Opinion

Felix Salmon

Counterparties: How to fix libor

Sep 28, 2012 21:55 UTC

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The Wheatley Review is out. No, that’s not an obscure literary magazine – it’s a British regulator’s proposal to overhaul Libor, everyone’s favorite manipulated benchmark interest rate. In June, Barclays agreed to pay a $470 million fine for manipulating Libor.

Libor is calculated daily based on banks’ own reporting of their borrowing costs, which, of course, left it open for manipulation. If banks report high borrowing costs, the markets can get spooked and think they’re in trouble; report artificially low borrowing costs, like Barclays did, and your traders could make millions.

Enter Martin Wheatley, who’s the managing director of the UK’s Financial Services Authority and wants to push “the reset button on Libor”. The new Libor will no longer be overseen by the inherently conflicted British Bankers’ Association. Say goodbye, in other words, to that secret Libor committee of bankers meeting in undisclosed locations. Manipulating Libor will now also be a criminal offense, and Libor will be simplified to 20 rates from 150. Also, Libor will be more closely tied to real lending transactions whenever possible.

All of this seems perfectly sensible and drew praise from Bloomberg and Breakingviews’ George Hay. Simone Foxman likes the proposal because it restores Libor to its original state of a “high-brow measure of interbank lending”. To Matt Levine, who’s done terrific work on the subject, the guidelines for what counts as a real transaction are vague enough that it’s still a matter of “ehhh, figure out the right Libor and write it down.” But Wheatley does get the incentives right:

The Wheatley Review doesn’t blow up the $300 trillion of contracts referencing Libor; it just gently nudges banks away from them. Now they know that judgment-based Libors will be subject to a lot of scrutiny and criminal penalties, so they have every incentive to come up with a better system that avoids jail risk for them – but that also is efficient and trustworthy enough for the market to adopt.
Levine thinks the market (read: bankers) are the best group to come up with the correct Libor numbers. Floyd Norris, on the other hand, is skeptical: Banks are still submitting unrealistic bids, he writes, citing CFTC Chairman Gary Gensler’s recent testimony. Norris argues that Libor should be replaced with a “real” interest rate, something like the Fed’s overnight index swap rate.

In theory, that would prevent traders from chuckling over instant messages like “Nice libor“. – Ryan McCarthy

And on to today’s links:

Data Points
Since 1990, China’s GDP has quadrupled, but happiness hasn’t increased – NYT

Apple
Apple CEO to customers: “We are extremely sorry” – All Things D

Bad Data
Drug companies routinely withhold trial data when it hurts their bottom line – Guardian

Wonks
Meet the world’s worst central banker – Atlantic

Sinodependency
China’s economic slowdown is taking a brutal toll on Appalachian coal mining towns – WSJ

Depressing
Upward economic mobility is increasingly uncommon unless you are born “with wealth or particular talents” – National Journal

Crisis Retro
BofA just paid $2.43 billion to settle charges it hid losses at Merrill Lynch – DealBook
How BofA execs hid their losses – in their own words – ProPublica
BofA has paid $29 billion in settlement costs since 2009 – WSJ

Alpha
College students launch hedge fund with incomprehensible market-babble strategy – Hedgeco

Dept Of Sanitation
Treat banks like restaurants – and tell us where the rats are – Jonathan Weil

Oxpeckers
“Isn’t it glorious when editors stand up and take some blame?” – WaPo

Recovery
Jeff Gundlach’s art has been found “at an automobile stereo shop in Pasadena” – LAT

Innovation
New York: stuck with 1980s MetroCard technology – Capital New York

Primary Sources
Stress tests show Spanish banks are undercapitalized by 59.3 billion euros – Oliver Wyman

Politicking
The Postal Service is defaulting (again) because the House won’t act – WSJ

Tax Arcana
France is launching a 75% tax on millionaires – Quartz

Stuff We’re Not Linking To
The benefits of a more vigorously vibrating iPhone – Atlantic Wire

COMMENT

I moved to NYC from Chicago in 2005; the NYC transit payment system shocked me then, and seems to have made no progress since then.

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Art-loan datapoints of the day, Peter Brant edition

Felix Salmon
Sep 28, 2012 21:25 UTC

Miles Weiss and Katya Kazakina, of Bloomberg, have a fascinating article today about the art-finance activities of Peter Brant, who — like many big-time art collectors — is using much of his collection as collateral in order to borrow money. The Bloomberg report is pretty straight-down-the-line, however, which makes me suspect that they missed a rather more interesting story.

First up, there’s this:

Brant will also use part of the proceeds from the borrowings to finance the purchase of another major piece of artwork, the person familiar with the plans said.

