Felix Salmon

Under the weather

Felix Salmon
Jan 10, 2014 15:26 UTC

13 months ago, the Hurricane Sandy jobs report was released — the one for November 2012. Analysts were bracing themselves: a lot of people hadn’t been able to work that month, due to bad weather. But in the end, the report was not that bad: 146,000 new jobs were created in the month, and the unemployment rate nudged down to 7.7%. Markets, which had been expecting a mere 80,000 new jobs, were positively surprised.

This month, the story is the exact opposite. Yes, we knew there was bad weather in December, but no one expected it to have a huge impact on job creation. And yet the actual jobs report for the month is a huge disappointment: there were just 74,000 new jobs created, and the labor participation rate fell sharply yet again. On top of that, substantially all of the jobs which were created were in low-wage sectors.

Once you take into account the weather, however, the December report wasn’t that bad. A whopping 273,000 people were counted as “Employed – Nonagriculture industries, Bad weather, With a job not at work”, which is to say that they did not get counted in the payrolls figures even though they’re employed. Most of the time, that number is in the 25,000 to 50,000 range, and although it always spikes in the winter, this was the worst December for weather-related absence from work since 1977.

None of this is an exact science. The January 2011 jobs report, for instance, showed a weak gain of 36,000 in the headline payrolls number — but would have looked insanely strong if you added in the 886,000 people who couldn’t get to work, and weren’t paid, because of the snowstorms that month. That’s not just bigger than this month’s figure of 273,000; it’s also vastly bigger than the Hurricane Sandy figure of 369,000 in November 2012. And sometimes the numbers can be much bigger still: the record was set in January 1996, when 1,846,000 people were kept off payrolls by stormy weather, and the headline number on the employment report was a negative 201,000.

Still, when the weather series starts going skewy, the signal-to-noise ratio in the jobs report, which is pretty low to begin with, tends to drop even further. As a result, the Fed is unlikely to pay too much attention to this report. We’ve already started the taper now, so the important signal has already been set by the Fed: it doesn’t need to reduce the pace of bond-buying even further at this month’s meeting, the last one with Ben Bernanke as chairman. He’ll probably just hand over the reins to Janet Yellen and let her decide how aggressively to pull on them over the rest of the year. Certainly, with Yellen as chair and Stan Fischer as vice chair, the Fed has more than enough credibility: it can draw out the taper as long as it likes, in an attempt to help support the pace at which jobs are being created.

It’s worth remembering that when it comes to monetary policy, the markets are still looking almost exclusively at the jobs report: no one is remotely worried about inflation figures. So long as we continue to see underwhelming job creation, the Fed’s going to keep its foot on the accelerator. Especially if the weather is particularly awful.


That is why short-term numbers are so meaningless. Only annual figures make sense.

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Blameless Blackrock

Felix Salmon
Jan 10, 2014 08:31 UTC

If you want a good test of whether someone is an ideologue on the subject of bank prosecutions, just have them look at today’s agreement between Eric Schneiderman, the New York attorney general, and Blackrock. If they think it makes perfect sense, and that Schneiderman should have pursued this line of prosecution, and that Blackrock has been behaving badly, then they will never find a bank prosecution they don’t love. Because this thing is an utter farce.

To read the NYT coverage of the deal, the problem was that Blackrock was trying to get advance inside information on analyst upgrades and downgrades:

Analysts’ changing assessments on the public companies they follow can make a stock plummet or soar, so receiving such information ahead of other investors can be highly profitable for traders.

As a result, regulatory rules require brokerage firms to limit the information flow from research departments to prevent the potential for trading ahead of analyst reports.

But if you read the actual settlement document, it rapidly becomes clear that that’s not what Blackrock was doing at all. Although the AG seems to be doing its very best to obscure that fact.

The entity at the heart of this settlement is a quant-shop subsidiary of Blackrock called Scientific Active Equities, or SAE, which manages an impressive $80 billion. SAE, like all quant shops, constantly monitors a large number of information streams, and then trades when the streams display certain pre-set characteristics. It’s basically a set of if-then rules: various patterns trigger various different buy or sell orders.

Most, but not all, of the information streams that SAE monitors are wholly public information: momentum, earnings, trading volume, that kind of thing. But there was one stream which was non-public: a periodic survey that SAE would send out to its brokers. Brokers talk to big investors all the time, of course: that’s their job. And they’d happily talk to any investor working for any $80 billion subsidiary of Blackrock. But SAE is a quant shop, and it’s hard for a computer to have a short conversation with an analyst. So instead, SAE would send out a questionnaire — which was very clear, at the top, that it was asking only for public information, which had already been disclosed in research notes, investor calls, and the like. What’s more, even if that was a CYA disclaimer, which everybody was happy to ignore, the questions in the questionnaire are exactly the kind of questions that a sell-side client would ask of a sell-side analyst on a phone call. And as Matt Levine points out, neither Schneiderman nor anybody else is looking to put an end to such phone calls.

But here’s the thing: if a human was asking such questions, they might be fishing for a hint about a possible future upgrade or downgrade. When a computer asks such questions, it isn’t. The point of the questionnaire was emphatically not to try to get inside information on which brokers might be upgrading or downgrading which firms. Instead, it was trying to get a feel for how analyst sentiment in aggregate might be changing, especially around earnings season. Once you added all of the survey responses up and put them all together, then they received a weight of about 5% in the SAE quantitative trading model. But any individual survey response was negligible. An analyst could have said “I’m going to downgrade Stock X tomorrow”, as an answer to the questionnaire, and the SAE model wouldn’t even notice: that’s not the kind of signal it was looking for. A human would notice and care about such a thing, but SAE’s buying and selling decisions aren’t made by humans.

