Felix Salmon

The four rules of writing about art auctions

Felix Salmon
Dec 4, 2013 06:12 UTC

A loyal reader asks my advice for writing about art auctions. It’s pretty simple, and boils down to four rules:

  1. It isn’t a market for masterpieces.
  2. Ignore auction records.
  3. Adjust for inflation.
  4. Make judgments.

The best way to illustrate the first rule is via a chart, which I generated from data given to me by the good people art Artnet:

What you’re seeing here is a pretty volatile six years in the history of art auctions. (The figures for 2013 are to November 30.) Artnet took all the lots sold at Sotheby’s and Christie’s in each year, and separated them into the top 20% and the bottom 80%. They then measured how much money the top 20% of lots brought in, as a fraction of the total.

In absolute terms, the ranges were big: the top 20% of lots brought in $6.8 billion so far this year, compared to just $3.2 billion in 2009. But in percentage terms, the numbers are astonishingly constant, right around the 90% level: they never dipped below 89%, or rose above 92%.

In other words, no matter what the market, the top quintile of art works will always accounts for 90% of the value of the art sold.

This is a fact every art reporter should know — because the minute you start interviewing self-appointed art-market experts, they’re all going to say exactly the same thing. It’s a quote found in auction report after auction report, and it generally comes from some dealer or other: “the very best art is in high demand and getting amazing prices,” he’ll say, or words to that effect, “but anything less than the very best is going to be very hard to sell”.

The astonishing thing is that art-market reporters fall for this every season, even though it’s exactly the same thing they’ve heard in every other season. In today’s market, they write, it’s all about the masterpieces — the truly amazing works which sell for jaw-dropping megabucks. Everything else is an also-ran. (It’s taken for granted that the most expensive works are masterpieces; we’ll come back to that in a bit.)

But the fact is, statistically speaking, that the distribution of art-market values never really changes at all. What’s true today was true yesterday, and was true a decade ago as well. The only difference is the way in which the art-market caravan has moved on and anointed a new set of art works as being the “masterpieces” worth spending insane amounts of money on.

Similarly, every season there’s breathless coverage of new auction records — a long list of artists, all of whom just saw a work sell for more money than that artist has ever received at auction before. The auction houses love to present those auction records as a sign that the market is particularly healthy. But in fact, it’s more of a sign of how fickle both the auction houses and the art market are. Each season, a new artist is hot, and sells for high prices; the superstars of yesteryear, by contrast, aren’t even accepted for auction at all, much of the time. Today’s masterpiece is tomorrow’s mildly embarrassing reminder of how bad our taste used to be.

And then, of course, there’s the simple act of adjusting for inflation, which seemingly no art-market reporter is capable of. For instance, that record-busting Francis Bacon triptych is not “the Most Expensive Artwork Ever Sold at an Auction” if you follow the sensible rule that all prices should be adjusted for inflation. The record still belongs to Vincent van Gogh’s Portrait of Dr. Gachet, which was sold for $147 million, in today’s money, back in 1990.

So what should you do, if you want to cover the art auctions? Here’s one idea: try to spot the artists who aren’t selling, or who are quietly being moved to the day sales. The auction houses do a very good job of expectations management, in setting public estimates for the paintings they’re selling: if the estimate is low, and the price realized is equally low, it’s easy to think there’s nothing newsworthy going on — even if, a few years ago, the same piece might have sold for multiples of what it’s now able to fetch.

But the best art-auction reports go further than that, and talk in detail about the ever-present gap between price and quality. Inside an auction house, it’s in everybody’s interest to pretend that the most expensive art is the best art. But no one actually believes that. So: which works are faddishly overvalued? Which ones look like they’re selling for a (relative) song?

A little bit of connoisseurship, in an auction report, goes a long way. Maybe that should be the first rule of covering such events: don’t leave your critical faculties at the door. Without them, indeed, you’re unlikely to be able to say anything particularly insightful at all.


Two more: avoid generalising from tiny samples, and adjust for the premium. Journalists often report that a lot sold for ‘low estimate’ when the sale price includes an extra 1/3 premium. These are great rules. I’ve elaborated and applied here: http://grumpyarthistorian.blogspot.co.uk  /2013/12/how-to-write-about-auctions-ol d-master.html

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The $5 trillion dilemma facing banking regulators

Felix Salmon
Dec 3, 2013 17:16 UTC

Last month, I wrote about bond-market illiquidity — the problem that it’s incredibly difficult to buy and sell bonds in any kind of volume, especially if they’re not Treasuries. That’s a big issue — but it turns out there’s an even bigger issue hiding in the same vicinity.

The problem is that there’s only a certain amount of liquidity to go around — and under Dodd-Frank rules, a huge proportion of that liquidity has to be available to exchanges and clearinghouses, the hubs which sit in the middle of the derivatives market and act as an insulating buffer, making sure that the failure of one entity doesn’t cascade through the entire system.

Craig Pirrong has a good overview of what’s going on, and I’m glad to say that Thomson Reuters is leading the charge in terms of reporting about all this: see, for instance, recent pieces by Karen Brettell, Christopher Whittall, and Helen Bartholomew. The problem is that it’s not an easy subject to understand, and most of the coverage of the issue tends to assume a lot of background knowledge. So, let me try to (over)simplify a little.

During the financial crisis, everybody became familiar with the idea that a bank could be “too interconnected to fail”. The problem arises from the way that derivatives tend to accumulate: if you have a certain position with a certain counterparty, and you want to unwind that position, then you can try to negotiate with your original counterparty — but they might not be particularly inclined to give you the best price. So instead you enter into an offsetting position with a different counterparty. You now have two derivatives positions, rather than one. The profits on one should offset any losses on the other — but your counterparty risk has doubled. As a result, total counterparty risk only ever goes up, and when a bank like Lehman Brothers fails, the entire financial system gets put at risk.