Which is another way of saying that Brant is basically trying to put together a leveraged art collection, built on a combination of his own wealth, on the one hand, and borrowed money, on the other. That’s very dangerous, given that art by its nature doesn’t throw off any kind of interest or dividend payments. You can’t use cashflows from art to pay the interest on the debt used to buy it.

But then, more worryingly, we find this, a bit later on:

According to a separate September filing with New York state, Brant also pledged a 1963 Warhol work entitled “Merce” to Joseph Allen, his cousin and former business partner at White Birch. The 82-inch by 81.5-inch silkscreen of the late dance director Merce Cunningham sold in 1989 for about $2 million and is now worth $25 million to $35 million, said a person familiar with the piece who requested anonymity because the information is private.

I’m pretty sure the work in question is this one:

The piece is large, to be sure, and dates from the early 60s, which is the most valuable period in Warhol’s oeuvre. But an instantly-recognizable, iconic Warhol this is not. It’s smudgy, and monochromatic, and features Merce Cunningham — not exactly a household name, either in 1963 or today — with a chair on his back.

We don’t know, of course, how much money was paid for this painting in 1989: it wasn’t sold at auction. But there are some things we do know. For one thing, up through the end of 1987, the highest amount ever paid for a Warhol painting at auction was $660,000. In 1988, two paintings broke the million-dollar barrier, including Marilyn Monroe (twenty times), the first Warhol ever to sell at auction for more than $2 million. And in 1989, the year this painting was sold, there were three Warhols which sold at auction for more than $2 million: Shot red Marilyn, Liz, and Triple Elvis. Liz, of course, is Liz Taylor. All of these super-expensive Warhols were classic celebrity paintings.

If you had $2 million to spend and were in the market for a Warhol in 1989, you could have bought a large and colorful Race Riot, at Christie’s, for $1.76 million; or an enormous Flowers painting — twice the size of Merce — which sold at Sotheby’s for $1.54 million. Or even Double Elvis, which sold for $1.02 million. All of those would seem to be obviously more valuable paintings than Merce.

Merce is a pretty obscure work, which is why it’s hard to value. But we do have one public datapoint: in 1997, when Warhol works in general were maybe a tiny bit cheaper than they were in 1989, a smaller (35.5″ x 81.5″) Merce sold at Christie’s for a decidedly modest $112,500. To be sure, the bigger work will be more valuable than that. But not eighteen times more valuable.

And what about the idea that Merce is worth somewhere north of $25 million today? Well, there’s been precisely one Warhol sold at auction for more than $20 million in the past year, a Double Elvis which sold at Sotheby’s in May for $37 million. Go down the other Warhols which have gone for north of $20 million in recent years, and you’ll see a list dominated by Marilyns and Lizes and self-portraits, with a few iconic coke bottles and the like thrown in. Nothing remotely as dark or difficult or self-consciously Arty as Merce.

All of which is to say that you’d be well advised to take Bloomberg’s source, here, with a very large pinch of salt. I very much doubt that Brant actually spent $2 million on Merce in 1989, and I also very much doubt that it’s worth anything near $25 million, let alone $35 million, today.

But that doesn’t really matter, because Brant’s not selling it. Instead, he’s just borrowing against it. And when you borrow against art, you take it to a lender, and ask for a certain percentage of its value. It stands to reason that the numbers cited by Bloomberg are the numbers being used by Brant’s lender, who would seem to be Joseph Allen. Which means it’s entirely possible that Allen has lent Brant more than Merce is actually worth, thanks to a hugely overinflated valuation.

Not all Warhols have soared in value since 1989. Thomas Galbraith, of Artnet, put an index together for me of Warhol portraits of what you might call second-tier males: Joseph Beuys, Frank Stella, Sidney Janis, Bruno Bischofsberger, Miguel Berrocal, Gianni Versace, and Hartmut Stocker. He even threw Marlon Brando in there to sex things up a bit. And it turns out that every dollar you spent on one of those paintings in 1989 would be worth about $2.54 today. Which means that even if Brant did spend $2 million on Merce in 1989 — which seems improbable — fair value in 2012 would probably not be much more than $5 million.

What the Bloomberg story says to me is that Brant is playing all manner of weird games with his art collection, ascribing improbable values to certain works, and borrowing large sums of money against it to make it even bigger. Even as his “real” business — White Birch Paper Co — continues to struggle. And the lesson of this story, as far as I’m concerned, is that if Peter Brant comes up to you asking to borrow money against his art, treat the request very carefully. And don’t take anything he says at face value.

COMMENT

@Chris08, the simple answer is that the only people to become super-rich playing the art market are art dealers. Larry Gagosian, say. And I think the auction houses do send 1099s to their US consignors, but I can’t speak for all small dealers.