SAE — and I quote the document here — “aggregated and averaged the survey responses before converting them into signals. These signals were expressed as numeric values that were used in SAE’s quantitative trading models”. (My emphasis.) You can’t get insider information from aggregated and averaged survey responses, it’s impossible. And yet, that notwithstanding, Schneiderman still says that the information from the surveys could have been “used to trade ahead of the market reaction to upcoming analyst reports”. This is insane.

Now it’s true that the survey measured analysts’ sentiment — in aggregate. And because it did so on a regular basis, SAE (or its computers) could tell when sentiment — again, in aggregate — was turning. Sometimes, it takes a while for such sentiment to show up in the form of detailed research notes. And in that sense, SAE could take a position in a stock, expecting that the full change in sentiment wouldn’t be fully priced into the market until after at least a few such notes had been published. Which means that Schneiderman is not really accusing SAE of trading on advance knowledge about specific upgrades or downgrades. He’s just worried, to quote a later part of the document, that SAE “could obtain information not generally available in already published analyst reports”.

But it’s investors’ job to obtain information not generally available in already published analyst reports! That information can come from lots of places, including analysts — who, as Levine says, do rather more than just “spend their days in caves writing lengthy reports that they release once a quarter or so”. Indeed, the act of answering questions from clients — or even just filling out SAE questionnaires — is an integral part of the analysis process: it helps analysts get their thoughts in order, and focus on what the clients think is most important. Analysts spend most of their day on the phone to clients — and all of those clients are receiving information not generally available in already published reports. If SAE also received such information, that proves nothing beyond the fact that it’s a client.

Yet according to Schneiderman, SAE’s surveys “violated provisions of the Martin Act, Article 23-A of the General Business Law, and violated provisions of § 63(12) of the Executive Law”. None of these provisions are quoted, and Blackrock was not asked to admit to any violations. But it seems to me that if the surveys really did violate such provisions, then Schneiderman would have been rather more explicit about exactly which part of which law was being broken.

Now it’s in Blackrock’s interest to have good relations with Schneiderman, and so, at the AG’s request, it has stopped sending out the surveys. (And even before it stopped sending them out, it gave them a weight of zero in its algorithms.) But really, Blackrock and SAE did absolutely nothing wrong. And it’s a minor scandal that Schneiderman is bullying them around and forcing them to cease an entirely legitimate business practice. Efficient markets require investors who put work into gathering information, analyzing it, and acting on it. That’s exactly what SAE was doing. It ought to have been receiving praise from Schneiderman, not brickbats.



Short answer: You’re right, Reg FD pertains to corporate disclosure.

Long answer: Analysts cannot show one opinion to favored institutions and another to retail investors. (Should be Reg HB for Mr Blodget). That’s one thing BlackRock was trying to tease out of the data–data that only they received.

Black Rock said they’ve stopped doing it and paid for the AG’s costs. What’s the problem? Is that bullying?

Is the story of finance for the last 15 years one where heavy-handed regulators and investigators bully the largest financial operators in the world?

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Why Zions needs to bite the bullet and sell its CDOs

Felix Salmon
Jan 9, 2014 15:15 UTC

It’s hardly news that in the run-up to the financial crisis, some banks created highly-toxic collateralized debt obligations, and other banks bought those highly toxic CDOs and put them on their balance sheets. The result was that when the crisis hit, and the CDOs plunged in value, a lot of banks needed to take a lot of write-downs.

Certain banks, however, holding certain CDOs, managed to avoid taking any write-downs, and instead quietly just held on to those instruments, keeping them on their books at 100 cents on the dollar. Essentially, they bought complex financial instruments, and then treated them for accounting purposes as though they were their own loans, being held to maturity, which therefore didn’t need to be marked to market. And regulators allowed them to get away with it — until now.

Nick Dunbar has a very good explainer of what’s been going on with these CDOs — specifically, the ones which include obscure creatures known as trust preferred securities. And Floyd Norris has the best short description of exactly what TruPS are, and how they became CDOs:

Trust-preferred securities became popular with bank holding companies in the 1990s because bank regulators allowed them to be treated as capital by the issuing bank, just like common stock, but they were treated as debt securities by the Internal Revenue Service, allowing the issuing bank to deduct interest payments from income on its tax return. The C.D.O.’s were created to allow many small banks to issue such securities, with the buyers reassured by the apparent diversification.

These gruesome instruments actually helped some banks get through the crisis: if you issued TruPS, then you could (and almost certainly did) suspend interest payments for as long as five years, without penalty. But we’re now getting to the end of that five-year period, and, as Norris says, “it is unclear how many of them will be able to make back payments before the periods end this year and in 2015”. Which means that TruPS CDOs, like many other financial innovations of the 2000s, have notably failed to bounce back to their pre-crisis valuations.

As Dunbar says, these things have no place on banks’ balance sheets. And, gloriously, the Volcker Rule has ensured that they’re being kicked off those balance sheets. (Better late than never.) Under the rule, CDOs of TruPS are categorized as a “covered fund”, which banks aren’t allowed to own.

The problem is that certain banks, most notably Zions Bancorp, still own billions of dollars of these things, and have never written them down. If and when they do so, they’re going to have to take hundreds of millions of dollars in losses. And so out come the lobbyists — and out come the silly pieces of legislation, seeking to create a massive carve-out from the Volcker Rule, which would allow Zions and others to hold on to these TruPS CDOs indefinitely.

