Felix Salmon

When should we aid Detroit?

Felix Salmon
Jul 29, 2013 11:00 UTC

John Cassidy and Steve Rattner agree that the destruction which has been visited upon Detroit, in recent decades, is at least as devastating, and as worthy of federal support, as the chaos which was wreaked by Hurricane Sandy in richer parts of the country.

Cassidy and Rattner disagree, however, on how they would like to spend Uncle Sam’s billions. Rattner, you won’t be surprised to hear, concentrates on financial engineering, and he singles out Detroit’s pension plans: he calls them “grossly underfunded” (which is highly debatable), and calls for “shared sacrifice by creditors, workers and other stakeholders”. Beyond that, he wishlist seems to consist simply of the “$1.25 billion in reinvestment spending that Detroit’s emergency manager, Kevyn Orr, has included in his proposed budget”.

Cassidy, on the other hand, goes further:

What is needed is a comprehensive and adequately funded plan to stabilize the city’s finances, repair its public infrastructure—almost half the street lights don’t work—and raze its semi-abandoned neighborhoods, consolidating its population into a smaller, more manageable area. (At the moment, Detroit sprawls across a hundred and thirty-nine square miles, more than Boston and San Francisco combined.)

What Cassidy is talking about here, under the happy euphemism of “consolidation”, is a massive program of destruction, displacement, and forced relocation — one affecting hundreds of thousands of families. It’s the kind of thing one can maybe imagine in China, or possibly even in New York City circa Robert Moses — but both of those examples involve acting with the tide, as it were, a government helping to expand cities which are growing fast and which will in any case require a vast new infrastructure.

In Detroit, by contrast, it’s much harder to orchestrate any kind of big rebuilding program: it’s much easier to tame and shape existing economic forces than it is to try to conjure them up from scratch. And while there is a certain degree of gentrification in downtown Detroit, it’s on such a small scale, compared to the city as a whole, that its role in any city-wide urban regeneration plan is always going to be limited.

Rattner is, depressingly, entirely correct when he says that “while logical, the potential for downsizing Detroit is limited because the city’s population didn’t flee from just one neighborhood”. Detroit is too big; it must get smaller; it can’t get smaller. That’s the real tragedy of Detroit, and it’s one that no amount of federal funds can solve.

It can seem heartless for Washington not to step in and help save Detroit. Cassidy’s plaint is clear and simple: “Shouldn’t one of America’s iconic cities be rebuilt, rather than picked apart? If so, it is going to require the leadership, and the financial support, of the federal government.” It’s infuriating to watch the government stand idly by as Detroit sinks into a fiscal and economic morass. But at the same time, the government should never act on the basis of “something must be done; this is something; therefore let’s just throw some money at the problem and hope for the best”. Whenever that happens, failure is pretty much guaranteed.

Over the long term, there are good reasons to be bullish on Detroit. North America is becoming increasingly urban, which should benefit all of its cities. Michigan, more broadly, is one of the few parts of the world which will see a real benefit from global climate change, and it needs a healthy Detroit to thrive. To the city’s east and west, both Toronto and Chicago are booming, and in general the big US border cities — Seattle, Detroit, maybe Buffalo — can’t help but benefit from Canada’s continued oil-fueled expansion.

But for the time being it’s hard to anticipate exactly how those forces are going to align to reshape Detroit. The city’s emergence from bankruptcy should absolutely be structured so that the city has every opportunity to grow and thrive over the long term. But it’s not necessarily the best possible time for the federal government to start providing the kind of “leadership” which, as far as I can tell, has been asked for by neither Detroit nor the state of Michigan.

The lesson of Japan’s fiscal mega-projects over the past 20 years or so is that even with effectively unlimited funds, it’s impossible for government alone to change the economic destiny of a major city. The federal government should absolutely keep a close eye on the economy of Detroit, and stand ready to help if and when such aid will have the greatest positive effect. I just find it hard to believe that right now is that time.


Washington cannot bail out Detroit. Discretionary spending is permanently sequestered, and bailing out Detroit is not high on John Boehner’s wish-list. Plus the Us has been “investing in our cities” for 50 years, and Detroit is the outcome. Paging Lyndon Johnson.

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How not to compete with payday lenders

Felix Salmon
Jul 26, 2013 17:26 UTC

I’m in the UK at the moment, where it’s quite amusing to see the amount of attention paid to national institutions for which there is no American equivalent. Obviously, there’s the way in which a woman having a baby became front-page news for days on end, generating astonishing quantities of coverage despite the fact that all the facts could be summed up in a single tweet. And then, on the financial side of things, you have the Archbishop of Canterbury, Justin Welby.

Yes, financial. The head of the Church of England gave a long interview to a magazine called Total Politics, and if you get through the first 3,000 words or so, you’ll eventually find two paragraphs on the subject of payday lending. The archbishop says he would like to compete with High Street payday lenders, helping to build up a network of “credit unions that are both engaged in their communities and are much more professional”.

This incredibly vague plan, which even Welby admits is a “decade-long process”, was treated as a major announcement by the UK press: the BBC covered it at great length, and got reactions from senior politicians of all stripes; AFP ran a story under the headline “Church of England declares war on payday loans firm”; the Economist weighed in on historical parallels; and the FT flooded the zone, providing a news story (“Church of England to take on payday lenders”), a video, and a column from John McDermott.