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Counterparties: The state of the economy, restated

Ben Walsh
Sep 27, 2012 22:23 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

Are you better off than you were 24 hours ago? The US labor market is, according to the Bureau of Labor Statistics.

The BLS released revised employment data that shows the US added 386,000 more jobs from January to March than previously thought. That variation, 0.3% of total nonfarm jobs, is exactly average: “the annual benchmark revisions over the last 10 years have averaged plus or minus three-tenths of one percent of total nonfarm employment”. This revision won’t be the last: another will be released in February 2013, covering all of 2012. But as Bill McBride at Calculated Risk notes, the preliminary revision we got today is usually “pretty close to the final benchmark estimate”.

US GDP for the second quarter of 2012 was also restated today. The Commerce Department announced the economy grew at a rate of 1.3% in the second quarter, a downward revision from the previously announced 1.7%, and below the first quarter’s 2%. The single biggest revision was in drought-hit farm inventories, and economists at Morgan Stanley expect agricultural output to “continue to be a drag on growth in the second half” of the year. The bad news, says the WSJ’s Paul Vigna, with a stall-speed economy, ”is that it’s exposed, and liable to be knocked over by any sort of exogenous shock” like the euro crisis, or a diplomatic crisis with Iran or China.

Today’s jobs revision was immediately pulled into the narrative of whether or not President Obama can claim net positive job creation since he took office (now, barring further revision, he can). As Jared Bernstein writes, that doesn’t change the fact that “we’re still way behind where we need to be to tighten up the job market”. And the GDP numbers show that growth is “still a slog”. – Ben Walsh

On to today’s links:

Housing
Why “it’s good to be a mortgage originator right now” – Sober Look

Charts
The value of the revolving door: political appointees and the stock market – Vox EU

Tax Arcana
How Romney used the gift tax to avoid millions in taxes with an “I Dig It” trust – Bloomberg
A record 1 in 5 households, and 40% under 35 years old, owe student debt - Pew Social Trends

New Normal
Lending is booming in Cedar Rapids, for some reason – WSJ
“For three years in a row, more people have been convicted of immigration offenses than of any other type of federal crime” - Chris Kirkham

EU Mess
Spain announces 40 billion euros in budget cuts and plans to draw down pension reserves to “cover some treasury needs” – WSJ

Popular Myths
“Meritocracy, at least as normally understood, does not exist and probably cannot exist in a free market” – Stumbling and Mumbling

Regulations
The United States is way behind the rest of the world in cracking down on high-frequency trading – NYT

Sinodependency
North Korea has secretly sold more than 2 tons of gold to China to make up for a currency shortage – China Post

Oxpeckers
What the new NYT public editor reads – Atlantic Wire
“Social ad units” or no, the Web media economic model is still broken – David Pakman

WTF
1,000-plus Nigerian women stranded at the Saudi airport because they weren’t accompanied by men – Raw Story

Wonks
Bring back Build America Bonds – Bloomberg

Inequities
“Tech plays a role in structuring” the divide between rich and poor – Alexis Madrigal

COMMENT

The state of the U. S. economy can be described with one word, “fear”. The average citizen’s real income has dropped and his/her insecurity and fear has risen. The result has been anemic demand in general and almost no demand for long term consumption items like houses. A similar situation exists for businesses as they hoard cash and invest only cautiously. Consumers will go out to dinner and pay for their expensive cell phone bills but don’t have the confidence to make lifetime investments. Until our leaders put us on a sustainable path, the fear will be holding back the recovery.

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The caprice of publishers

Felix Salmon
Sep 27, 2012 12:36 UTC

TSG and Edward Champion have found a flurry of lawsuits brought by Penguin various authors who never delivered the books they promised. The lawsuits are asking for the authors’ advances back — but they’re also asking for interest, at pretty high and arbitrary rates.

Going down the list, Penguin is asking for $2,000 in interest from Rebecca Mead, on a $20,000 advance: that’s 10%. Marguerite Kelly is being asked for $5,000 in interest on her $25,000 advance, which is 20%. Lucy Danielle Siegle, Bob Morris, and Deborah Branscum are also being asked for 20% in interest, Elizabeth Wurtzel is at 25%, Jamal Bryant is at 24%, Carol Guber is at 26%, Herman Rosenblat is at 33%, and the Reverend Conrad Tillard is being asked for 35% on the unrepaid portion of his advance. Meanwhile, John Dizard is being asked for 45% in interest, while Ana Marie Cox is being asked for a whopping $50,000 in interest, which is 61.5% of her $81,250 advance.