There are two solutions to this problem. One is bilateral netting — a system whereby banks look at the various contracts they have outstanding with each of their counterparties, and simply tear them up where they offset each other. That can be quite effective, especially in credit derivatives. The second solution is to force banks to move more of their derivatives business to centralized exchanges. If there’s a single central counterparty who faces everyone, then the problem of ever-growing derivatives books goes away naturally.

Of course, if everybody faces a central counterparty, then it’s of paramount importance to ensure that the clearinghouse in question will itself never fail. Naturally, the clearinghouse doesn’t own any positions, but on top of that it has to be able to cope with its own counterparties failing. Typically, the way it does that — and we saw this during MF Global’s collapse — is to demand ever-increasing amounts of collateral whenever there’s a sign of trouble.

Such demands have two effects of their own. The first, and most important, effect is that they really do protect the central clearinghouse from going bust. But the secondary effect is that they increase the amount of stress everywhere else in the system. (MF Global might have ended up going bust anyway, but all those extra collateral demands certainly served to accelerate its downfall.) Pirrong calls this “the levee effect”:

Just as making the levee higher at one point does not reduce flooding risk throughout a river system, but redistributes it, strengthening a central counterparty (CCP) can redistribute shocks elsewhere in the system in a highly destabilizing way. CCP managers focus on CCP survival, not on the survival of the entire system, and this is quite dangerous when as is almost certainly the case, their decisions have external effects. Indeed, greater reliance on CCPs increases the tightness of the coupling of the financial system, which can be highly problematic under stressed conditions.

Essentially, when markets start getting stressed, liquidity and collateral will start flowing in very large quantities from banks to clearinghouses. Indeed, to be on the safe side, central clearinghouses are likely to demand very large amounts of collateral — as much as $5 trillion, according to some estimates — even during relatively benign market conditions. That is good for the clearinghouses, and bad for the banks. And while it’s important that the clearinghouses don’t go bust, it’s equally important that the banks don’t all end up forced into a massive liquidity crunch as a result of the clearinghouses’ attempts at self-preservation.

The banks, of course, will look after themselves first — especially as the new Basel III liquidity requirements start to bite. If they need to retain a lot of liquid assets for themselves, and they also need to ship a lot of liquid assets over to clearinghouses, then there won’t be anything left for their clients. Historically, when clients have needed to post collateral, they’ve been able to get it from the banks. But under Basel III, the banks are likely to be unable or unwilling to provide that collateral.

So where will clients turn? These are truly enormous businesses which might need to be replaced: Barclays has cleared some $26.5 trillion of client trades, while JP Morgan sees an extra half a billion dollars a year in revenue from clearing and collateral management.

Just as in the bond markets, one option is that the clients — the buy-side investors — will turn to each other for collateral, instead of always turning to intermediary banks. That’s already beginning to happen: some 10% to 15% of collateral trades already involve non-banking counterparties. But it’s still very unclear how far this trend can be pushed:

While corporates and buysiders might be comfortable sharing confidential information with their banking counterparties, shifting to a customer-to-customer model is a big step.

“The problem is that buyside firms have to open up their credit credentials to each other to get a credit line in place. I always felt that was an impediment to customer-to-customer business, but the combined impact of new rules changed that,” said Osborne.

Osborne, here, is Newedge’s Angela Osborne; her job is to start replacing banks in the collateral-management business. Once you adjust for Osborne talking her own book, it’s clear that there’s still a very long way to go before the banks will realistically be able to step back from this market.

After all, it’s not as though the banks’ buy-side clients themselves have unlimited amounts of collateral which they can happily post at a moment’s notice. It’s true that they aren’t as leveraged as the banks are. But they themselves have investors, who can generally ask for their money back at any time — normally, when doing so is most inconvenient for the fund in question. If they tie up assets posting collateral for themselves or others, that makes it much harder for them to meet potential redemption requests.

All of which means that as we move to a system of central clearinghouses, a new systemic risk is emerging: “fire sale risk” is the term of art. If a market becomes stressed, and the clearinghouses raise their margin requirements, then the consequences can be huge. In the bond market, the death spiral is all too well known: a sovereign starts looking risky, the margin on its bonds is hiked, which in turn triggers a sell-off in that country’s bonds, which makes them seem even riskier, which triggers another margin hike, and so on. This can happen in any asset class, but derivatives are in many ways the most dangerous, just because they’re inherently leveraged, and the amount of leverage that the clearinghouses allow can be changed at a moment’s notice.

Do the world’s macroprudential regulators have a clear plan to stop this from happening? Do they have any plan to resolve the inherent tension involved in demanding that banks retain large amounts of ready liquidity, even as they also allow clearinghouses to demand unlimited amounts of liquidity from the very same banks? The answers to those questions are — at least for the time being — very unclear. But the risk is very real, and it makes sense that regulators should do something to try to mitigate it.


Maybe I am missing something but this pretty much seems to be a made up risk to me. It would make sense for the banks to push this story so they can keep screwing over their costumers with OTC derivatives.

Is there any example in history of a clearing house causing a financial crisis? Collateral calls add stability to the system by lowering leverage before it gets to levels where systematic default is a danger. If a collateral shortage leads to the credit derivative market shrinking that is a positive in my book.