This is all pretty impressive given that what we’re talking about here is the ultimate in vaporware. Welby didn’t really announce anything, there is no real plan in place for anybody to compete with the payday lenders, and in fact, if you read what he says carefully, it’s good news, not bad news, for those he is criticizing. According to Welby, when he met the head of Wonga, the biggest payday lender in Britain, the bishop said to the businessman that “we’re not in the business of trying to legislate you out of existence, we’re trying to compete you out of existence”. Which must have been music to Wonga’s ears — since competition from the Church is the last thing Wonga is worried about. The big risks, for Wonga, are legislative.

The fact is that Welby’s plan “to fight capitalism with capitalism”, in McDermott’s words, is doomed to fail. I’m a big fan of credit unions and of non-evil alternatives to payday loans, but the only way to beat Wonga, and the payday lenders more generally, is to make their actions illegal. You could set up a credit union at every church in the country, offering vastly better deals than anything available from Wonga, and Wonga wouldn’t bat an eyelid — because the first thing you learn, when you study payday lenders, is that they don’t compete on price.

Payday lenders do compete with each other, quite aggressively, but they do so on convenience first, and friendliness second. If you want to be successful in payday lending, you have to be convenient above all; that means having welcoming storefronts which are open very late and at weekends, and it also means — in the case of Wonga — being incredibly easy to use from any smartphone. The way that the competition works is that they start with someone who needs cash; the company which can get that person the cash in the quickest and easiest manner will be the winner.

I can also tell you who the loser will be, in that race: a credit union which has limited hours; is based out of a church rather than the high street; which is staffed with do-gooders who want to give out Helpful Financial Advice rather than friendly young sales staff who just want you to take out as big a loan as possible; and which by its nature bundles its loans with a large dollop of paternalistic concern.

If payday lenders ever have to compete with credit unions, it will compete in much the same way as MP3s compete with vinyl. You can make the case that the latter has better sound quality, but the fact is that no one cares: convenience trumps everything.

Welby is in fact a legislator: he sits and votes in the UK parliament, where he has an important voice. If he’s decided that he doesn’t want to legislate payday lenders out of existence, then he has basically decided that he’s OK with them continuing to gouge the very Britons who can least afford such things. Because there is no way he’s ever going to be able to effectively compete with them.


The business model is this: Make the spread between lack of impulse control and your borrowing costs.

This business is a play on immediate gratitude, the inability to delay pleasure.

So Felix’s observation that they compete not on price, but on convenience and friendliness would seem spot on. The customer is buying the product to feed good/ avoid pain NOW.

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Don’t send Summers to the Fed

Felix Salmon
Jul 24, 2013 14:59 UTC

Quickly: can you name the only person to have served as both Fed chair and Treasury secretary? The answer is William Miller: he was Fed chair for 17 months in 1978-79, and Treasury secretary for another 17 months, in 1979-81. He was an unmitigated disaster as Fed chair, and his tenure at Treasury was undoubtedly more helpful to Ronald Reagan than it was to his boss, Jimmy Carter, in the 1980 election.

So I’ll say this for Larry Summers: if he is indeed going to become only the second person to hold both jobs, he will surely do better than William Miller. Still, if Obama picks Summers over Yellen, as Ezra Klein says that he’s likely to do, his choice will be enormously disappointing on many levels.

The first and most important reason for Obama to pick Yellen over Summers is that doing so would constitute a vote for the better candidate. There’s been a huge amount of commentary surrounding this choice, and it’s instructive to read all of it. Start with the pro-Yellen pieces: Bill McBride and Cardiff Garcia are particularly erudite and convincing that she has exactly what it takes to run the Fed right now.

Then, look at the pro-Summers pieces, such as they are. You’ll find much less in the way of arguments on the merits from the likes of Ed Luce and Tyler Cowen; instead, you’ll find talk about style and politics — talk which even Brad DeLong, a good friend of Summers’s, finds unconvincing.

Finally, it’s worth looking at the anti-Summers pieces, especially from Scott Sumner, although Noam Scheiber is worth reading too. (And, if you want, you can disinter a bunch of my old posts on Summers, such as this one, this one, this one, and this one.)

The upshot, from doing all that reading, is pretty clear. The arguments for Yellen are very strong; the arguments against Summers are strong; the arguments for Summers are weak; and the arguments against Yellen are all but nonexistent. (While there are lots of people who think that Summers should not be Fed chair, there’s pretty much no one who feels the same way about Yellen.)

As a result, if Obama picks Summers, it won’t be on the merits; instead, it will be on the grounds that Obama likes Summers, and is in awe of his intelligence. (Summers is, to put it mildly, not good at charming those he considers to be his inferiors, but he’s surprisingly excellent at cultivating people with real power.)

What’s more, the move would be a calculated snub to bien pensant opinion. Never mind the utter shambles that Summers made of Harvard, or the way he treated Cornel West, or his tone-deaf speech about women’s aptitude, or the pollution memo, or the Shleifer affair, or the way he shut down Brooksley Born at the CFTC, or his role in repealing Glass-Steagall, or his generally toxic combination of ego and temper — so long as POTUS likes Larry, and/or so long as Summers is good at working key Obama advisors like Geithner, Lew, and Rubin, that’s all that matters.