There are two ways I can think of to justify the enormous range here. The first is just that the contracts were written differently. But if you look at the contracts in the lawsuits (for instance, in the filings for Cox, Wurtzel, Mead, Rosenblat, and Tillard), there’s no mention of interest or interest rates at all.

The other potential justification is that the interest has been accruing over time, and that the authors being asked for the highest interest rates are those who are most behind on their obligations. But that doesn’t hold up either. Wurtzel, for instance, signed her contract in February 2003, and Penguin asked for its $33,000 back in October 2008. If you annualize the interest she’s being asked for, it comes to 2.4% per year if you date the obligation back to 2003, or, alternatively, to 5.8% if you date it back to 2008.

Cox, by contrast, signed her contract much later, in January 2006, and Penguin asked for its money back a little earlier, in August 2007. (Penguin’s clearly a lot less patient when it comes to Cox than when it comes to Wurtzel.) The interest Cox is being asked for works out at 9.2% per year using the earlier date, or 12.1% per year using the later date.

In other words, there’s really no rhyme or reason whatsoever to the interest rates being demanded from these authors. And there’s a reason for going through this exercise: it reveals just how capricious and arbitrary Penguin is being, here. One book agent, Robert Gottlieb, immediately responded on the record, commenting on TSG that “if Penguin did this to one of Trident’s authors we could cut them out of all our submissions” — and you can be quite sure that Penguin did consider the agents of the authors in question before taking this course of action.

Publishers have a lot of power: they can reject a book, and ask for the author’s advance back, just if they say they don’t like the way that it’s written. That $325,000 advance they gave to Ana Marie Cox is certainly a lot of money, but most of it was never paid out, and if Cox’s star waned between the time that the deal was signed and the time that the book was due, Penguin could and did quite quickly move to make it very clear that they didn’t want the book after all — and that they did want their $81,250 back. Regardless of how much work and time and money Cox had invested into the book up to that point.

So while on the one hand it’s reasonable for publishers to ask for their money back if they never got anything in return, on the other hand the incredibly arbitrary nature of these suits — who gets one, who doesn’t, who gets asked for a little interest on top, who gets asked for lots — only serves to underscore the sheer unpredictability inherent in the publishing industry. You might think that you’ve hit the jackpot when you score a massive-sounding book advance. But in fact you’re just embarking on the toughest and most volatile part of the entire process.

COMMENT

Oh, and I want to add, I don’t have a lot of sympathy for authors who sign big-money contracts and don’t deliver.

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Sheila Bair against the world

Felix Salmon
Sep 27, 2012 00:16 UTC

American Banker’s Donna Borak has found the juiciest bits of Sheila Bair’s book yet — and it turns out to be buried in, of all places, the chapter on Basel III. Bair’s backstory to the September 2010 Basel III announcement is full of insider gossip and score-settling, and from reading Borak’s account I’d definitely class Bair as a dubiously reliable narrator. But her story is fascinating, all the same.

For one thing, Bair reveals, Tim Geithner involved himself quite deeply in Basel III negotiations. Bair can’t stand Geithner, and ascribes malign intent to everything he does. Geithner asks questions about Basel III without explicitly saying what his own opinion is? “It wasn’t clear whether Tim was trying to build consensus among the U.S. regulators or trying to stir the pot.” Geithner agrees to push for higher capital standards — exactly what Bair wanted all along? Well, that’s just his way of trying to marginalize her:

Bair sees the entire episode as a power play by Geithner. She argues he was trying to blow up the meeting between international regulators so that the issue would be kicked higher to the Group of 20 finance ministers who were set to meet in November. If the G-20 took over negotiations, Geithner would be leading the U.S., not Bernanke. The FDIC would have little say in the final number.

This simply isn’t credible. For one thing, Geithner just isn’t that Machiavellian: his biggest weakness is that he isn’t political enough, rather than that he’s some kind of master puppeteer. But beyond that, it also isn’t credible that the BIS and the world’s central bankers would ever cede the final decision on Basel III to a group of finance ministers. The central bankers might have found it hard to come to agreement, but they were technocrats working quietly to come to agreement on something very, very complicated. Basel III was a quiet victory: it came together, in the end, because it wasn’t politicized by finance ministers. The technocrats in Switzerland always knew that if Basel III were given to the G20 finance ministers, it would never go anywhere. And so they would never do that.

But Bair doesn’t see it, because she’s not one of life’s central bankers: she’s far to noisy and aggressive and opinionated. She’s a guns-blazing kind of negotiator, and seems to think of central bankers in general, and American central bankers in particular, as meek and pathetic:

U.S. regulators had trouble convincing French and German officials to go along with the idea.

In part, this was due to weak leadership from the Fed, Bair said, criticizing Pat Parkinson, the central bank’s lead negotiator, for not speaking up more.