Even if your goal is to keep the TruPS CDOs on banks’ balance sheets, this legislation is a dreadful way of doing so — since, as Norris notes, the proposed law goes much further than that, and effectively allows banks not only to hold the old instruments, but even to create brand-new ones. Talk about not learning our lesson. But in any case, Zions and the other banks which bought these instruments should, finally, be forced to rid themselves of them. Zions is never going to be happy about taking a loss, but now’s not a bad time for banks in general to be taking losses. And frankly, all of these gruesome CDOs should have been jettisoned from banks’ balance sheets years ago. Let’s hope this legislation goes nowhere, and that these ugly reminders of pre-crash “financial innovation” finally start being held by buy-siders who mark to market, rather than by banks claiming that they’re worth 100 cents on the dollar.

The invincible JP Morgan

Felix Salmon
Jan 8, 2014 16:11 UTC

When JP Morgan paid its record $13 billion fine for problems with its mortgage securitizations, the bank came out of the experience surprisingly unscathed, in large part because Wall Street reckoned that the real guilt lay mainly in the actions of companies that JP Morgan had bought (Bear Stearns and WaMu) rather than in any actions undertaken on its own watch. There was a feeling that the bank was being unfairly singled out for punishment — a feeling which, at least in part, was justified.

The latest $2 billion fine, however, which also comes with a deferred prosecution agreement, is entirely on JP Morgan’s shoulders — and still, as Peter Eavis reports, it’s being “taken in stride” by the giant bank. It really seems that CNBC is right, and that profits really do cleanse all sins. How is it that a $450 million fine sufficed to defenestrate the CEO of Barclays, but that Jamie Dimon, overseeing some $20 billion of fines plus a deferred prosecution agreement just in the space of one year, seems to be made of teflon?

To answer that question it’s worth looking at the details of what exactly JP Morgan did wrong in this case. The key part of the Deferred Prosecution Packet is Exhibit C, the Statement of Facts, all of which have been “admitted and stipulated” by JP Morgan itself. And it certainly lays out some jaw-dropping behavior on the part of the bank, which oversaw Madoff’s main bank account for more than 20 years: between 1986 and 2008, account #140-081703 received a jaw-dropping $150 billion in total deposits and transfers, and showed a balance of $5.6 billion in August 2008. Even when you’re as big as JP Morgan, that’s a bank account you notice.

Except, maybe, not so much:

With respect to JPMC’s requirement that a client relationship manager certify that the client relationship complied with all “legal and regulatory-based policies, a JPMC banker (“Madoff Banker 1”) signed the periodic certifications beginning in or about the mid-1990s through his retirement in early 2008…

During his tenure at JPMC, Madoff Banker 1 periodically visited Madoff’s offices… Madoff Banker 1 believed that the 703 account was primarily a Madoff Securities broker-dealer operating account, used to pay for rent and other routine expenses. Madoff Banker 1 also believed that the average balance in Madoff Securities’ demand deposit account was “probably [in the] tens of millions.”

This is sheer unmitigated — and, yes, probably criminal — incompetence. It takes a very special kind of banker to not notice that an account has more than a billion dollars in it, for a period of roughly four years, from 2005 through most of 2008. As Matt Levine says, “Madoff Banker 1 is like the one banker on earth who underestimated his client’s business by a factor of 100 or so. ‘Boss, I’ve made the firm thousands of dollars this year,’ he probably said, ‘and I deserve a bonus of at least $200.’”

The incompetence doesn’t stop there. At the beginning of January 2007, the account — which, remember, JP Morgan officially considered to be used “for rent and other routine expenses” — saw inflows of $757.2 million in one day. This tripped all manner of automated red flags, but the investigation into those red flags consisted of — get this — visiting the Madoff website. That’s it.

Was there other suspicious activity in this account? Of course there was: lots of it. As far back as December 2001, a client of JP Morgan’s private bank, who also held a huge amount of money with Madoff, moved an astonishing $6.8 billion in and out of that 703 account. In one month. You just can’t do that without generating all manner of suspicious activity reports from JP Morgan to bank regulators. And yet, somehow, impossibly, no such report was generated.

Similarly, in 2007, JP Morgan’s private bank conducted due diligence on Madoff — after all, many of its clients wanted in on Madoff’s amazing funds — and concluded that the numbers “didn’t add up”. And still no hint of running any problems up the chain to either JP Morgan’s regulators or Madoff’s. The same thing happened again in 2008, at an entity called Chase Alternative Asset Management.

And then in late 2008, shortly before the whole Madoff enterprise imploded, JP Morgan bankers in London became so suspicious of the whole enterprise that they sent two different reports to the UK’s Serious Organized Crime Agency. Yet none of this information made it to US regulators.

Levine has a relatively benign explanation for all this: he says that JP Morgan comprises “more or less independent” businesses, which naturally don’t speak to each other, or inform each others’ regulators when they smell something suspicious.

But sometimes the different bits of JP Morgan did talk: for instance, in June 2007 there was a meeting about Madoff in Manhattan, which included the investment bank’s chief risk officer; the Hedge Fund Underwriting Committee (which included “executives from various of JPMC’s lines of business”); the London Equity Exotics Desk (which later examined Madoff in detail and concluded he was probably a fraud); the investment banks’s Global Head of Equities; executives from the broker-dealer; and other people who had direct credit relationships with Madoff. The meeting concluded that JP Morgan wasn’t going to do a big deal with Madoff based simply on Madoff saying “trust me”, and not allowing any direct due diligence. But while JP Morgan was careful with its own investments, and ultimately took out most of the money it had with Madoff before the firm collapsed, once again it saw no reason to tell regulators about its suspicions.

And specifically, there’s one individual within JP Morgan, identified as the “Senior IB Compliance Officer”, who had all of the information from London, who was responsible for passing suspicions on to US regulators, and who ended up doing nothing beyond having “an impromptu conversation in a hallway” with a few colleagues.