The choice of Summers would also be the clearest signal yet that Obama feels that he did what needed to be done to deal with the financial crisis, and that financial reform is, for the rest of his presidency, going to be a very low priority. Summers is a deregulator in his bones; he didn’t like the consumer-friendly parts of Dodd-Frank, and his actions have nearly always erred on the side of being far too friendly to Wall Street. He considers monetary policy to be largely irrelevant in a zero interest rate environment, and there is no chance whatsoever that he would take a robust leadership role with respect to the Fed’s other big job, which is regulation. If you want to repeat all of the Clinton-era mistakes of financial regulation, you can’t do better than appointing Clinton’s very own Treasury secretary.

Janet Yellen has all the makings of an excellent and prescient Fed chair — but she’s a White House outsider, and a woman. If Obama allows Yellen to be thusly disqualified, he deserves all the outraged dismay that will surely follow any Summers nomination.


The Chair of the Fed should not be a political appointment. The job demands multiple and sophisticated skills. As brilliant as Summers maybe – I doubt he understands banking regulation in depth – repealing Glass-Steagal in the context it was done shows this. On the other hand, while Sheila Bair knows how to assess the health of the financial system, she may not have a strong command of the tools for monetary policy. The Fed chair should be an insider, with the appropriate job training. Notice that it is not common for central banks to have that many roles in an economy. In Europe banking regulation is separated from the central bank activity, even in Britain. While Britain is not a member of the European monetary union, it follows Basel committee regulation delegates financial services regulation to the FSA. Even more reason to strengthen the importance of a career at the Fed by appointing an insider.

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The SEC’s important case against Stevie Cohen

Felix Salmon
Jul 21, 2013 12:43 UTC

Stevie Cohen is one of the greatest stock-market traders of all time. Indeed, there’s a strong case to be made that he’s the greatest. Cohen is not the greatest investor — he doesn’t really go in for buy-and-hold positions which steadily accumulate enormous value over decades. He’s not even the greatest hedge-fund manager: he doesn’t go in for the big macro bets (Soros vs. the pound, Paulson vs. mortgage-backed securities) which are the stuff of legend. Instead, he’s a trader, and while normal people pretty much understand what someone like Warren Buffett does, or what someone like John Paulson does, it’s much harder to understand what a trader does, or what differentiates a good trader from a bad trader.

Trading isn’t usually about making bets, and then cashing them in when things go as you thought they would. It’s more about understanding probabilities, seeing when securities are mispriced, taking advantage of fleeting arbitrage opportunities, being paid for providing liquidity to the markets (selling when others are buying, buying when others are selling), and, most importantly, “reading the tape” — understanding the way that money is flowing around the market, and how those flows are going to manifest themselves in securities prices.

Being a great trader is hard work: you’ve got to be constantly aware of subtle price actions in dozens of different markets and thousands of different securities. (Jim Cramer is a great example of a trader: he doesn’t have a deep understanding of any particular stock, but he knows where thousands of them are trading, and how their movements relate to each other.) What’s more, trading is hard to scale effectively. You need to be a certain minimum size in order to be effective, but there’s a maximum size too: you have to be able to get in and out of positions without moving the market so much in doing so that you end up erasing all of your profits.

Being a great trader is also increasingly difficult. 30 years ago, for instance, you could make surprisingly good money with very, very basic strategies. You could buy convertible bonds at issue, for instance, and hedge by shorting the underlying stock; or, even more simply, you could just pick a set of stocks and buy consistently at the bid while selling consistently at the ask. The buyers and sellers would pretty much cancel each other out, and you’d pocket the bid-ask spread, which, in the years before decimalization, was often substantial.

Today, however, all of those strategies have been arbitraged away by algorithms, and the result is that markets are faster and more treacherous than ever. Strategies which seem as though they’re work very well often have enormous and unforeseeable fat tails: look at the monster losses during the quant meltdown of 2007, for instance, or JP Morgan’s crazy London Whale trade.

And yet there’s still one thing which can scale, and which will never be competed away by algorithms, and where the upside is much larger than the downside: black edge.

Cohen has never been easy to invest with. He deliberately charges some of the highest fees in the industry — his 3-and-50 makes the standard 2-and-20 seem downright generous. And even then it has historically been very hard to get him to agree to manage your money. Cohen makes his fund inaccessible for a reason: he knows how hard it is to scale the astonishing results he’s been posting, year after year, and that at the margin, the bigger he gets, the lower the returns he’s likely to see.

But at the same time, there’s no way that he can run a $15 billion trading book on his own. He has roughly 1,000 employees, of which about 300 are investment professionals. And if you’re one of those professionals, you have one of the hardest jobs in the business.

The way that SAC works is that Cohen gives his individual traders, and teams, their own trading accounts, with millions or billions of dollars: the traders who make the most money get the biggest allocations. Traders get paid a percentage of the profits they make, which makes them compete against each other: in order to be successful at SAC it isn’t good enough to make good profits. Instead, you have to make better profits than any of the other traders — who themselves are some of the best in the business. If you can’t do that, you get fired. If you can do that, you get to manage ever-increasing amounts of money — plus, Cohen will mirror your positions in his own account, the largest at the firm, giving you a shot at extra profits over and above the ones generated by your own positions. In the immortal words of David Mamet, first prize is a Cadillac El Dorado. Second prize is a set of steak knives. Third prize is you’re fired.