“The Fed representative was supposed to be the head of the U.S. delegation, but Pat hardly ever spoke up,” Bair writes. “He talked a good game when he met with us, but when it came to engaging the French and Germans during the Basel Committee discussions, he was reticent.”

Similarly, Bernanke appeared reluctant to weigh in at the meetings of the Group of Governors and Heads of Supervision, a collection of the principals of international regulators, in part because of his status.

“As the head of the world’s largest central bank, he didn’t want to get down into the fray, which I understood,” Bair writes.

Dudley and Tarullo, meanwhile, also “spoke with frustrating rarity.”

“I didn’t know if they were just intimated by mixing it up with the French and Germans or whether I was being gamed and they didn’t really want reform,” writes Bair.

Again, this is about as uncharitable as it’s possible to be. The thing about being America, in any kind of international negotiations, is that you’re America. You don’t need to speak loudly: frankly, you don’t need to speak much at all. Everybody knows what your position is, and most of the time, if you just sit there and say nothing, everybody will ultimately come around and do what you want, just because it’s what America wants. Getting tougher capital standards is harder than, say, getting Jim Kim to be the new president of the World Bank, but the general principle is the same: what America wants is the base case scenario, and is likely to be what ultimately gets done. And if America shouts loudly about what it wants, that is unlikely to help and actually quite likely to hurt matters.

Bair has always come across as someone with a bit of a persecution complex: she has a tendency to think of herself as the sole defender of what is good and true, even as the rest of the government allows itself to get captured by the rapacious financial services industry. And of course there’s some truth to that: she’s absolutely right that the OCC, in particular, was an utterly toothless regulator which could always be relied upon to do whatever was wanted by the banks it was supposed to be regulating.

But it’s really not helpful, let alone accurate, to ascribe malign intent to any and every public servant you disagree with. Bair had a relatively narrow job — to make sure that banks didn’t fail, leaving her FDIC on the hook for untold billions of dollars in deposit guarantees. She fought her corner aggressively. But other people, including Ben Bernanke and Tim Geithner, had different jobs, and looked at the decisions being made, especially during the crisis, in different ways.

What’s more, it’s entirely natural that Geithner, who moved straight to Treasury from the presidency of the New York Fed, would take an interest in Basel III: after all, the New York Fed generally provided most of the frontline negotiators hammering out details far from the view of principals like Bair. And, it’s worth noting, the New York Fed was actually very aggressive in the Basel negotiations — much more aggressive, actually, than the higher-level negotiators from Washington. That was the culture Geithner came from, and if he was more sympathetic to Citi and BofA than Bair was, he was also well aware that the tougher the capital-adequacy standards, the better the competitive position of US banks in general, vis-a-vis their woefully undercapitalized European counterparts.

Geithner has only a few more months left in his job; once he leaves, he will surely be approached with many juicy offers from publishers. I have a feeling that discretion will win out, and that he’ll choose instead to float effortlessly into the world of grey financial eminences. But if he does choose to engage with Bair, expect sparks to fly. I’d give very good money to read his chapter on WaMu.

COMMENT

“[Geithner's] biggest weakness is that he isn’t political enough, rather than that he’s some kind of master puppeteer.”

This is just horse shite, Felix. You know better. If you don’t believe me, ask Brad DeLong, who was championing Timmeh even back when you knew better and thought then that it was a positive thing that Geithner “was never on the losing side of an argument” in the Clinton White House.

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Counterparties: The never-ending story of the Euro crisis

Sep 26, 2012 22:18 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 

The pattern of Euro crisis flare-ups is getting very familiar:

Step 1: News of political turmoil in ailing European Country X raises questions about their dedication to austerity. This is often be accompanied by missing deficit targets, riots and/or burgeoning political change.

Step 2: The bond market freaks out, which raises borrowing costs for European Country X. Wonks, politicians and pundits quickly chime in.

Step 3: The can is thoroughly kicked down the road. Concessions are made for Country X, negotiations are held, quotes are given/intentions leaked.

Step 4: After some period of time, the crisis appears again.

Spain, like Greece, is is back in the Euro crisis spotlight today, as the country is gripped by massive protests over budget cutbacks and rising borrowing costs. Greece, of course, has been through this process before; Spain has now proceeded to step 2.