The government doesn’t show — it doesn’t need to show — that if JP Morgan had done what it was supposed to do, then US regulators would have cracked down on Madoff before the Ponzi scheme collapsed under its own weight. The point is that regulators can only do their job if they’re given the information they’re required by law to receive — and JP Morgan (not Bear Stearns, not Washington Mutual, but JP Morgan itself) utterly failed, over many years, to provide them with that information.

And yet, to Eavis’s point, JP Morgan is now effectively untouchable by the government. Sure, it can be fined billions of dollars; it can even be slapped with a deferred prosecution agreement. But the fines just come out of the pot of money devoted to paying such things — it’s known as “legal reserves” — and so long as the bank can show that it makes good profits after reserving for fines, Wall Street seems happy for the bank to make few if any major changes. Jamie Dimon remains as CEO, answering to a board chaired by himself; the bank remains one of the biggest in the world; and while prosecutors are winning countless battles against the bank, it’s abundantly clear that the bank is going to win the war.

When did JP Morgan effectively become too big to regulate? How is it that Jamie Dimon and his starry-eyed shareholders have been able to see off forces which toppled many other banks and CEOs? That’s an article I’d love to read — the story of how, with some combination of luck and aggression, Dimon held on to his position as the most powerful bank CEO in the world — even as other banks, and other CEOs, fell steadily by the wayside.

In the face of a determined regulatory onslaught over the past 18 months, from mortgage-related prosecutions to the Volcker Rule, JP Morgan’s share price has gone steadily up and to the right, almost doubling over that period. In the view of Wall Street, that share price is Dimon’s vindication, and his ultimate shield. The lesson of yesterday’s news cycle is that no one can pierce it. Not even the Justice Department.


“The government doesn’t show — it doesn’t need to show — that if JP Morgan had done what it was supposed to do, then US regulators would have cracked down on Madoff before the Ponzi scheme collapsed under its own weight.”

The suspicious activity that JPMorgan failed to file was in fact filed earlier:

“12 Years Before Madoff Was Arrested, A Major JP Morgan Chase Competitor Filed A Suspicious Activity Report”

http://www.forbes.com/sites/robertlenzne r/2014/01/08/12-years-before-madoff-was- arrested-a-major-jp-morgan-chase-competi tor-filed-a-suspicious-activity-report/

“In 1996, some 12 years before Bernie Madoff was arrested for the largest Ponzi scheme in history, a JP Morgan Chase competitor, rumored to be Deutsche Bank DB -3.66%, filed a suspicious activity report on Madoff with regulators, closed its Madoff account and turned over its Madoff deposits to JPMC.”

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NYT vs Pirrong and Irwin: David Kocieniewski responds

Felix Salmon
Jan 8, 2014 05:01 UTC

At the end of December, I wrote about the non-scandal of Scott Irwin and Craig Pirrong, a response to a hit-piece in the NYT by David Kocieniewski. Later that week, Kocieniewski offered to answer questions about his article, so I provided some. Here are my questions, along with Kocieniewski’s answer:

Q: Concerning “Academics Who Defend Wall St. Reap Reward,” I would love Mr. Kocieniewski to respond to criticisms of his piece by myself, Craig Pirrong and others, including, but not limited to:

-Why does Mr. Kocieniewski believe that the money flowing to the University of Illinois business school is a reward for research by Scott Irwin, when Mr. Irwin doesn’t teach at the business school?

-Does Mr. Kocieniewski believe that Irwin has violated the A.E.A. code of ethics? If not, does he believe that the A.E.A. code of ethics doesn’t go far enough? What would he like it to say?

-Does Mr. Kocieniewski believe that Mr. Pirrong is anything other than a straight shooter when it comes to his own opinions? Does he believe that Mr. Pirrong’s opinions are shaped by the money he’s getting from consulting contracts?

-Mr. Kocieniewski says that “major financial companies have funded magazines and websites to promote academics with friendly points of view.” Which companies? Which magazines? Which websites?

-Would Mr. Kocieniewski agree with Mr. Pirrong that most of Mr. Pirrong’s consulting engagements “have been adverse to commodity traders and banks?”

-Mr. Kocieniewski says that Mr. Pirrong has written “a flurry of influential letters to federal agencies.” How many is a flurry?

More generally, does Mr. Kocieniewski believe that Mr. Irwin and Mr. Pirrong are especially worthy of being singled out in this article and in this manner? Or was this just a case of finding a couple of professors at public universities which could be FOIAed? — Felix Salmon, Reuters columnist, New York

A: Despite the disclosure requirements of the American Economic Association and the University of Houston, Mr. Pirrong did not release details of his paid consulting work with 11 different clients until The New York Times filed repeated requests under the Freedom of Information Act. Among the businesses paying him were the world’s largest commodities exchange, the Chicago Mercantile Exchange, and one of the largest commodity trading houses, Trafigura.

Mr. Pirrong was also a paid consultant of a Wall Street group, the International Swaps and Derivatives Association, which is funded by Goldman Sachs, Morgan Stanley and other major traders, at the time the association was quoting his research extensively in a lawsuit that for two years blocked attempts to regulate speculation.

Mr. Pirrong declined to answer questions about how much he was paid or the nature of some of his consulting work. The article nonetheless cited one instance in which his findings went against the interests of the Wall Street affiliated group that had funded his research.

Mr. Irwin, as the article notes, did report his financial ties in his disclosure form with the University of Illinois. In describing the Chicago Mercantile Exchange’s dealings with the University of Illinois, the article also pointed out that Mr. Irwin’s only direct request for money from the C.M.E. was denied.

Emails obtained under the Freedom of Information Act nonetheless show a close relationship between the exchange’s public relations and research departments and the university’s academics — helping Mr. Irwin get his opinion pieces placed in newspapers, trying to schedule him to testify at congressional hearings and, when that failed, using his research to shape its executives’ testimony.