While Cohen does still generate his own ideas, then, most of the time he outsources that function to his employees. There’s a relatively static allocation of capital between the various traders, but then there’s a dynamic overlay as well: Cohen “tags” the positions in his own account with the names of the traders whose trades they are, thereby giving every trader the opportunity to see his positions multiplied in size at any time. While his traders are moving money in and out of stocks, Cohen can be thought of moving his money in and out of his own traders’ positions. He’s not betting on stocks so much as he’s betting on individual employees, in one big zero-sum game.

As such, Cohen is much more than a simple employer/supervisor. He’s constantly sending clear and public messages to his traders, about what he likes, what he approves of, and what he disapproves of — and he’s sending those messages in the most unambiguous way possible, in the form of extraordinarily large sums of money. If he wanted to, he could withhold money, and even employment, from anybody who was working with black edge. Alternatively, he could manufacture a spurious layer of deniability, while actively encouraging, in terms of financial incentives, the one kind of trade which has the very best risk-adjusted returns.

The SEC’s decision to charge Cohen with failing to supervise his employees is, yes, a clever way to try to put together the most winnable case before the statute of limitations runs out. But it’s also a serious charge which goes straight to the main way in which Cohen makes his money. Cohen’s returns come directly from the way that he supervises and incentivizes his employees, and once you’ve read the complaint, it’s pretty clear that Cohen loves any trade which makes money, and has no particular compunctions when it comes to whether or not the trader in question is behaving in an entirely legal manner.

It’ll be interesting to see Cohen’s defense to these charges, but he has an uphill task ahead of him — especially given that the hearing will be held in front of the SEC’s own judge. The SEC has home-field advantage, here, while Cohen oversees a firm which has seen four different traders already plead guilty to criminal insider-trading charges. It’s good that the SEC has finally managed to charge Cohen personally, rather than just his traders. The only pity is that we’re still a long way from a criminal case. That might yet come, but I’m not holding my breath.


While the government can show a clear pattern of abuse by at least 3 of his 300 investment professionals, he can dump reams of legally justifiable securities research of why they entered and exited every one of tens of thousands of positions.

In my view this gets back to the difference Felix often points out between US and UK laws:

Did Cohen violate the spirit of the law by hiring well connected individuals, strongly encourage them to use and even create expert networks which by their nature were on the edge of the law while at the same time force them to sign ironclad code of conduct contracts swearing never to use insider information. Absolutely he violated the spirit of the law.

When you get to the technicalities none of it sticks to him. After reading the complaint I think he’ll walk if he is tried by a jury of his peers.

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from Shane Ferro:

HSAs: When your health insurance becomes a retirement account

Jul 18, 2013 18:11 UTC

A few weeks ago, we received an email from a reader who had some questions about his health savings account. The email raised two interesting questions: Are these tax-favored insurance products becoming retirement accounts, and, to quote the email, “does anybody regulate these clowns”?

On the first count, the answer is pretty clearly yes. The personal finance subsection of the web is overflowing with advice on how to, and whether you should, use an HSA as a retirement account.

Why HSAs?

Theoretically, HSAs are meant to be a way for you to use before-tax money to pay for your healthcare costs when you have a high-deductible plan (meaning your deductible is at least $1,200 a year for an individual or $2,400 for a family before your insurance benefits kick in). But they have morphed into something more than that, thanks to their triple tax advantage:

  • Your account contributions are pre-tax or tax-deductible.

  • All earnings, interest, and, yes, investment returns are tax-free.

  • Any withdrawals for qualified medical expenses are tax-free. Plus, once you reach age 65, all nonmedical withdrawals are taxed at your current tax rate, just like a traditional IRA. (If you withdraw money for nonmedical expenses before you’re 65, then there’s a 20% penalty.)

Investment returns? Indeed. It turns out that HSAs aren’t limited to cash. You certainly can put your money (restricted to $3,250 for an individual or $6,450 per family per year, plus an extra $1,000 a year if you are over 55) into an FDIC-insured savings account. State Farm offers such a product through State Farm Bank. But many companies offer a richly varied menu to suit any risk appetite: a company called Health Savings Administrators, for instance, gives you a list of of no fewer than 22 Vanguard funds to choose from, including funds devoted to small-cap stocks and “strategic equity”.

Wells Fargo offers both types of accounts. When you open an HSA at Wells Fargo, you put your money in an FDIC-insured deposit account that pays a tiny bit of interest annually. Once you have $2,000 in that deposit account, you then have the option to start putting money in a separate, non-insured HSA investment account, with various mutual fund options.

For anybody with high-deductible insurance, then, this is an attractive tax-free way to invest money in the stock market. It’s especially attractive to the young and healthy, since those people have a lower risk of having to tap their HSA to pay medical expenses before their money has had a chance to grow.

HSAs aren’t owned by your employer, or even connected to your insurance, so you can open one and keep it until you retire -- they are even listed in the code of federal regulations as retirement accounts. And so, while they were perhaps not originally intended to be a retirement account, that’s what they have morphed into.

Is having an HSA catching on?

As of January, there were 15.5 million people in the US with insurance plans that qualified them to open an HSA, up from 3.2 million in 2006. That said, it’s hard to find data on how many people actually have an HSA. There has certainly been a rapid rise in the number of employers who offer what the industry refers to as “account-based health plans”.

High deductibles pass much of the cost of medical expenses to the individual, and also avoid the 40% excise tax that the Affordable Care Act will introduce to high-value insurance plans. As the latest Towers Watson report on “Reshaping Health Care” puts it:

Account-based health plans (ABHPs) can be an important strategy for reining in costs in advance of the 2018 excise tax and facilitating the shift toward greater accountability from employees and more consumer-like behavior in their purchase of health care.