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Philanthropy, stock-picking, and Presbyterian frugality

Felix Salmon
Dec 2, 2013 18:50 UTC

I love the story of Jack MacDonald, which is only becoming public now, after his death. The short version: MacDonald inherited a substantial fortune from his parents, the proprietors of MacDonald Meat Co. in Seattle. But he made the classic promise to himself, that he wasn’t going to let the money change his life — and he kept it. He worked as a government lawyer for 30 years, he clipped coupons, he wore tatty sweaters, and even at the end of his life he was imploring his doctor to treat him only with generic drugs. He died a happy man, and bequeathed his fortune to three charities: the law school from which he graduated in 1940; Seattle Children’s, a pediatric research institute beloved of his mother; and the Salvation Army, in memory of his father.

Or rather, he bequeathed the income from his fortune equally to all three charities. The fortune itself — valued at $188 million — will remain fully invested.

MacDonald did not like to spend his money, but he loved to invest it:

When it came to picking stocks, “he was amazing,” said his stepdaughter, Regen Dennis, of Utah. “He didn’t trust a lot of other people to do his research; he directed what he wanted bought, and he really knew what he wanted.” …

MacDonald and his wife moved in 1997 to the Horizon House retirement community, where Mary died in 1999. In the retirement home, MacDonald continued to keep his hand in the stock market while nurturing his image as a man without means, even wearing sweaters with holes in the elbows…

Picha, of Children’s, often visited MacDonald at Horizon House, where copies of The Wall Street Journal and Forbes magazine were stacked on both sides of his favorite chair. His routine included an early-morning workout, a visit to the grocery store and a walk to his stockbroker to check on his accounts, Picha said.

There are three things going on here of note. Firstly, there’s the idea of stock-picking as a hobby for men. MacDonald was a devotee of this particular hobby, and clearly loved it. His stepdaughter says that he was very good at it, too — but without knowing how much money he started with, or when the inheritance took place, it’s hard to tell exactly how good he was. MacDonald might not have been spending his money on consumption, but he was still getting pleasure from it.

Secondly, there’s the deeply Scottish/Presbyterian idea that saving is something you do in perpetuity — an idea which lies at the heart of the thousands of endowments which dominate the non-profit sector in the US. MacDonald was a steward for his parents’ savings, and, at the end of his life, he created a structure which attempted to ensure that those savings would remain intact for generations to come. This is, at heart, a deeply futile stance, a little bit like hoarding bitcoins and never spending them. I’m reminded of the story told by Mary Ann Glendon:

Bostonians still tell the story of the respectable society matron who was crossing the Common one day and ran into an old college chum she hadn’t seen for years. The matron was dismayed to see that her friend was obviously engaged in the world’s oldest profession. “My dear,” she said, “whatever has happened to you?” “Well,” said her friend, “it was either this or dip into capital.”

From a philanthropic perspective, the point here is that as a rule it makes sense to front-load donations, not to back-load them. I don’t know when MacDonald first inherited his fortune, but it might well have been 50 years ago. That’s 50 years’ worth of children who haven’t received the benefit of his generosity. What’s more, the world and Seattle have been getting richer and healthier all the while, which means that the future recipients of MacDonald’s money will be less needy than the hypothetical past recipients would have been.

And yet, even now that MacDonald has died, Seattle Children’s Research Institute will receive, annually, just 5% of its share of the bequest. That’s the bare minimum, under US law, that MacDonald can give away and still be counted as a charitable trust. I’m sure that if the law allowed the trust to give away even less than 5% per year, MacDonald would have chosen an even lower number. There’s lots of self-congratulatory back-slapping going on around this bequest, but the fact is that MacDonald isn’t really giving his money away: he’s controlling it, to the maximal extent possible, from beyond the grave.

Finally, it’s worth noting that Doug Picha, president of the Seattle Children’s Foundation, cultivated MacDonald for 30 years before finally achieving this donation. I’m sure that his motives weren’t entirely mercenary, and that the two men were genuine friends. But if you’re in the fundraising business, and you’re looking for really big donations from incredibly rich individuals, that means you’re going to be playing a very, very long game — and, quite possibly, having to wait until those individuals die.

MacDonald reportedly said he “wanted to be remembered as a philanthropist” — and he’s certainly less self-effacing now that he’s dead, slapping his name all over the central square of Elora, Canada, as well as the Jack MacDonald Endowed Chair at the University of Washington. But the fact is that if he were really philanthropically inclined, he would have given much more money away many decades ago. And he wouldn’t be giving away only the barest minimum now that he’s dead.


You really need to preface that whole piece with an introduction that you are about to flyspeck the relative virtues of various kinds of exceptional generosity. In life (maybe yachting) or death (maybe a colossal statue of himself), Mr. MacDonald could have just spent all of his money, and we have no reason to expect otherwise of people generally. Also, even while investing, he was giving society the benefit of his resources, instead of calling in his chips for personal consumption. “If he were really” more “philanthropically inclined” than almost everyone else, he might well have done exactly what he did.

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When loans beat grants

Felix Salmon
Dec 2, 2013 02:48 UTC

What’s best: giving a man a fish, teaching a man to fish, or lending a man a fish? Nathan Fiala, of the German Institute for Economic Research, went to Uganda to find out, and the results of his study make for fascinating reading.

Fiala’s study is the first to directly pit the newly-trendy area of cash transfers (which come in both conditional and unconditional flavors), against the slightly tarnished area of microfinance. He found a group of small Ugandan businesses, and divided them randomly into five groups. The first received loans; the second loans with business skills training; the third cash grants; the fourth cash grants with business skills training; and finally, there was a fifth control group. The loans and the grants were both around $200; Fiala went back to all of the businesses after six months and nine months to see how the various groups were doing.