The university development office was also involved in scheduling Mr. Irwin to speak at the C.M.E. at the same time its fund-raisers were soliciting donations from the exchange for the business school, the emails show. Last fall, the C.M.E. also named Mr. Irwin to its Agricultural Markets Advisory Council, the emails show. Mr. Irwin subsequently said that he, like other academics on the committee, is paid a $10,000 annual stipend.

Finally, while friends and colleagues of Mr. Pirrong and Mr. Irwin may complain that they are being singled out for scrutiny, public records show just the opposite. Since this debate began more than five years ago, there have been many media references to the financial ties of those who have argued that speculation is responsible for price increases — whether they were academics performing industry funded research or hedge fund managers whose holdings in autos and airlines would benefit from regulation that might reduce oil prices. By reporting where the financial interests of Mr. Pirrong, Mr. Irwin and the universities that employ them intersect with those of speculators, the article gives readers additional information that they may wish to consider when weighing the professors’ public statements. — David Kocieniewski

The failure of Kocieniewski to answer any of my specific questions more or less speaks for itself; I won’t belabor it, except to note the irony involved in him complaining about Pirrong doing the exact same thing.

I will push back against the “friends and colleagues” line, however: I, for one, am a friend of neither Pirrong nor Irwin. To my knowledge, I have never met either of them. And I don’t think that, say, Thomas Sowell has, either.

It’s also worth mulling over the idea that Kocieniewski’s article was merely designed to provide “additional information” for readers who might have noticed that the 21st paragraph of a Financial Times article in August 2011 drew a passing connection between an academic, Kenneth Singleton of Stanford, and the Air Transport Association of America. I’m sure that both of those readers appreciated the new light that Mr Kocieniewski shed on this issue from his platform on the front page of the NYT. Still, I can’t quite understand how public records could possibly demonstrate that Pirrong and Irwin were not being singled out for scrutiny, as Kocieniewski avers. After all, Kocieniewski himself was the person singling them out. It’s rather worrying that he now seems to deny that he was doing any such thing.


“1. He is typically deceptive in invoking the AEA disclosure policy. This relates to articles submitted to journals. I submitted no article relating to speculation or commodities generally to any journal that received financial support from anyone. So the AEA policy is not relevant and Kocieniewski is dishonest in insinuating it is. Or maybe it’s just that he doesn’t know what the policy is, and doesn’t care.” – Pirrong

Well, no. From the American Economic Association Disclosure Policy –

(7) “The AEA urges its members and other economists to apply the above principles in other publications: scholarly journals, op–ed pieces, newspaper and magazine columns, radio and television commentaries, as well as in testimony before federal and state legislative committees and other agencies.”

Pirrong’s response appears to be stupidly and carelessly wrong or stupidly dishonest.

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Why movie studios happily violate journalists’ copyright

Felix Salmon
Jan 7, 2014 19:18 UTC

The white-goods queen of Eighth Avenue asks my opinion on @aoscott adgate. I take requests, over here, so: is it kosher for a movie producer to selectively quote from the Twitter feed of the NYT’s movie reviewer, in a print ad, even when the reviewer in question explicitly said he would not give permission?

The simple answer is no. The tweet from Tony Scott was used in the NYT print ad precisely because he’s a public figure of authority to NYT readers. As a public figure, he’s entitled to determine when and whether he’s used to promote some commercial interest. Besides, the use of the tweet is arguably a violation both of copyright and of Twitter’s terms of service (which say that tweets can’t be used in advertising “without explicit permission of the original content creator”).

The more complicated answer, however, is that this is a form of blurb, and blurbs from publications have been used — without either the publication or the author’s explicit consent — for decades. Reviewers write reviews, journalists write articles, and then producers happily pick a word or two and slap it in huge type across their ads or marquees. The more high-minded journalists have always disliked this practice, but have been largely powerless to prevent it. And when a play or a movie wants to spend tens of thousands of dollars on an ad buy, where the ad in question features such blurbs, the producers (or media buyers) in question are always welcomed with open arms.

In any organization, the bits of the business which bring in the money tend to be the bits of the business with the most power and influence. At high-minded publications like the NYT, the ad side is grown-up enough to stop itself from trying to directly interfere with what the edit side produces. But still, products like the NYT’s thick annual “Summer Movies” section are entirely driven by the massive quantity of ads that they generate. There’s an unspoken rule that the coverage in such supplements is going to generally be upbeat and fluffy — that it’s going to make readers want to see the movies being written about.

And even if the ad side has no control at all over the edit side, it does at least enforce reciprocity: that the edit side won’t seek to control what the ad side allows to be printed. If there’s a fight between ad and edit over whether or not NYT reviews can be selectively quoted in movie ads, then ultimately the ad side is going to make the final determination. And whatever the clients (the movie studios) want, is very likely to end up being exactly what the clients get.

For me, then, the fact that the ad used a tweet rather than a formal review is not such a big deal. In some way it’s more interesting that the use of a tweet spurred vastly more discussion and outrage than any highly-selective blurb, culled from a more traditional source, has done in years. You’d think that tweets were more easy-come, easy-go — that people wouldn’t care as much about tweets as intellectual property. But it seems that they do! At least, they do when those tweets start appearing in print.

In a world where the brands of individual journalists have never been more valuable, and where the money flowing from print ad revenues has never been lower, this storm in a teacup might be a sign that the balance of power is changing. It may be a sign that the big ad buyers don’t have quite as much ability to dictate the rules as they used to. Or, it might just be a slow news week. Frankly, I suspect that the movie studios are going to continue to produce whatever ads they want to produce, and that the NYT is going to continue to publish just about anything that the studios would like them to publish. Just so long as the ads in question don’t use dirty words or show too much skin.