For people who need to make use of their health insurance often, ABHPs shift expense away from the employer and insurance company, and onto the individual. However, if you are healthy, ABHPs are great: their premiums are lower than other health plans, and if you don’t need to spend a lot on healthcare, your money has a chance to grow in your investment HSA account. Furthermore, HSA proponents argue, making consumers pay for more of their medical expenses will drive prices down as people put more effort into shopping for the lowest price for medical care.


But back to our reader’s second question on HSAs: Who are the regulators? The answer depends on what kind of account you have, and who is providing it. If your HSA is in a bank, in cash, then it likely to be FDIC-insured (State Farm, for instance). If you have HSA money in mutual funds, however, those investments are not insured (except in the case of a total bank failure, in which case the SIPC is there for you, probably). Mutual funds are regulated by the SEC.

Non-banks can also be HSA providers, and if your money isn’t in a bank, it won’t be FDIC insured. Take SelectAccount, for example. It’s a subsidiary of the insurance company Blue Cross Blue Shield of Minnesota, which is technically regulated by the Minnesota Department of Commerce. The IRS continues to check that it meets the requirements to be an HSA provider, according to spokesperson Marlo Peterson. It does have deposit accounts -- and they are not FDIC insured. It also has investment HSA accounts, where the management of your investment and your mutual fund choices is outsourced to Charles Schwab. In turn, Schwab is regulated by the SEC. Got that?

The Bottom Line

Should you use an HSA as a retirement account? The simple answer is yes: if you already have a high-deductible health plan, then you should, if you have the money, put the maximum amount into an HSA every year.

The second question is what you should do when medical expenses come along. Should you pay them out-of-pocket, using after-tax money, or should you use the funds in your HSA? That’s more of a judgment call, and depends in large part on whether you will miss the money if you spend it out of your pocket, rather than out of the HSA. But given that substantial medical costs in retirement are almost certain for all of us, it makes sense to start saving up for them today in as tax-efficient a manner as possible.

And if you’re now thinking of your HSA as a place to save up for retirement medical costs, rather than for current medical costs, then it’s logical to invest that money in long-term investments, like mutual funds, rather than just keeping it in cash.

Just make sure that you have enough cash lying around to cover any unexpected medical costs you have for the time being. The last thing you want is to be forced to use your HSA to cover near-term medical costs, just when your investments have gone south.

Finally, is your money safe, in an HSA, and do you need to worry about the HSA provider going bust? That one’s harder, and really the only way we’ll find out is if and when it happens. But insofar as you’re keeping your HSA funds in cash, you should certainly make sure that cash is FDIC insured.

Why Paulson’s talking

Felix Salmon
Jul 17, 2013 20:52 UTC

The ostensible job of a hedge fund manager is to deliver alpha, in the words of today’s conference, just like the ostensible job of a legislator is to govern. But just as the real job of a legislator it to get re-elected, the real job of a hedge fund manager is to raise money — to maximize the amount of funds under management.

John Paulson has been a hedge fund manager for 20 years now, and for most of that time he was fair-to-middling when it came to raising money. He had solid returns, he was respected in the industry, and he plugged away, mostly in the stock market, making a good living for himself and keeping his investors reasonably happy. Outside the industry, almost no one had heard of him.

All that changed, of course, in the financial crisis, when this long/short stock market investor suddenly switched his attention to bonds, and made one of the largest bets ever seen, on the implosion of the mortgage market. The bet paid off, and Paulson became a household name, a hero about whom an entire book was written, under the title “The Greatest Trade Ever”.

Making $15 billion for your investors is the best marketing any hedge fund manager could dream of, and soon Paulson found himself with money pouring in. Nearly all of the investors who were invested with him in 2007 kept their profits fully invested; many more lined up to join them. And by 2011, the $7 billion that Paulson was managing in 2007 had grown more than fivefold to $36 billion. Paulson & Co was suddenly catapulted to a whole new level of fame and size. The number of employees grew, the number of offices around the world grew, and Paulson suddenly found himself managing an organization much bigger, and much more complex, than anything he had been used to previously.

Size, it turned out, didn’t much suit Paulson. The money which was quick to flow in after Paulson made monster returns turned out to be just as quick to flow out when his returns were disappointing, and now Paulson & Co has just half the assets it had in 2011, with about $18 billion under management.

That’s the context in which Paulson gave his first-ever television interview today, fielding softball questions from CNBC’s Carl Quintanilla. Paulson is not a brash self-publicist in the mould of Bill Ackman or David Einhorn, and he’s not the kind of investor who likes to orchestrate the release of his own positions as a way of moving the market in his favor. But hedge fund managers don’t only appear on CNBC because they like the opportunity to talk their book. There’s another big reason they make such appearances: it’s free marketing for their funds.

It’s no coincidence that Paulson’s debut CNBC appearance took place after the single largest drop in AUM he’s ever seen. All market participants know what momentum looks like, and right now investors aren’t looking at Paulson’s performance so much as they’re looking at the steady outflow of funds from Paulson’s once-hot company. Paulson knew that he had to change the narrative, so he agreed to appear at a high-profile investor conference, to talk about his recent run of positive results, to talk his book a little bit, and — of course — to distract attention as much as possible from the goings-on downtown, where his former colleague Paolo Pellegrini was testifying about the role that Paulson played in a high-profile fraud case.