The world has been waiting for Spanish prime minister Mariano Rajoy to formally request an EU bailout. But, Rajoy appears to be in no particular hurry, even as analysts doubt Spain will meet its own deficit targets. Ahead of the release of Spain’s 2013 budget tomorrow, the FT cites uncertainty over whether Rajoy will impose harsh enough cuts to win the EU’s approval, using methods like freezing pensions and raising the retirement age. (Then there’s the minor worry that an entire region of Spain wants to secede). (See step 1)

Predictably, European markets tanked and yields on Spanish 10-year bonds jumped to back toward the danger zone of 7%. Nouriel Roubini and Bill Gross were quick to prognosticate on what’s next; just as quickly, Rajoy offered the perfunctory we-are–totally-committed-to austerity comments. (See step 2).

But how will Spain ever get to Step 3? Bloomberg wonders if Rajoy is simply playing a game of bailout chicken with Italian prime minister Mario Monti — forcing Italy to request a bailout first, the thinking goes, would mean a greater leverage and a better deal for Spain. Joe Weisenthal points to one analyst who thinks Rajoy’s new budget will be impose much of the austerity burden on regional governments.

Rajoy, in an interview with the WSJ, seemed relaxed: “I can assure you 100% that I would ask for this bailout.” Asking for that bailout, though, will mean imposing even harsher cuts on the masses who are taking to the streets of Spain. (Approximately 25% of Spain’s citizens are unemployed. Eco Diario shot this gripping footage of a Madrid cafe owner by making a peaceful stand against riot police).

This puts Rajoy in that familiar European position, caught between serving his citizens and bowing to the EU’s bailout requirements. As a recent Goldman Sachs report put it : “The more the Spanish administration indulges domestic political interests … the more explicit conditionality is likely to be demanded.” — Ryan McCarthy

On to today’s links:

Liebor
A British banking group may give up control of everyone’s favorite rigged interest rate – Dealbook
“Our six-month fixing moved the entire fixing, hahahah” – Bloomberg

Charts
The long decline of labor – Felix
Where uninsured Americans live – Atlantic Cities

The Fed
We’re falling “deeper into permanent zero bound territory” – Tim Duy
The Fed’s latest move is helping bank profit margins, not homeowners – Bloomberg

Apple
Apple could have easily waited another full year to improve its crappy map product – The Verge
Foxconn pulls in just $8 for every iPhone it builds for Apple – Slate

Alpha
Everything you think you know about risk and return is wrong – Falkenblog
Smartphone patents are the new asset class – Dealbook

Amaranth-esque
Commodity traders, now systemically important institutions – FT Alphaville

Economics
“56% percent of women said contraception had allowed them to support themselves financially” – BuzzFeed

Oxpeckers
Penguin sues to recoup advances from writers, plus random amounts of interest – The Smoking Gun

Strange Bloomberg Headlines
Grads Shun Italy Disease Proving Dirty US Hands Work – Bloomberg

Plutocracy Now
Being rich and powerful turns out to not actually be that stressful – LAT

Wonks
Why the US is already in a recession – Lakshan Achuthan

Be Afraid
100 million people (16,000 people per day) will die if we do nothing about climate change – Reuters

Investigations
11 different U.S. agencies have investigated HSBC for money laundering charges — and they can’t get along – Reuters

Troubling
Tesla is burning through cash and missing production targets – Dealbook

Awesome
“My name is Joe Biden and I’ll be your server” – The New Yorker

The Poway deal gets fishier

Felix Salmon
Sep 26, 2012 14:18 UTC

Remember Poway, and the exorbitant interest costs it was paying on its debt? At first glance, those costs were so huge because of the way the deal was structured: there were no interest or principal payments before 2033, and the final payments weren’t due until 2051.

In reality, however, there was something else going on as well: while Poway claimed to have only borrowed $105 million, they were lying about that: in fact, they borrowed $126 million, taking a $21 million kickback on top of the $105 million they were ostensibly borrowing.

As such, in reality they’re “only” paying $855 million of interest on a $126 million principal amount, rather than the $876 million of interest on $105 million in principal that we originally thought. But this is not a good thing. In fact, Will Carless — who’s been pushing this story hard, and has done a huge amount of work in reporting and explaining it — makes a very persuasive case that it’s illegal.

After all, the whole point of pushing the repayment dates back to 2033 and beyond was that Poway had already maxed out everything it was allowed to borrow before that. “When voters allow a school district to issue bonds,” Carless explains, “they set what appears to be a strict dollar limit on how much can be borrowed”. But somehow, that cap on the amount the district can borrow does not seem to be well defined. Somewhere along the way, definitions got fuzzy.

It should be pretty simple, this question of how much someone has borrowed: you just look at how much money they received when they did the borrowing. And to determine how much interest they’re paying, you take all the money they repay, and subtract that initial amount.

But Poway isn’t doing that. Instead, it’s defining the amount that it’s borrowing as the face value on the bonds. Set a bond with a low face value, and you get to borrow much more than face value, without going over the borrowing limit set by voters.