The results were not what you might expect. On the simple question of loans versus grants, it stands to reason that you’re going to be better off if you don’t have to repay the money than if you do. Except that’s not what happened:

By the nine-month point in the study, businesses which received grants saw a negligible increase in profits, while businesses which received grants and training actually saw their profits go down, on average. Women-run businesses also saw a decrease in profits after getting loans, whether they were accompanied by training or not. In fact, the only area where the intervention seemed to do any good at all was in male-owned businesses receiving loans: they did well overall, and even better when they got training as well.

Obviously, this is only one study — although Chris Blattman says that it’s a “very important” one. Certainly people should start trying to replicate it. But I suspect that the effects it finds are real. For while the study itself might be new, there are three well-known effects at work here.

The first is that most microlending very rarely makes people richer. That doesn’t mean that it’s a bad thing: access to loans can be very useful in terms of things like consumption smoothing. But if what you’re trying to do is create increased wealth and economic growth, microlending is a very inefficient way of getting there.

The second is the exception to that rule. The one time when microlending does predictably make people richer is when it takes unemployed women and turns them into small businesses. In many parts of the world, women have not historically been given the opportunity to go into money-making work — and in those parts of the world, microlending can make a substantial difference. It increases the number of employed people, and thereby increases both wealth and economic growth.

Finally, as we know from Portfolios of the Poor and from David Roodman’s book, there are many mechanisms, within poor societies, for wealth to get redistributed — and those mechanisms have existed for much longer than microfinance. When one person needs money, they will get it somehow; when another person comes into an unexpected windfall, that money will find its way to people in need.

Put these three things together, and it’s easy to see how Fiala’s study found what it did. As he says, when the small business owners were given cash grants, “the cash does not appear to have been spent into the business, for men or women, but is instead either spent on family obligations or other consumption.” But loans need to be paid back, which makes it more important for the money to be invested into the business: “knowing that the loan had to be repaid appears to have led men to use the money more effectively in their businesses,” he writes.

Because everybody in the study was already running a small business when the interventions began, all of the recipients of funds — men and women both — had jobs all along. There was no opportunity, in this study, for women to use funds to enter the workforce. On the other hand, there was opportunity for men to use loans to start employing their relatives. It’s unclear why men find it easier to hire their relatives than women do — but once again, the only way to increase wealth and growth seems to be to find a way to employ people who would otherwise be unemployed.

It’s worth emphasizing, here, that Fiala isn’t measuring welfare improvements: I’m quite sure that the people who received cash grants, for instance, are noticeably better off for having received them. Instead, he’s just measuring the profitability of small businesses. Using that narrow criterion, it turns out that throwing money at the business doesn’t make it more profitable — which, if you put it that way, is maybe not so surprising. If you want to help small businesses grow, then there is a case to be made for using loans rather than grants. But even then, I suspect, the really valuable resource is underutilized labor, rather than cash.


Thanks for the information. I will definitely look towards and will read out all the terms and conditions of loans while borrowing.

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Waiting for bitcoin to get boring

Felix Salmon
Nov 30, 2013 23:16 UTC

Something of a milestone was reached very early in the morning of Friday, November 29, a time when most Americans were either sleeping off their Thanksgiving excesses or out seeking Black Friday bargains. At the end of Wednesday, the price of gold, on Comex, had closed at $1,240 per ounce; that market would not reopen until Friday morning. And then at about 1am Friday, EST, there was a trade on Mt Gox, the largest bitcoin exchange, which valued each coin at $1,242. If only briefly and theoretically, at that point in time a bitcoin was worth more than an ounce of gold.

Bitcoin, by its nature, is a highly volatile asset, which is prone to astonishing run-ups in price. Check out these three one-year charts of the bitcoin price:




The first chart is the year to June 2010; the second is the year to April 2013; and the third is the current chart. Without looking at the y-axis, they’re basically identical.

To put it another way, there is nothing surprising about what bitcoin is doing right now; it has done it many times in the past, and it will probably do it in the future as well. After all, there’s no way to calculate the fundamental value of a bitcoin: indeed, it’s probably easier to justify a price of $1,000 per bitcoin than it was to justify a price of $10. At least now it’s increasingly looking like a Thing, complete with Congressional hearings and front-page-of-the-FT publicity stunts.

The latest bright idea from Alderney — that the tiny island (population: 1,900) should print physical bitcoins backed by electronic bitcoins — is certifiably bonkers. For one thing, the whole point of bitcoin is that it isn’t going to suffer the same fate as all those currencies which the government promised were backed by something else. (The dollar was backed by gold, once; the Argentine peso was backed by the dollar. Neither lasted, and if the burghers of Alderney ever change their mind about the bitcoin backing, or it gets hacked or stolen, the owners of the physical bitcoins are going to have no recourse.)

More weirdly, the Alderney bitcoins are going to have about £500 worth of gold in them, which makes no sense at all. Let’s say that the gold in the coin is worth $800, while the bitcoin backing it is worth $1,000. What, then, would the coin be worth? It can’t be much less than $1,000, at least as long as it can be redeemed for an electronic bitcoin, or a bitcoin’s worth of pounds sterling. But by the same token, it can’t be worth much more than $1,000, because numismatists don’t tend to value gimmicks very highly, so it’s not going to have significant value as a collector’s item. And the most you could sell it for, in terms of its fundamental value, is the value of one bitcoin. Which means that there’s no point whatsoever in pouring £500 worth of gold into it — the gold doesn’t increase the value of the coin at all.