All of this looks a tiny bit desperate. The Delivering Alpha conference is hardly slumming it, of course: it was full of boldface names, including Treasury secretary Jack Lew, and there’s no reason why Paulson should not turn up at such an event. But he did look uncomfortable under the hot TV lights, and his main message — that everybody should be making big leveraged bets on a housing-market recovery — was not particularly compelling.

There’s an art to media and conference appearances as marketing schtick: you need to come across as being smarter than everybody else, with a fresh and profitable angle. By that standard, Paulson failed today. He said nothing which would convince the assembled investors that they’d be better off investing with him than with anybody else. And in truth there’s not much he could say.

For although Paulson likes to talk about the long track record of his fund, and how he’s been managing money since 1994, in reality Paulson & Co is pretty unrecognizable now, compared to its pre-crisis incarnation. The Greatest Trade Ever changed Paulson from a reliable base-hitter to someone swinging for the fences. And from a bottom-up stock-focused investor to someone looking to monetize big macro theses about things like inflation.

The result has been a lot of volatility, a lot of misplaced conviction, and a lot of people wondering whether there’s any reason at all to believe that lightning can strike twice. Paulson’s still making big bets; some will succeed, and some will fail. But the fact is that hedge fund investors are increasingly institutional, looking for steady outperformance and careful risk management, rather than looking for ten-baggers. Post-crisis Paulson doesn’t fit that bill: he’s too much of a risk-taker. Which is why he’s now doing his Willy Loman act, taking his story to the delegates at a CNBC conference, and the viewers at home. If the big institutions aren’t buying his pitch, maybe the smaller fry will be more interested.


Remember the discussion we had surrounding a “living wage”? The question is coming to the fore in Massachusetts, not as a result of government regulation but due to “market” forces.

Shaws has been on the decline in the region since they were purchased by SuperValu. Labor battles, poor customer service, and high prices are a very poor combination. Their sales volume has fallen by more than 20% over six years.

In contrast, Market Basket has been steadily successful. They pay higher wages, share profits with employees, and offer their customers the lowest prices around. Nobody has anything bad to say about the chain.

…except for the Market Basket shareholders. They don’t think it is right that the employees and customers should be treated so well. So they are meeting to fire the CEO and make some changes.

http://bostonherald.com/business/busines s_markets/2013/07/market_basket_ceo_may_ get_chopped

Paying above-market wages is a good way to build a strong and growing business, but it can’t survive corporate culture for long.

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The silly trial of Fabrice Tourre

Felix Salmon
Jul 17, 2013 14:54 UTC

There’s a huge amount of legal firepower on display in lower Manhattan right now, all centered on a University of Chicago grad student named Fabrice Tourre. Arrayed against him, in this civil case, is the might of the SEC, which has tapped the head of its trial unit, Matthew Martens, to take a lead role. Tourre’s own lawyers, who have been representing him for the past three years, include none other than Sean Coffey.

It’s fair to assume that many, many millions of dollars are being spent on this trial. But what’s much less clear is why. Tourre was a junior salesman, buried deep inside the Goldman Sachs CDO machine, and, almost exactly three years ago, Goldman Sachs paid $550 million to settle the charges against it. Why is the SEC, in 2013, still putting so much effort into chasing a single individual from Goldman Sachs? Certainly Tourre doesn’t have the wherewithal to be able to make any significant difference to the amount of money the SEC will end up collecting in this case — which means that this case is personal: the SEC wants to ban Tourre from the securities industry, and to possibly drive him into personal bankruptcy, as well, if they can extract a large enough fine.

The pathos here is unavoidable: this single case, brought against a minor spear-carrier in the great CDO saga, has become the SEC’s best hope, in the words of the NYT, for “a defining victory in its uneven campaign to punish those at the center of the crisis”. Surely the SEC would have been better off quietly settling: even a victory will seem pretty thin gruel, given that the people who really made out like bandits are being celebrated with keynote luncheon appearances at the Pierre Hotel even as the trial drags on downtown.

Meanwhile, of course, the downside is substantial. If the SEC loses this case — which is entirely possible, given how incomprehensible the charges are — it looks even more Keystone Cops. The burden of proof in civil cases is lower than it is in criminal cases: the SEC just needs to convince the jurors that a preponderance of the evidence is on its side. But while I’m pretty sure that what Goldman did was immoral, I’m much less convinced that it will be easy to convince a stultified jury that there was something illegal going on.

All in all, the upside for Goldman, here, is much bigger than the upside for the SEC. Goldman is paying Tourre’s legal fees — they’re a rounding error, in the context of the cost of the bigger settlement, and doing so also sends a clear internal signal that Goldman will have its employees’ backs, should they get into trouble as a result of the work they do for the firm. A victory for Tourre would be a victory for Goldman — which, remember, never admitted the allegations the SEC made against it.

The rather dispiriting truth of the matter is that the SEC has spent four years and millions of dollars trying to find someone, anyone, to prosecute in the wake of the financial crisis — and has ended up bringing to trial a guy whose biggest mistake was to display a little too much braggadocio in private emails to his girlfriend. If I were on the jury, I’d be hesitant to find Tourre not guilty, if only because of the synecdoche here: one look at the legal teams is enough to demonstrate that the defendant in this trial is not really Tourre, so much as it is a man standing in for Goldman Sachs as a whole. But Goldman has already settled. So the best outcome, I think, would be for the jury to find Tourre guilty, to fine him $1, and to let him go back to his studies and to the rest of his life. But in order to do that, the jury would probably have to have a reasonably sophisticated understanding of what exactly is going on. Which, quite clearly, they don’t.