And that’s exactly what Poway did. By artificially jacking up the interest rate on the bonds — and the longest-dated bond, remember, had an interest rate of a whopping 7.2% — Poway managed sell the bonds at a substantial premium to par. That action, according to a formal letter filed by the California attorney general’s office, was not legal. The AG’s office didn’t prosecute Poway, on the grounds that doing so would cause Poway to incur substantial litigation costs. But it explicitly said that Poway’s behavior was unlawful, and that if this kind of thing became a habit, then it might indeed end up being prosecuted.

What’s more, if Poway sold these bonds at 120 cents on the dollar, there’s no way it could buy them back at 105 cents or less, as I suggested a few weeks ago: unwinding this deal is going to be expensive. Not $850 million expensive, of course, but tens of millions of dollars all the same. I was going on the fact that Bondview shows the bonds trading at about 101 cents on the dollar, but there might be something weird going on there.

In any case, the more we learn about this Poway bond, the smellier it gets. And of course officials aren’t talking:

“The simple fact is that [Poway Unified] did not borrow any more funds than those approved by the voters,” Superintendent John Collins wrote in an email on August 29.

Collins wouldn’t elaborate on this position. He and the Poway school board did not respond to several requests for interviews. Nor did Poway officials agree to interviews with their legal or financial staff.

Well done to Carless for pushing on this; I hope his piece causes enough of a stir that Poway is going to be forced to answer for its actions in some forum. But in the meantime, it would be great to get some clarity on which bonds in particular ended up selling at well above par, and where those bonds are trading today. If, that is, they’re trading at all.

COMMENT

I agree with MrRFox, and I don’t know why a state legislature would/should allow any local or municipal government to issue long-term, zero coupon bonds. The temptation is too great for politicians to promise something today while pushing payment into the distant future.

The taxpayers of this school district several decades out – a group whose overlap with people currently living there I would expect to be limited – will be saddled with the full cost of building and expanding schools today, including both principal and accrued interest. As an extra “bonus” for these future taxpayers, by then the buildings built today ought to be in need of replacement or major renovation, so they will get to pay for that also.

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Chart of the day: The long decline of labor

Felix Salmon
Sep 26, 2012 10:21 UTC

2012-13-1w.gif

This chart comes from Margaret Jacobson and Filippo Occhino at the Cleveland Fed, and it’s reasonably terrifying — yet another one of those charts where the trend is down and to the right, and where it’s only gotten worse since the end of the recession.

What you’re looking at here is the share of total national income which is accounted for by labor — a measure that includes wages, salaries, bonuses and things like pension and insurance benefits. Everything else is capital income: interest, dividends, capital gains. There are two ways of measuring this, which is why there are two lines; both of them are telling the same story.

The fascinating thing to me, here, is what has happened since the crisis. Over the past three years or so, wages and salaries have been rising steadily, while interest rates have been stuck at zero. It’s never been harder to make income from capital, while incomes for people with jobs have actually kept on rising. And unemployment, while still high, has been coming down.

Given all that, it would stand to reason that the share of national income going to labor should be rising, not falling. Labor incomes are going up, the number of employed people is going up, and income from savings is going down. And yet! It turns out that people with capital are so rich, and getting so much richer, that it’s not even close. All that belly-aching about the plight of savers on fixed incomes in a zero interest-rate environment? Well, you don’t see it in these numbers. Looking at this chart, if you were given the choice between having money and no job, or having a job but no money, it’s not obvious which one to go for.

Of course, as the Cleveland Fed paper shows, a lot of the story here is about rising inequality. But the more powerful, if less obvious, story, is just how entrenched capital income has become in the US economy. As recently as 2000, it was at levels more or less in line with the historical average. And then, something big happened. During the Great Moderation — when yields fell on all capital asset classes — capital income went up sharply. Then the crisis happened, a classic case of a dog not barking: you’d expect capital income to have fallen enormously, at least for a year or two, but it didn’t, it just stopped rising. Most recently, in the wake of the financial crisis, capital income has been soaring again.

There’s a big lesson here for anybody serious about fiscal policy, too. (Paul Ryan, I’m looking at you.) As the labor share of income goes down and the capital share of income goes up, the only way that we can stop tax revenues from plunging disastrously is to tax capital income at least as much as we tax labor income. By contrast, the Ryan plan proposes taxing capital income at zero — putting ever more of a burden on working Americans, while giving unearned income a massive tax break the rich really don’t need.

There are big global forces driving this chart, most importantly the way in which labor is becoming increasingly global and fungible. Labor income has been declining for a good 25 years, and the only substantial countertrend was the dot-com bubble. The trend is a bad one, and it’s getting worse. And while I don’t see any policies, on either side of the aisle, which really try to address it, the fact is that Republican policies seem explicitly designed to exacerbate it. Think of capital income as the money flowing to “job creators”, and the chart is very clear on that front.