I’m surprised that this article discusses copyrights and quoting another person and manages not to discuss fair use. When the reviewer comments on the movie, they may use a line or two in their review. They can do so under fair use. While I don’t believe that using a reviewer’s quote in a movie ad is definitely a fair use, I do believe that the argument should at least be acknowledged.

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The payments impasse

Felix Salmon
Jan 6, 2014 23:16 UTC

I’ll say this for bitcoin: it’s got a whole new class of people, like Matt Levine and Guan Yang, increasingly interested in one of my longstanding obsessions — payments. (You might be surprised to learn how hard it is to get people interested in payments.) Guan’s post, along with the response to it from Simple’s Shamir Karkal, provide a techie’s viewpoint into a question which many non-Americans have when they start living in this country: how on earth can can moving money from one person to another be so difficult, expensive, and time-consuming?

The simple answer, as Karkal hints at, is that we’re suffering from a particularly toxic combination: an outdated payments system combined with a seemingly powerless central bank, which is happy to let the big banks dictate the pace of change (or lack thereof). And as American Banker’s Kevin Wack explained in a great piece last November, the big banks are very good at vetoing even incremental improvements in the US payments infrastructure.

The best place to start, if you want to understand the massive opportunities here, is the public consultation paper on payments which was put out by the Federal Reserve Banks last September. It’s written in reasonably plain English, and makes it clear that the Fed would love to see two key “desired outcomes”:

Desired outcome 2: A ubiquitous electronic solution(s) for making retail payments exists that does not require the sender to know the bank account number of the recipient. Confirmation of good funds will be made at the initiation of the payment. The sender and receiver will receive timely notification that the payment has been made. Funds will be debited from the payer and made available in near real time to the payee.

Desired outcome 4: Consumers and businesses have better choice in making convenient, cost-effective, and timely cross-border payments from and to the United States.

In other words, the Fed absolutely understands what Guan and I have been saying for a while. The big problem, however, arises before we even get to the two big “desired outcomes”. Indeed, it’s so big that the Fed puts it right at the top of the list:

Desired outcome 1: Key improvements for the future state of the payment system have been collectively identified and embraced by payment participants, and material progress has been made in implementing them.

It’s this that isn’t ever going to happen. As the Fed paper drily notes, the results of its analysis of gaps and opportunities in the payments system “are not surprising as they are comparable to the results of a similar gap analysis conducted in 2002”. And the paper itself was released just a month after the big banks which control the existing payments system voted down an attempt to speed it up just a little bit. Probably because they feared that a faster and more efficient payments system would cut into the fees they get from wire transfers, which they charge as much as $50 for despite a cost of only 14 cents.

The Fed is a bit like a hippy parent: it doesn’t want to force anything on its charges, it wants them to change on their own. And so it asked for responses to its paper, which can be found at a dedicated website. If the Fed had any doubt about the banks dragging their feet, then the responses will certainly have put those doubts to rest.

The responses from The Clearing House, Nacha, and the American Bankers Association all basically say exactly the same thing (which is not surprising, given their highly-overlapping memberships). Do we really need instant funds transfer? Can’t we just have instant messaging saying that the funds transfer will happen, instead? How are we going to make money doing this? Do you have any idea how expensive it’s going to be? Don’t you know that we already have a massive regulatory burden? This is no time to ask us to do even more. (Although, by the same token, it wouldn’t be fair to allow non-bank competitors like Ripple to compete against those of us who have many more regulators.) Besides, just thinking about the cybersecurity aspect of the whole thing makes our heads hurt!

The impasse has never been more obvious. The Fed wants changes; it wants those changes to come from the banks; the banks have no interest in implementing such changes. Which means that either the Fed is going to have to get tough, and force the banks to change, or else we’ll have about as much change in the next ten years as we’ve had in the last ten.

What are the chances of the Fed forcing America’s banks to get with the 21st Century? Very slim, I’d say. The banks have been extremely good at squealing very loudly whenever anybody has attempted to implement any new regulation, even regulations designed to safeguard the entire national economy. Improving payments doesn’t protect us against systemic risks: it just makes everybody a little bit better off in a million different ways. And as all politicians know, any policy which benefits everybody a little, but which a small number of key players are vehemently opposed to, will never get off the ground.

Non-bank solutions to this problem, be they based on cybercurrencies or anything else, are never going to cut the mustard: the key element here is ubiquity, which means people shouldn’t have to sign up for yet another service like PayPal or Bitpay or Square. Instead, the entire national (and international) payments architecture needs a massive upgrade.

Realistically, that upgrade can only be overseen by the Federal Reserve — an entity which doesn’t feel empowered to enforce such a thing. Until then, as Guan says, “US Dollars, while a good store of value and unit of account, are also terrible for making payments.”


Here in Germany people have used direct, cost-free bank transfers for decades – slow but fully protected by law – now we have ‘Sofortüberweisung’, aka instant internet transfer, that confirms a payment will be made within seconds – even across EU national borders. German banks have their own problems but letting customers transfer money is not one of them.

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The rise of long-term thinking

Felix Salmon
Jan 5, 2014 07:16 UTC

Morgan Housel has penned a rather odd column to mark the new year, declaring 2013 to be the year that “long-term thinking” died, with “his last true friend, Vanguard founder Jack Bogle,” at his side.

The weird thing about this column is that long-term thinking isn’t dead at all; in fact, it’s never been healthier. Housel did manage to find a trader on CNBC exhibiting symptoms of short-term thinking — but that’s what CNBC does, and in fact it’s possible to use CNBC’s ratings as a reasonably good proxy for the general prevalence of short-term thinking. Guess what: they’re at their lowest point in 20 years, with the channel reaching just 38,000 viewers over the course of a day. That’s a really tiny niche. A potentially profitable niche, to be sure, but tiny all the same.