If I understand the SEC’s theory, Goldman had a duty to disclose to buyers of the CDO that another client planned to short it. My understanding is that, should GS have done so, it would have been a breach of client confidentiality. By analogy, when I go online to Fidelity to buy a share of Google, does Fidelity has a duty to tell me who is selling the share, and what his long/short position is?

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Art, venture capital, and down-round phobia

Felix Salmon
Jul 16, 2013 14:32 UTC

Ben Horowitz has a great guide to the dreaded “down round” today — that unloved point in the evolution of a venture-backed technology company when it’s forced to raise money at a lower valuation than it received in previous rounds. Certainly, such things shouldn’t be unexpected. As he explains:

The average company on the S&P 500 IT index with $10 million in annual earnings would be worth $210 million in March of 1995, $820 million in March of 2002, $310 million in March of 2004, and $155 million in March of last year. And those are big companies with real earnings, so you can imagine how a private company’s valuation might fluctuate.

Still, Horowitz likens the experience to being “the captain of the Titanic”, and he notes that it only starts looking attractive when you realize that the alternative is “suicide”: “Down rounds are bad and hit founders disproportionately hard,” he writes, “but they are not as bad as bankruptcy.” And he notes, in a clear-eyed fashion, that it would take a “miracle” for a founder to survive the process. (Startup founders are short-lived at the best of times; it’s rare they can survive a down round.)

The problem here is clear: a simple lack of honesty and transparency when it comes to funding. Valuations go up and down, but no one likes to admit it; investors, in particular, love to delude themselves that the value of the company only went up after they bought in, and that they got a spectacular deal.

Indeed, this is one of the reasons why so many startups fail: taking VC money is a deal whereby, in practice, if you don’t grow super-fast, in both size and valuation, then you will be left for dead. David Segal, on Sunday, had an intriguing piece about what you might call distressed startup opportunities, but that’s a very, very new market, and one which VCs aren’t yet interested in. For the most part, VCs all operate according to the same convention, which treats downward valuation fluctuations not as some natural occurrence but rather as a mortal threat.

When I was reading Horowitz’s piece, I couldn’t help but be reminded of Allison Schrager’s article about how “high-end art is one of the most manipulated markets in the world”. Again, the problem is that the art market isn’t allowed, by its practitioners, to be a real market, and instead operates on a series of conventions which make it deeply broken on many levels.

There are two startling data points Schrager’s piece. The first shows that it doesn’t have to be this way: in China, she says, 50% of primary sales — sales of fresh works, which have never been sold before — take place at auction. That certainly helps explain why Chinese artists are so dominant in the contemporary-art auction-volume league tables.

The second is a story which shows what happens when artworks are not sold at auction: they can sell instead for a discount of 99%.

A few years ago a young art collector from New York I know bought a painting from a New York gallery. A few weeks later she went to the Miami Basel art fair where a celebrity heard about the painting. He offered to buy it for more than 50 times what she paid for it. She refused and he raised his offer to a sum that would mean she’d never have to work again. She explained that she would not bargain with him—any resale of the painting must go through the gallery, so they’ll get a commission and select the price—not her. The young collector knew there would be consequences to making the sale. She may have owned the painting, but reselling it at a profit without the gallery’s permission would blackball her from the art industry. To her, that was not worth the millions she was offered.

There are a lot of lessons to be drawn from this story, including of course the fact that we’ve been deep in bubble territory for at least “a few years” now. But mostly, it’s one of those unfalsifiable anecdotal beauties which the small and gossipy art world requires even more than it does money. Put aside the question of whether it’s literally true — that really doesn’t matter. What matters is the art-world conventions which are revealed here.

First is the way in which social currency — whom you know — trumps actual currency. The young collector in this story made a simple calculation: the value of a good relationship with the gallery in question was higher than the millions of dollars dangled in front of her by the celebrity. And of course the value of social currency is the reason why the celebrity was in Miami in the first place, too. The monster success of global art fairs like Art Basel Miami Beach, which have pretty much eaten the entire art world at this point, is ostensibly about commerce — but in reality has just as much, if not more, to do with the fact that they’re a way of getting a far-flung crowd together in the same place at the same time. For all the financial deals which are struck at art fairs, there’s just as much value, if not more, created in the social ties found at the endless round of parties and dinners at such occasions. In many ways, the spectacle of Jay-Z performing at Pace Gallery for six hours last week was his way of buying social currency in the art world — essentially, buying himself the option to lay out huge sums of cash for work by hot young artists.

Art, then, is very similar to venture capital, insofar as who you know matters — and also insofar as both markets go to great lengths to hide natural valuation fluctuations. “Down rounds” are if anything even more harmful to an artist than they are to a startup: galleries will, as a rule, drop an artist before selling her art for less than she was charging at her previous show. The reason is entirely to protect the gallery’s own credibility: the gallery wants collectors to see it as a place where they can buy art which is going to rise in value, and as a result it will do everything in its power to make it look as though the work of all of its artists is only ever going up in price rather than down.