All of which is to say that the FT is splashing all over its front page a crazy bitcoin scheme which is never going to happen. “An independent company will provide the Bitcoins,” explains the newspaper, credulously. “If the price plunged, neither Alderney nor the Royal Mint would lose anything.” But what independent company would ever do such a thing? The company would essentially need to hand over its bitcoins to Alderney, would probably have to help fund the cost of manufacturing the coins out of gold, and would get essentially nothing in return for the huge risk it was taking that all its coins would become worthless.

The news here, then, is not so much that there’s some new cockamamie scheme involving bitcoins — a new such scheme is dreamed up every day. Rather, it’s the way in which the bitcoin bug has infected news editors to the point at which they’ll splash any old vaporware silliness all over their front pages. One of the less reported aspects of the bitcoin story is the way in which editors tend to be much more excited about it than reporters, who are generally more skeptical, and who worry that their own reporting will only serve to inflate the bubble even further.

This is something which should worry the bitcoin faithful, if they really want to see bitcoin become a broadly-used global currency. After all, press coverage of bitocins runs in lockstep with the bitcoin price: it’s times like this, when the price is at its fluffiest, that bitcoin gets written about the most. (If it’s not physical bitcoins, it’s hard drives in landfills.) The largely unspoken assumption behind all such stories: bitcoin is an asset class, and people should get excited about it when (and, implicitly, only when) the price is going up. This is what I think of as the CNBC Premise: when an asset rises in price, that is necessarily a Good Thing, and when it falls in price, that is always a Bad Thing.

The CNBC Premise has never made much sense with respect to currencies, however. And with respect to bitcoin in particular, its most exciting aspect is not its value, but rather its status as an all-but-frictionless international payments mechanism. If you want bitcoin to really take off with respect to payments, you actually don’t want to see crazy price spikes — such things are the best possible way of stopping people from using bitcoins for payments. After all, if your bitcoins are doubling in value every few days, why on earth would you want to spend them?

For me, the most interesting period in the short history of bitcoin was the period from roughly the beginning of May to the end of September, when the volatility in the price of bitcoin was relatively low, even as the price was pretty high* — more than $100 per coin. And more generally, it’s the long flat areas of the three charts above, rather than the attention-grabbing spiky bits, that bitcoin bulls should get excited about. If and when those long flat areas last for years rather than months, bitcoin might start becoming a boring, credible currency. We’ll know that bitcoin has made it to the next level not when editors all want to write about it, but rather when editors don’t want to write about it, because it’s just another way of people paying each other for stuff.

*Update: As Joe Weisenthal points out, stability at a high price is more bullish for the bitcoinverse than stability at a low price, because the higher the market capitalization of bitcoin, the greater the amount of commerce that can be transacted in it.


Great article. Bitcoin should be approached prudently with an eye towards risk management. We comment on this and similar issues on our blog.

http://www.bitmorecoin.com – Quick and easy way to buy Bitcoin in the UK.

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Are Heloc defaults about to spike?

Felix Salmon
Nov 26, 2013 17:51 UTC

Peter Rudegeair is worried about Helocs. In particular, he’s worried about all the home equity lines of credit which were written in the run-up to the financial crisis, and which are now beginning to turn 10 years old. When they do that, their default rates have a tendency to spike, since most borrowers have to start paying down their principal after ten years.

Here’s the chart, which I put together from FDIC data; the red line marks the ten-years-ago point.

Rudegeair’s point is that we’re only just embarking on the 10th anniversary of the run-up in Heloc issuance. What’s more, a large proportion of the Helocs issued between 2003 and 2008 went to subprime borrowers. Because they’re credit lines, they don’t need to get paid down, at least for the first ten years. And so as these loans hit their tenth birthdays, millions of borrowers around the country are going to start being faced with new mandatory repayments. Which they might not be able to afford:

After 10 years, a consumer with a $30,000 home equity line of credit and an initial interest rate of 3.25 percent would see their required payment jumping to $293.16 from $81.25, analysts from Fitch Ratings calculate.

That’s why the loans are starting to look problematic: For home equity lines of credit made in 2003, missed payments have already started jumping.

Borrowers are delinquent on about 5.6 percent of loans made in 2003 that have hit their 10-year mark, Equifax data show, a figure that the agency estimates could rise to around 6 percent this year. That’s a big jump from 2012, when delinquencies for loans from 2003 were closer to 3 percent.

This is worrying — but I’m more sanguine than Rudegeair. Firstly, delinquency rates on Helocs naturally go up over time. As the best borrowers pay off their loans, and as people sell their homes for whatever reason, the denominator shrinks. The 5.6% delinquency rate for is a percentage of outstanding 2003-vintage Helocs, not a percentage of all the Helocs which were written that year. What I’d really like to see is the chart above, but with each bar split in two, showing what proportion of total outstanding Helocs are more than ten years old. We don’t know that number, and until we know that number, it’s hard to tell how big the problem is.

Secondly, what we can tell from the chart is that total outstanding Helocs are falling at an impressive rate — in fact, they seem to be falling, right now, nearly as fast as they were rising in the final years of the credit bubble. That’s partly because banks are writing off loans when underwater homes are sold, it’s partly because borrowers are paying down their loans, it’s partly because borrowers are refinancing their loans as the property recovery gives them a bit more equity, and it’s partly because borrowers are paying off their loans entirely, as they’re forced to, for instance, when they move. So even if delinquency rates start to rise, they’re going to be rising only as a proportion of a shrinking pool of Helocs.

Finally, we can also see from the chart that the banks have a few years’ experience already, in terms of seeing what happens to ten-year-old Helocs. The big rise in Heloc issuance doesn’t date back to the end of 2003; it’s much older than that, and really goes all the way back to the end of 1999. So the banks have the data they need — and their reaction to that data has been to ramp up their Heloc issuance. According to Moody’s Analytics, Heloc originations are likely to rise 16% this year, and will hit another five-year high in 2014.