Meanwhile, long-term thinking’s true friends at Vanguard have never been healthier: the Vanguard Total Stock Market Index Fund is now the largest mutual fund in the world, having overtaken the Pimco Total Return Fund in October, and Vanguard’s total assets under management are jaw-droppingly huge: they started last year at $2 trillion, and were already over $2.5 trillion by the end of June. I wouldn’t be surprised if they were at or near $3 trillion by now. It’s pretty safe to say that substantially all of that money is being invested according to the tenets of long-term thinking — and that it vastly exceeds the amount of money being traded on a daily basis by the 38,000 viewers of CNBC. (They’d need to have $80 million each to get to $3 trillion; and while CNBC viewers might be rich, they’re not that rich.)

The height of short-term thinking, when it comes to investing, was surely the dot-com bubble, when everybody wanted to be a day trader, and everybody believed in the greater fool theory. When the dot-com bubble burst, individuals (outside a core group of hobbyists) pretty much gave up on stock-picking and short-term trading. With hindsight, we can even say that the dot-com burst was very well timed to prepare America’s investors for the financial crisis: once they had lived through 1999-2001, they grew up, and ended up responding to the crisis in a surprisingly mature and sensible manner. Here, for instance, is a chart of ETF flows during the crisis:

Screen Shot 2014-01-04 at 4.06.21 PM.png

What you’re looking at here are some of the most torrid months that stock-market investors have ever seen. Just look at the monthly return figures on the S&P 500, from September 2008 through February 2009: -9.2%, -16.8%, -7.5%, +0.8%, -8.6%, -11.0%. Add it all up, and you get a stomach-churning 42% drop in the market — more than enough, according to conventional wisdom, to spark a major panic among retail investors. But what did they actually do? They ended up putting a net new $90 billion into ETFs over the course of those months.

Or, here’s a chart of mutual fund flows — a chart which naturally exaggerates outflows, since there’s a long-term secular trend out of mutual funds and into ETFs. Again, there’s no real sign of panic during the financial crisis: there was selling, to be sure, at a time when Americans found themselves in sudden need of liquidity, but you’re not seeing any short-term thinking here: you’re not seeing people trying to time the market. More generally, the main lesson of this chart is how small all the numbers are. Compared to the trillions invested in the stock market, weekly flows in the single-digit billions are pretty small beer, and show that nearly all investors, nearly all of the time, are doing the sensible buy-and-hold thing. When flows are small relative to stocks, that bespeaks long-term thinking, rather than short-term thinking.


This is not the impression that you get from talking to professional financial advisers, of course, most of whom paint themselves as a desperately-needed bulwark protecting investors from their base instincts. And it’s not the impression that you get from reading scaremongering stories about high-frequency trading, or misleading statistics from the likes of Housel, who says that the average stock holding period fell from eight years to five days between the 1960s and 2010. The problem with such numbers is that averages are little use to us here: a very small number of high-frequency algobots, who can hold their positions for less than a second, will skew the averages to the point of meaninglessness.

Indeed, a big reason for the rise and rise of private markets, and the ever-increasing amount of time that companies wait before they go public, is precisely that there is an unprecedentedly large pool of long-term patient money out there, willing to tie itself up in private-equity and venture-capital funds for five or ten years or longer. Individuals are looking for investment advice not so much from the braying noisemakers on CNBC, but rather from institutions with quasi-permanent capital pools: endowments, foundations, sovereign wealth funds.

Or, to put it another way, the war has pretty much been won at this point, and retail investors have got the message. They understand the superiority of passive investing, and they understand the importance of long-term thinking: none of these things, any more, are remotely difficult or counterintuitive concepts. Housel’s column is in effect an attempt to persuade the sensible majority that they’re some kind of beleaguered minority. In reality, however, long-term thinking is alive and well and utterly mainstream. Which should good news for everybody, with the possible exception of CNBC.


@diceros, he is looking at equity mutual funds. Most small-time individuals invest this way, so the cash flows for mutual funds are a proxy for this group.

If cash is flowing into equity funds, then somebody else is selling — presumably institutional and high-net-worth investors who invest directly. I’ve been steadily taking profits off the table over the last couple years, and I’m sure others have as well.

As you note, the small-time investors typically have terrible timing. Positive flows into equity funds is often a signal that the market is about to crash.

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Netflix’s dumbed-down algorithms

Felix Salmon
Jan 3, 2014 15:27 UTC

Alexis Madrigal has a rollicking investigation into Netflix’s movie genres — all 76,897 of them, from category #1 (African-American Crime Documentaries) to category #91,307 (Visually Striking Latin American Comedies). His story is titled “How Netflix Reverse Engineered Hollywood”, and as such, it’s the latest entrant to a well-stocked category of its own: Awestruck Narratives About Netflix’s Technology and the Systematization of the Ineffable.

Netflix has meticulously analyzed and tagged every movie and TV show imaginable. They possess a stockpile of data about Hollywood entertainment that is absolutely unprecedented…

When these tags are combined with millions of users viewing habits, they become Netflix’s competitive advantage. The company’s main goal as a business is to gain and retain subscribers…

Now, they have a terrific advantage in their efforts to produce their own content: Netflix has created a database of American cinematic predilections. The data can’t tell them how to make a TV show, but it can tell them what they should be making. When they create a show like House of Cards, they aren’t guessing at what people want.

I’m something of a curmudgeon when it comes to such stories, however — and it seems to me that there’s an alternative reading to Madrigal’s story, which tells a rather more bearish story about Netflix.

