policy wonks and data-heads pore through the 25 different tables in the report, sometimes looking at their own favorite number (U-6 is particularly popular these days), and sometimes just looking for something to jump out at them. (Look at what happened to youth unemployment among Hispanics!)

The latter exercise is particularly dangerous. When you have 25 tables, each with hundreds of datapoints, it’s a statistical certainty that one or two of them are going to be weirdly off in some way. If you then pull out that datapoint and read too much into it, you’re guilty of a logical solecism, a bit like two people who discover they share a birthday and then exclaim at how unlikely that is.

But even the simple check-out-this-headline-number exercise, which every major news organization goes through every month, is statistically dubious. The headline payrolls number has error bars which are more than 100,000 people wide in either direction: if the number everybody’s quoting is 163,000, for instance, all that really says is that there’s a 95% chance that it’s somewhere between 59,000 and 267,000. What’s more, there’s a good 5% chance that it’s outside that wide range. Take the last two years of payrolls headlines, and the chances are that somewhere in there, a number is more than 100,000 off.

And the unemployment rate is less accurate still. Most people will say that it ticked up this month, to 8.3%; the official news release is closer to the mark in saying that it was “essentially unchanged”. And if you look at the numbers it’s based on, they’re all over the place.

This month, the two parts of the report tell differing stories: the headline payrolls number was higher than most people expected, even as the headline unemployment rate went up. Look a bit more deeply, and things become ever messier, what with all the revisions and the changes in people looking for work, and the decrease in median unemployment duration, and so on and so forth. As a result, this month of all months it’s actually quite easy for the markets (if not the politicians) to move on to the next thing. After all, they have very short attention spans at the best of times.

But the fact is that even when the stars align, and the two parts of the jobs report tell the same story, and there seems to be a clear message shining through — even then, there’s nearly always much less to the report than meets the eye. All those numbers will be revised in subsequent months, and the message is never as clear as the media and the markets make it out to be, and in any case the chances are that we’re not actually seeing signal in the noise at all, but instead that we’re just being fooled by randomness.

So be happy, this month, that you can’t work out what the jobs report is trying to say. Because that’s probably exactly the right conclusion to draw on the first Friday of every month.

Treasury announced yesterday that it was going to start issuing floating-rate notes, probably at some point next year, although the details are still extremely vague:

Treasury projects that it must now sell an estimated $667 billion of additional debt to the public over the next four years. The floating-rate notes will help give the government flexibility in its increased debt offerings…

Officials confirmed that the notes will not be indexed to the Libor overnight lending rate, which has come under scrutiny in the wake of a scandal that it was manipulated during the financial crisis.

The Borrowing Advisory panel said it was interested in referencing the securities to the DTCC GCF Repo index.

None of this makes a huge amount of sense to me. For one thing, if you’re the US Treasury, with $16 trillion of debt outstanding, an increase of half a trillion over four years is not a really huge deal — especially in a world where demand for Treasury securities remains incredibly robust.

What’s more, a floating-rate note isn’t really a new product. At heart, it’s incredibly similar to an investment in T-bills; the only real difference is that you don’t need as many roll-overs with a floating-rate note.

And then there’s the question of the reference rate. Don’t be embarrassed if you haven’t heard of the GCF Repo index: it’s less than two years old, and it has been tradable for only a couple of weeks.

The Repo index gives an overnight interest rate from the repo markets, and as Stephen Stanley of Pierpoint Securities points out (via Pedro da Costa), there are serious risks there.

Continuing in the mode of offering self-serving advice that would be bad for Treasury, the TBAC recommended that Treasury use the new GCF index as the reference rate for FRNs. This would put Treasury in a position of taking on private credit risk, since, if we had a 2008-style meltdown and general collateral (rates) widened out due to counterparty risk, Treasury’s FRN borrowing costs would soar.

Good luck to any Treasury Secretary who would have to explain that to the House Oversight Committee. That sounds like a one-way ticket to a forced resignation.

Essentially, repo rates always include a certain amount of counterparty risk, and they can spike alarmingly during a credit crisis when no one trusts anybody any more, and there’s a huge flight-to-safety trade going on. It would be utterly bonkers, in that situation, for the yield on floating-rate Treasury securities to go up, rather than down.

But even if the reference rate was Fed funds, or some other interest rate which doesn’t include counterparty risk, there are still problems here: I don’t think it should be an overnight rate at all. The way that floating-rate notes work, they pay an interest payment every coupon period, which is calculated by looking at some reference rate. The interest payments can come every quarter, or twice a year, and the reference rate, similarly, is usually a three-month rate, or maybe a one-month or six-month or one-year rate. The period between coupon payments is generally pretty close, on the yield curve, to the duration of the reference rate.

But the Treasury floaters, by contrast, seem to anticipate using an overnight rate to calculate the periodic interest payment. And that’s very dangerous, because overnight rates are by their nature more volatile and unpredictable than rates for 30 or 60 or 90 days. During crises, it’s quite common to see yield curves which are very steeply inverted between overnight and 30 days: the overnight rate could be in triple digits while the three-month rate could be in the teens. One of the tools in every central bank’s arsenal is the ability to ratchet up overnight interest rates in order to crack down on speculative activity; again, there’s absolutely no reason why that kind of action should result in higher interest payments on government debt.

Finally, it seems a little bit weird for Treasury rates to be linked to themselves, which is the other obvious alternative: using the three-month Treasury yield, say, as the reference rate for a longer-dated Treasury FRN would set up all manner of odd arbitrage trades with no real underlying value.

If a country is borrowing in someone else’s currency, then I can absolutely see why floating-rate notes can make a lot of sense for both issuers and investors. But the U.S. borrowing in its own currency? I really don’t see it. It might well provide some nice profit opportunities to the dealers who sit on Sifma’s Treasury Borrowing Advisory Committee. But I’m far from convinced that Treasury should listen to them.