Horowitz concludes his piece by saying this:

The only surefire antidote to capital market climate change is positive cash flow. If you generate cash, investors mean nothing. If you do not, then your success will depend upon the kindness of strangers.

Apply that lesson to the art world, and the conclusion is clear. No art has positive cash flow; ergo, all artists are dependent upon the kindness of strangers. Schrager takes this idea to its logical conclusion, considering — and then rejecting — the idea that an old-fashioned patronage model might be better for artists than the current grinfuck model.

She’s probably right about that, although there are certainly artists who quietly do quite well for themselves on the patronage model, selling their work directly to a small number of collectors and bypassing the craziness of the gallery system. Those collectors are well aware that the artists in question aren’t going to become auction-house stars, but that’s OK: they’re buying art for the right reason, because they love it, rather than for mercenary reasons surrounding dreams of future wealth.

The question is whether a more transparently market-based system, one where people understood that prices can fluctuate, would be better for artists than the current system, where artists’ careers, a bit like startup valuations, have to always be improving lest they fall into the art-world equivalent of bankruptcy. Schrager thinks it might be:

If pricing were transparent, it would probably be lower and art more available to a wider range of collectors. This would be an unwelcome move for dealers and elite artists but it could also demystify the market and lower tier artists could earn more because the market would be less segmented. To some extent technology is naturally making it happen. Websites are cropping up that sell primary art and make it more available to the masses. Even Amazon has set its sights on the art market. It plans to partner with certain galleries to sell some of their inventory online but it’s not clear whether it will become a “market for lemons,” where the best pieces from the most promising artists are still reserved for certain collectors and prices of promising emerging artists still unknown.

I’m not holding my breath: the art market, more than ever, is controlled by a handful of large international galleries, and those galleries have no incentive whatsoever to give up their pricing power. Doing so might be good for artists, just as transparency around fluctuating valuations would probably be good for startups. But it’s not going to happen.


Nice sharing.

China Ventures is a leading section at Tisunion which focused on developing business with China viewed from global strategy consultancy. China has the world’s largest and fastest growing trade markets. We strongly believe that most potential investment project will be dominated by china Market.

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How do you restructure a contingent liability?

Felix Salmon
Jul 12, 2013 19:54 UTC

Lee Buchheit and Mitu Gulati have another great paper out on the subject of how on earth a sovereign is meant to restructure its contingent liabilities.

Here’s the problem, in a single chart:


What you’re looking at here is the way in which European countries especially have turned to sovereign guarantees as a way of masking the true size of their national debt. Many of these guarantees, once upon a time, would have simply been sovereign loans: the nation would have borrowed the money, and then lent it on, at a modest profit, to the borrower. But European countries want to do everything in their power not to borrow money right now. So instead of lending and borrowing, they simply guarantee a borrower’s debt instead. That brings down the price of debt for the borrower, but it doesn’t show up in any national debt-to-GDP statistics.

As you can see from the chart, this technique is increasingly popular — which means, in turn, that it’s going to have to be addressed in future debt restructurings. When sovereign guarantees were de minimis, they could be — and were — ignored. But at this point, they’re too big to be ignored. For one thing, sovereign bondholders won’t allow it. Let’s say Ruritania has $3 billion in bonds and $2 billion in guarantees. The bonds then get restructured, so they’re worth only $1 billion: a 66% haircut. But then, let’s say that half of the borrowers with sovereign guarantees go bust. Will Ruritania really pay out the $1 billion in full, with no haircut at all? It wouldn’t be fair to the original bondholders, that’s for sure.

As Buchheit and Gulati explain:

The restructurer’s dilemma is that contingent liabilities, if they are of any material size, cannot safely be left out of a sovereign debt restructuring, nor can they easily be included in a sovereign debt restructuring. This problem wasn’t a problem for so long as contingent liabilities represented only a small part of the debt stocks of affected countries. But for many countries, that period ended with the commencement of the financial crisis in 2008. The problem will therefore be unavoidable in at least some of the sovereign debt restructurings yet to come.

They do come up with one possible solution. If the guarantees are issued under domestic law, then the problem can be solved with legislation, along these lines:

All guarantees issued by the Republic of Ruritania in respect of debt obligations of third parties that are eligible to participate in the [Ruritanian restructuring] shall, if called by the beneficiary at any time after the closing of the [Ruritanian restructuring], be satisfied and discharged in full by delivery to the creditor of consideration equivalent to that offered in the [Ruritanian restructuring].

But the bond markets might have seen this one coming. After seeing the awesome power of domestic legislation in the Greek context, look what the market is now demanding in terms of sovereign guarantees:

While domestic-law guarantees were commonplace before 2010, that’s changing; at this point, foreign-law guarantees are catching up, and will almost certainly soon become an outright majority of the total.*

All of which leaves us with the paper’s conclusion — that contingent liabilities are going to have to be addressed somehow, in future restructurings, but no one knows how. If you thought that sovereign debt restructuring has been difficult until now, you ain’t seen nothing yet.

Update: I’ve removed a chart showing foreign-law guarantees making a huge proportion of recent bond issuance. That turns out not to be the case, necessarily. But I wouldn’t be surprised if we get there sooner rather than later.


Interesting idea, y2kurtus. Except I would suggest that the greatest risk in lending to the US is the value of the currency, not default. Backing a debt with assets wouldn’t change that much.

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