Netflix’s big problem, it seems to me, is that it can’t afford the content that its subscribers most want to watch. It could try to buy streaming rights to every major Hollywood blockbuster in history — but doing so would cost hundreds of billions of dollars, and could never be recouped with $7.99 monthly fees. What’s more, the studios can watch the Netflix share price as easily as anybody else, and when they see it ending 2013 at $360 a share, valuing the company at well over $20 billion, that’s their sign to start raising rates sharply during the next round of negotiations. Which in turn helps explain why Netflix is losing so many great movies.

As a result, Netflix can’t, any longer, aspire to be the service which allows you to watch the movies you want to watch. That’s how it started off, and that’s what it still is, on its legacy DVDs-by-mail service. But if you don’t get DVDs by mail, Netflix has made a key tactical decision to kill your queue — the list of movies that you want to watch. Once upon a time, when a movie came out and garnered good reviews, you could add it to your list, long before it was available on DVD, in the knowledge that it would always become available eventually. If you’re a streaming subscriber, however, that’s not possible: if you give Netflix a list of all the movies you want to watch, the proportion available for streaming is going to be so embarrassingly low that the company decided not to even give you that option any more. While Amazon has orders of magnitude more books than your local bookseller ever had, Netflix probably has fewer movies available for streaming than your local VHS rental store had decades ago. At least if you’re looking only in the “short head” — the films everybody’s heard of and is talking about, and which comprise the majority of movie-viewing demand.

So Netflix has been forced to attempt a distant second-best: scouring its own limited library for the films it thinks you’ll like, rather than simply looking for the specific movies which it knows (because you told it) that you definitely want to watch. This, from a consumer perspective, is not an improvement.

What’s more, with its concentration on streaming rather than DVDs by mail, Netflix has given up on its star-based ratings system, and instead uses what it calls “implicit preferences” derived from “recent plays, ratings, and other interactions”. Again, I’m not sure this is an improvement — but it does fit in a much bigger strategic move chez Netflix. While Madrigal and I might still think of Netflix as an online version of your old neighborhood Blockbuster Video store, Netflix itself wants to replace something which accumulates many more viewer-eyeball-hours than Blockbuster ever did. It doesn’t want to be movies: it wants to be TV. That’s why it’s making original programming, and that’s why the options which come up on your Netflix screen when you first sign in are increasingly TV shows rather than movies.

One huge difference between TV and movies is that audiences have much lower quality thresholds for the former than they do for the latter. The average American spends 2.83 hours per day watching TV — that’s not much less than the 3.19 hours per day spent working. And while some TV is extremely good, most of it, frankly, isn’t.

Television stations learned many years ago the difference between maximizing perceived quality, on the one hand, and maximizing hours spent watching, on the other. Netflix has long since started making the same distinction: it wants to serve up a constant stream of content for you to be able to watch in vast quantities, rather than sending individual precious DVDs where you will be very disappointed if they fall below your expectations. Netflix’s biggest fans tend to be parents of young kids — but in a sense, Netflix wants to turn us all into young kids, consuming an endless stream of minimally-differentiated material. (Note that Netflix doesn’t allow you to watch a trailer for a movie before streaming it; it just expects you to stop watching that movie, and start watching something else, if you don’t like it.)

Strategically, this move makes a lot of sense for Netflix. TV shows are cheaper to license than movies are, and people tend to be much more addicted to their TVs than they are to watching movies. And the rise of the micro-genre at Netflix only really makes sense once you understand its TVification. On Netflix, you can binge-watch one reality-TV show, and then watch another, and another; or you can do the same with, say, crime series. They don’t need to be great, they just need to be the kind of thing you like to watch. Which explains why Lilyhammer just started its second season, despite the fact that no one was particularly impressed the first time around.

The original Netflix prediction algorithm — the one which guessed how much you’d like a movie based on your ratings of other movies — was an amazing piece of computer technology, precisely because it managed to find things you didn’t know that you’d love. More than once I would order a movie based on a high predicted rating, and despite the fact that I would never normally think to watch it — and every time it turned out to be great. The next generation of Netflix personalization, by contrast, ratchets the sophistication down a few dozen notches: at this point, it’s just saying “well, you watched one of these Period Pieces About Royalty Based on Real Life, here’s a bunch more”.

Netflix, then, no longer wants to show me the things I want to watch, and it doesn’t even particularly want to show me the stuff I didn’t know I’d love. Instead, it just wants to feed me more and more and more of the same, drawing mainly from a library of second-tier movies and TV shows, and actually making it surprisingly hard to discover the highest-quality content. It’s a bit like what Pandora would be, if Pandora was severely constrained in the songs it could choose from.

This move is surely great for Netflix’s future profitability, and probably helps explain its resurgent share price. If Netflix can provide half of the service that traditional TV offers, at a tenth of the price, that’s a deal which can go a very long way. But it’s also a service aimed squarely at couch potatoes, not at movie lovers.

I don’t find myself with 2.8 spare hours to watch TV very often, and when I do, I want to make those hours count, by watching something great. For me, and for people like me, Netflix’s micro-genres create little more than a frustrating slurry of mediocrity in which it is increasingly difficult to find the gems. I find it much easier to find something I want to watch on the iTunes rental library than I do on Netflix. Normally, I’ll check canistream.it to see whether the film in question is available on Netflix, before I click the “rent” button. But there’s something a bit screwy about a world where I find iTunes to be a more useful discovery mechanism for Netflix material than Netflix itself.

The original version of the post mistakenly listed Shane Ferro as the author. It was in fact written by Felix Salmon.



this comment is the correct one. I am not sure how Felix could write such a misguided article. Everything he likes about Netflix is still there, the streaming service just doesn’t offer it. Why would it?

It is still a tremendous value. For nearly a decade Netflix has been my family’s sole visual entertainment expense.

It replaces going to the movies, renting movies, cable TV, buying DVDs, buying TV shows. We don’t do any of that anymore.

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