Looked at in that light, if the total amount of Helocs outstanding is falling even as the number of new Helocs is rising quickly, it stands to reason that the amount of churn is higher than you might think, and that ten-year-old Helocs make up a pretty low proportion of the whole. This is borne out by Rudegeair’s own numbers: he has $1.3 billion in Helocs turning ten years old at Citibank in 2014, $4.5 billion at Wells Fargo, and $8 billion at Bank of America. That’s less than $14 billion between those three big banks, compared to a $518 billion total pool of Helocs. Even if delinquencies on that $14 billion hit 9%, that’s still a mere 0.2% of total Helocs outstanding.

As Rudegeair says, if interest rates rise and default rates spike along with them, those numbers could yet rise. But for the time being, they’re entirely manageable. Especially considering the fact that interest rates on Helocs are floating-rate, which means that the performing loans will be paying more money even if the defaulting loans cause losses. Besides, we’re still recovering from the last credit crisis. It’s far too early to have a new one.


Another, less charitable, interpretation of your data is that Banks create new HELOCs to pay back for the old ones, thus avoiding the principal to be amortized. More interest income, less current delinquencies… what not to like ?

Extend and pretend of course, but such is the zeitgeist !

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GoldieBlox, fair use, and the cult of disruption

Felix Salmon
Nov 26, 2013 05:29 UTC

If you google “disrupt the pink aisle”, you’ll get 36,800 results, all of which concern a San Francisco-based toy company named GoldieBlox. The company first came to public attention in September of last year, when it launched a highly-successful Kickstarter campaign which ultimately raised $285,881. Like all successful Kickstarter campaigns, there was a viral video; this one featured a highly-photogenic CEO called Debbie, a recent graduate of — you probably don’t need me to tell you this — Stanford University. And yes, before the Kickstarter campaign, there was “a seed round from friends, family and angel investors”. When the viral video kept on generating pre-orders even after the Kickstarter campaign ended, GoldieBlox looked like a classic Silicon Valley startup: young, exciting, fast-growing, and — of course — disruptive.

Not wanting to mess with a proven formula, GoldieBlox kept on producing those viral videos: “GoldieBlox Breaks into Toys R Us” was based on Queen’s “We Are The Champions”, and got over a million views. But that was nothing compared to their latest video, uploaded only a week ago, and already well on its way to getting ten times that figure. This one was based on an early Beastie Boys song, “Girls”, and deliciously subverted it to turn it into an empowering anthem.

Under what Paul Carr has diagnosed as the rules of the Cult of Disruption, GoldieBlox neither sought nor received permission to create these videos: it never licensed the music it used from the artists who wrote it. That wouldn’t be the Silicon Valley way. First you make your own rules — and then, if anybody tries to slap you down, you don’t apologize, you fight. For your right. To parody.

In a complete inversion of what you might expect to happen in this case, it is GoldieBlox which is suing the Beastie Boys. And they’re doing so in the most aggressive way possible. There’s no respect, here, for the merits of the song which has helped their video go massively viral and which is surely helping to sell a huge number of toys. Instead, there’s just sneering antagonism:

In the lyrics of the Beastie Boys’ song entitled Girls, girls are limited (at best) to household chores, and are presented as useful only to the extent they fulfill the wishes of the male subjects. The GoldieBlox Girls Parody Video takes direct aim at the song both visually and with a revised set of lyrics celebrating the many capabilities of girls. Set to the tune of Girls but with a new recording of the music and new lyrics, girls are heard singing an anthem celebrating their broad set of capabilities—exactly the opposite of the message of the original. They are also shown engaging in activities far beyond what the Beastie Boys song would permit.

This is faux-naïveté at its worst, deliberately ignoring the fact that Girls, the original song, is itself a parody of machismo rap. The complaint is also look-at-me move, positively daring the Beasties to rise to the bait and enjoin the fight. Which the Beasties, in turn, are trying very hard not to do. In their letter to GoldieBlox, the Beasties make three simple points. They support the creativity of the video, and its message; they’re the defendants in this suit, rather than the people suing anybody; and, most importantly, they have a long-standing policy that no Beastie Boys songs shall ever be used in commercial advertisements. (They don’t mention, although they could, that this last was actually an explicit dying wish of Adam Yauch, a/k/a MCA, and an integral part of his will.)

Given the speed with which the GoldieBlox complaint appeared, indeed, it’s reasonable to assume that they had it in their back pocket all along, ready to whip out the minute anybody from the Beastie Boys, or their record label, so much as inquired about what was going on. The strategy here is to maximize ill-will: don’t ask permission, make no attempt to negotiate in good faith, antagonize the other party as much as possible.

This way, at least, the battle lines get drawn pretty clearly. The jurisprudential analysis comes out, defending GoldieBlox and its right to use the Beasties’ song as parody. After all, fair use is a protection under the law, which means that if it applies, then it doesn’t matter what the Beasties think, or want: GoldieBlox can do anything it likes. On the other hand, in the key precedent for such issues, Campbell vs Acuff-Rose Music, Justice Souter explicitly said that “the use of a copyrighted work to advertise a product, even in a parody, will be entitled to less indulgence” under the law than “the sale of a parody for its own sake”.

This is a distinction the Beasties intuitively understand. After all, this version of Girls has been viewed more than 3 million times on YouTube, without so much as a peep from the Beasties. And if you simply lop off the last few seconds of the GoldieBlox version — the bit where they shoehorn in the GoldieBlox branding — then that, too, would surely have been fine. If all GoldieBlox wanted to do was get out a viral message about empowering girls, they could easily have done that without gratuitously antagonizing the Beastie Boys, or putting the Beasties in their current impossible situation.