COMMENT

More @mlnberger than Felix, note that 1) individuals have continued to see their wages increase over the period of their working lives; each cohort is seeing lower wages with the requisite delay, and 2) since the guy before you mentioned demographics, it’s interesting to note that the incomes of different racial and ethnic groups have gone up faster than the overall level of income as the lower-income race/ethnicity groups have increased their share of the population and whites in particular have decreased their share of the population.

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Counterparties: Is QE3 working?

Ben Walsh
Sep 25, 2012 20:46 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 

Last week, noted inflation hawk and Minneapolis Fed President Narayana Kocherlakota changed his tune and spoke out strongly in favor of keeping interest rates extraordinarily low until at least mid-2015. Now, the president of the Philadelphia Federal Reserve, Charles Plosser, has joined his Dallas counterpart in criticizing the Fed’s latest round of monetary stimulus:

I do not believe that lowering interest rates by a few more basis points will spur further growth or higher employment. Business leaders who have talked to me continue to cite uncertainty about fiscal decisions — here and abroad — as the greatest hindrance to hiring and investment … the central bank can do little to alleviate them.

And as far as households are concerned … They are deleveraging and saving more. It seems unlikely that a small drop in interest rates will overturn the strong desire to save and, instead, induce households to spend more. In fact, driving down interest rates even further may encourage consumers to save even more to make up for lower returns.

Adam Davidson joins Plosser in diagnosing rising savings and a lack of household spending as a key dynamic holding back the economy. Ultimately, though, he comes down on the side of monetary action, despite the risks of unintended consequences. Similarly, Tim Duy doesn’t believe the severity of the crisis should be an excuse for inaction. “Bottom line,” he writes, “policy is effective even in the aftermath of a financial crisis. Don’t let policymakers fool you into believing otherwise”.

The Washington Post’s Neil Irwin plays QE3 professor and gives Dr Bernanke an A- on inflation expectations but only a C+ on mortgage rates. The problem, Irwin writes, is that markets had already priced QE3 into mortgages rates. Now banks are “cutting the mortgage rates they charge customers only gradually; if the banks slashed rates too fast, they would be overwhelmed by the demand from Americans looking to refinance or buy a home and would not be able to handle the load”.

QE3 is also weakening the dollar relative to the euro, according to Barclays’ research team. But that’s not necessarily a bad thing: It makes US products more attractive on the global market. President Obama is unlikely to meet his goal to double exports by 2015 so long as he’s presiding over a strong dollar. And, as Ezra Klein has pointed out before, the Fed knows that “although in the long run, a healthy, productive economy will lead to a stronger dollar, getting there probably requires a temporarily weaker dollar”.  – Ben Walsh

On to today’s links:

It’s a Fair Question
Can Facebook make money without being creepy? – Atlantic

Awesome
An amazing illustrated guide to econo-trolls – Noahpinion

New Normal
Healthcare costs are once again growing faster than the economy – WaPo
Those crazy young people responded to the financial crisis by saving more – WSJ
Lagarde: the world’s central banks are sending “big policy signals in the right direction” – IMF

Liebor
Instant messages show RBS managers condoned Libor fixing – Bloomberg

Alpha
Jeff Gundlach’s “emotions are pretty raw right now” after having $10 million in art stolen from his home – Kevin Roose
A different kind of 1%: The people who need very little sleep – WSJ

Oxpeckers
Interior designer or deputy assistant secretary of state? A classic Vogue correction – Huffington Post
The smartest take on Quartz’s tablet-centric launch – Nieman Lab

Usury
What’s worse than payday loans? Payday loans plus prepaid debit cards – WSJ

Be Afraid
The worldwide bacon shortage is now unavoidable – LAT

EU Mess
Why Merkel backed Draghi’s rescue plan: German banks have $139.9 billion in exposure to Spain, the highest in Europe – WSJ

Inefficient Markets
Traders will pay for astrological market research – Heidi Moore

COMMENT

Regarding Usury people should know why and who

Usury used to be illegal in the United States but it was “decriminalized” in 1980–the dawn of financial deregulation. A Democratic president and Congress repealed all interest-rate controls and the federal law prohibiting usury. Thirty years later, American society is permeated with usurious practices–credit cards charging 30 percent and higher, subprime mortgages and other forms of predatory lending, the notorious “payday” loans that charge desperate working people an effective interest rate of 500 percent or more. Businesses, especially smaller firms, are also prey to usury in less direct ways.

http://www.thenation.com/article/trouble -democrats?page=full#

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