Instead, however, GoldieBlox did exactly what you’d expect an entitled and well-lawyered Silicon Valley startup to do, which is pick a fight. It’s the way of the Valley — you can’t be winning unless some household-name dinosaur is losing. (The Beasties are actually the second big name to find themselves in the GoldieBlox crosshairs; the first was Toys R Us.) The real target of the GoldieBlox lawsuit, I’m quite sure, is not the Beastie Boys. Instead, it’s the set of investors who are currently being pitched to put money into a fast-growing, Stanford-incubated, web-native, viral, aggressive, disruptive company with massive room for future growth — a company which isn’t afraid to pick fights with any big name you care to mention.

Because in Silicon Valley, people will always prefer to invest in that kind of company, rather than in a toy company whose toys, in truth, aren’t actually very good.

Update: Turns out that GoldieBlox CEO Debbie Sterling was making deliberately-controversial viral videos long before she conceived of GoldieBlox. I’m not sure what to say about this, except that if you played any part in making it, you should never, ever get the benefit of the doubt.

Update 2: And here is Debbie’s blog from when she was in India, it has to be read to be believed. To think that this woman is trying to claim the moral high ground over Adam Yauch.

Update 3: GoldieBlox has now removed the video, saying that it does want to respect the Beasties’ wishes after all.


Gilson, above, makes a misrepresentation by only quoting the first sentence from one of the products on the GoldieBlox website: “In this much-anticipated sequel, Goldie’s friends Ruby and Katinka compete in a princess pageant with the hopes of riding in the town parade.”

Yeah that does sound hypocritical as Gilson suggests. Except when you read the next sentence and put it in context it makes a lot more sense: “When Katinka loses the crown, Ruby and Goldie build something great together, teaching their friends that creativity and friendship are more important than any pageant.”

So obviously Goldieblox is not promoting princess pageant culture but critiquing it.

As for the song issue, it’s kind of a tough one. As a musician who wouldn’t want works to be used in advertising, I think the creator correctly has certain rights over its use. And the Beastie Boys are cool guys, so why target them? There are loads of way more genuinely sexist male acts who could be parodied.

BUT, it’s also not a great song, by the band’s own admission, with embarrassing misogynistic lyrics. In that sense it deserves to be made fun of and turned upside down.

After careful consideration, I would have to side with the Boys. It may be a crap song, but it’s still their crap song and an advertisement is an advertisement is an advertisement.

What I really don’t get though is how people on this thread go from discussing this issue to vilifying “feminists”.

Get a grip! The issue of whether or not Goldieblox’s appropriation of “Girls” constitutes Fair Use, under the law, doesn’t actually have anything whatsoever to do with feminism!

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Bad bank of the day, RBS edition

Felix Salmon
Nov 25, 2013 19:07 UTC

Here in the US, the bank-related scandals pertaining to the financial crisis invariably focus on the go-go years before everything fell apart, when the originate-to-distribute model created horribly skewed incentives across most of the privately-owned financial sector. In the UK, however, the latest big scandal is in many ways the exact opposite: it governs the behavior of RBS, one of the largest banks in the world, after the financial crisis, and after it was effectively nationalized by the UK government.

One of the problems with this story is that it’s hard to find a single place where the scandal is clearly laid out in its full gruesomeness. The BBC has done probably the best job, but most of the credit here really goes to the Sunday Times, which conducted a two-month investigation, and whose story (which is behind a subscription paywall, sorry) is a fantastic example of how a well-chosen set of individual stories can really bring systemic problems into focus.

And then there’s the Tomlinson Report. Lawrence Tomlinson is an entrepreneur and advisor to the government, and has delivered a 20-page paper entitled “Banks’ Lending Practices: Treatment of Businesses in Distress”. Its conclusions are clear — but its methodology is not, and I’m a bit sad that Tomlinson, after six months’ work, didn’t spend a little bit of effort to make the report more readable and provide detail on how exactly he arrived at his conclusions.

But putting everything together, a coherent narrative does emerge. Basically, after the crisis, RBS was in desperate straits, and had to deleverage fast — especially when it came to property loans. It gave that job to a bunch of bankers — and bankers, quite naturally, have a tendency to try to maximize their own profits. Which is exactly what they did, with no regard whatsoever to the wellbeing of their borrowers. Indeed, the bankers seemed to relish taking a maximally adversarial stance towards RBS’s borrowers, as though they were players in a zero-sum game. The result was a large amount of unnecessary human distress, on the borrower side, along with an unknown quantity of marginal extra profits on the RBS/taxpayer side.

It helps to look at a real-world example or two, otherwise everything is just too abstract. John Morris spent £65 million converting a country house into luxury apartments; he had another £2.5 million in the bank to cover any last-minute problems, and already had buyers lined up for four apartments worth £7 million. But then, without warning, RBS drained the account with £2.5 million in it, stalling the development, and causing the buyers to walk away. Morris tried to buy the whole thing for £32 million, but RBS said no, instead selling it to its own property division, West Register, for £16 million.

Here’s another: Eddie and Cheryl Warren bought the Bold hotel in Southport for £3.7 million, with a loan from RBS. In the UK, mortgages are floating-rate, and the bank forced them to take out an interest-rate swap to protect them against rising rates. When rates fell, they had to pay penalties on the swap of £120,000 per year — but even so, they always remained current on all their payments. That notwithstanding, RBS declared that thanks to the rate swap, the Warrens were deeply underwater. The bank declared the hotel to be worth just £1.8 million, forced the Warrens into insolvency, and then ended up selling the hotel to — yes — West Register, for the bargain-basement price of £1.4 million. The Warrens lost everything, including their home; they are now divorcing.

And then there’s Leonard Wilcox, who took out a £2.5 million loan to buy a property site valued at £5.35 million, only to see it being sold to West Register for £1.1 million in the end, losing his own home in the process.

The Sunday Times found lots of other stories like this, all of which included something called the Global Restructuring Group (GRG) at RBS. This group had the ability to take over loans and behave with breathtaking aggression and arrogance — and it took full advantage of all its powers.

Once you’ve read the Sunday Times story, the Tomlinson report becomes much easier to understand. The GRG would storm into a portfolio, and decide that its first job was to find something wrong. The trick was always to declare the borrower in violation of some covenant or other, even if she was fully current on her payments. Often, that would be done by writing down the value of property collateral.

On top of that GRG would pile fees onto the businesses it was given oversight of: one such business says that it had to pay an extra £256,000 in RBS fees alone, while others had to pay six-figure sums for external accountants to conduct an “independent business review”. None of this ever helped the businesses in question:

When asked, a whistleblowing ex-RBS banker confirmed that they could not think of any occasion in which a business entered RBS’ Global Restructuring Group and came back into local management.

Tomlinson, as befits a free-market entrepreneur, thinks that more competition would solve these problems. He’s wrong about that. Remember that all of this activity took place within a panicky post-crisis environment: no banks would have stepped in to take over these loans in mid-2009, no matter how many banks there were. And now that credit is flowing more easily again, the problems have gone away of their own accord: they were an artifact of their time. What’s needed is just better bank regulation, to make sure that banks don’t behave atrociously when the economy is going through a nasty recession. As part of that, banks should be encouraged not to mark real-estate collateral to market, in situations where the loans are not delinquent or past-due.

Tomlinson is right, however, that bank customers do need some kind of avenue of redress or complaint — in the UK, for these borrowers, there is essentially none, and they can’t even sue the banks, since any law firm which does business with banks will refuse to take their case.

There are broader lessons here, too, for anybody thinking about splitting troubled banks up into a good-bank / bad-bank structure. The problem with bad banks, which inherit troubled assets and try to wind them down with the minimum of losses, is that they can’t make money from lifetime relationships: their lifetime is by its nature highly limited. And so they have every incentive to treat their borrowers very badly, even when, as in this case, the bank is state-owned.


Felix, GRG didn’t start doing this in 2008, it started in 1991, and it’s been polishing its game ever since.

http://www.ianfraser.org/has-rbs-become- a-rogue-institution/

E.g. relating to a rip-off set up in 2007:
http://www.scotcourts.gov.uk/opinions/20 10CSOH3.html

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The government-dominated bond market

Felix Salmon
Nov 22, 2013 22:27 UTC

JP Morgan’s Nikolaos Panigirtzoglou put a fascinating report out last week, looking at supply and demand in the global bond market in 2014. And although I consider myself something of a bond nerd, I was genuinely astonished by some of the charts he put together, starting with this one:


This chart alone suffices to explain why the markets care so much about the taper: central-bank buying accounts for $1.6 trillion — more than half — of the total demand for bonds in 2013. Meanwhile, private banks are taking the opposite side of the trade: while they were huge buyers of bonds in 2007 and 2008, they’re net sellers in 2013 and 2014, more or less completely negating the buying pressure from pension funds, insurance companies, bond funds, and retail investors. In 2014, it seems, substantially all the net demand for bonds is going to come from the official sector. So it matters a great deal when that demand is diminished.

What’s more, central-bank buying, overwhelmingly from the Fed and the Bank of Japan, accounts for the lion’s share of official-sector buying: sovereign wealth funds and other foreign official institutions will buy just $364 billion of bonds this year, according to JP Morgan’s estimates, down from $678 billion last year. So the heavy lifting is still going to have to be conducted by QE operations, in the face of a taper which JP Morgan estimates at $500 billion over the course of the year. (The assumption is that it starts in January, and is completed by September.) Between the taper and other sources of diminished demand, total bond-buying firepower is likely to be $750 billion smaller in 2014 than it was in 2013. Bad news, for bonds, right?

Not so fast! It turns out that even as demand for bonds is shrinking, the supply of new bonds is shrinking just as fast:

Screen Shot 2013-11-22 at 4.45.23 PM.png

Again, this chart surprised me: I knew that government debt was a very important part of the total bond market, but I wouldn’t have guessed how important it was — or how fast it is shrinking.

Panigirtzoglou puts the two charts together, and you end up with this result:

In total we expect bond supply to decline by $600bn in 2014 to $1.8tr, more than offsetting the $500bn decline in bond demand due to Fed tapering. The balance between supply and demand, i.e. excess supply, looks set to widen from $140bn in 2013 to $280bn in 2014.

That number has pretty large error bars: you could pretty much cover the entire thing just by delaying the taper for three months. So let’s not worry too much about the difference between the two estimates, here. Instead, step back and look at the big picture, which is pretty simple: as a stylized fact, the bond market is dominated on both sides by the official sector. Private participants might sit in the middle as market-makers, or try to borrow money here or there, but overall what you’re looking at, when you look at the bond market, is government issuing debt and governments buying it.

The good news is that this large transfer of money from the official sector’s left hand to its right hand is slowing down, but that’s going to take a while. In any case, there doesn’t seem to be any conceivable way that the private sector could possibly be able to fund the still-substantial government deficits which have been bequeathed to us by the financial crisis. As a result, I suspect that QE is likely going to be around for a while, just as a matter of mathematical necessity. The world’s national deficits can’t get funded any other way.


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