Felix Salmon

Give Corbat some time

Felix Salmon
Oct 17, 2012 15:08 UTC

Peter Eavis has the most dramatic of the second-day pieces on the shake-up at the top of Citigroup:

Some analysts believe Mr. Corbat could open the door to more radical moves at Citigroup…

The burning question is whether he has the resolve to get out of businesses that the bank doesn’t excel in, even if the near-term costs are high… In particular, some investors would like Citigroup to be quicker about selling assets in Citi Holdings, the bad bank that Citigroup set up for its unwanted and loss-making assets. Mr. Corbat ran Citi Holdings until the end of last year. Faster sales might mean Citigroup would not get the best price possible for the $171 billion in assets in Citi Holdings. That could lead to higher losses when sales took place. But selling assets more quickly could free up the capital the bank holds there…

Citigroup’s investment bank is the other obvious target for shrinkage. Right now, it is enormous… The unit is also seen as a black box, something Mr. Corbat will have to tackle if he wants to regain investors’ confidence, analysts say.

The quandary for Mr. Corbat may be that, if he increases disclosure, investors may balk at any alarming numbers and dump the stock. Even so, he may have to risk that outcome.

This is an intriguing idea, but it’s not going to happen, for various reasons. Firstly, if the board wanted a radical slash-and-burn artist, they would never have hired Corbat, a hugely competent Citi lifer. Corbat has shown very clearly how he likes to deal with the unwanted legacy assets at Citi Holdings: after all, he ran it for most of its existence. And he’s treating those assets much like Treasury has treated its stakes in Citi or AIG or General Motors: he’d love to sell them, but only if he can get a good price.

Secondly, it’s very hard to free up capital when you’re selling assets at a loss. It’s possible, if you sell at only a small discount. But any loss on the deal has to come straight out of the capital you’re supposedly freeing up — and it can easily eat up all of that capital entirely, and then some.

As for Citi’s investment bank, Eavis is absolutely right that with $900 billion in assets, it’s far too big. He’s also right that one reason Citi’s stock trades at such a large discount is that investors really have no idea what those assets comprise, or why the investment bank’s balance sheet needs to be so bloated. And in fact there’s a good chance that if Corbat reckons that Citi needs to get smaller, the investment bank is where he’ll start. He’s already done a good job at shrinking Citi Holdings, and Citi’s global commercial bank is the one core asset that should be encouraged to grow, rather get smaller. Which leaves all those traders and derivatives dealers and the like: Corbat knows how dangerous they are, having had a front-row seat for the Salomon Brothers bond-trading scandal.

What’s more, it’s pretty clear who’s really in charge of setting the strategy at Citigroup these days, and it’s not Mike Corbat, the man hired to implement it. Rather, it’s the chairman, Michael O’Neill, a commercial banker who would surely be much happier seeing traders getting axed than he would with branch closures or the like. In choosing Corbat, he’s chosen someone who can execute on the strategy which already exists, rather than some charismatic leader who promises to lead Citi to a land of high ROE and much-reduced balance sheet.

That makes sense: there’s a lot more competition in the lean-and-mean space than there is in the too-big-to-fail space. Investors don’t particularly like big banks these days, but Citi would be a miserable failure if it were to shrink: it doesn’t have a scrappy mindset, and it never will. Corbat has been on hundreds of sales calls, all over the world, talking about the strength of Citi’s franchise, how it has been committed to [insert country name here] for over a hundred years, etc, etc. Citi needs to stay big for much the same reason that banks used to build their branches out of heavy stone: the perception of weightiness and permanence is exactly what its clients are looking for — especially in the turbulent world of emerging markets, where most of Citi’s future growth is going to come from.

It seems to me that O’Neill knows exactly what he wants, that Pandit tried to deliver but wasn’t actually a very good manager, and that therefore O’Neill fired Pandit and replaced him with Corbat, in the hopes that Corbat can succeed where Pandit never really got traction.

All of which boils down to a very simple question: is Citigroup small enough to manage? The last time that the Citigroup’s senior executives were clearly in control of the company was during the Sandy-and-Jamie years. Ever since Sandy Weil fired Jamie Dimon in 1998, the top brass at 399 Park Avenue have had relatively little ability to steer this particular supertanker. Sometimes they manage to avoid a huge obstacle; sometimes they don’t. But in general, the best they have been able to hope for has been not-going-bust.

O’Neill thinks that he sees a route through the obstacles, at the end of which is a bright open ocean of prosperity and profitability. But he’s well aware that steering Citigroup is orders of magnitude more difficult than slicing off bits and pieces of Bank of Hawaii. And so he’s promoted the best skipper he knows, Mike Corbat, to take the helm.

Corbat isn’t viewed within Citi with the same mistrust that greeted Pandit — or even Chuck Prince, for that matter. For one thing, he has a proven history of actually getting things done at the bank, which is more than either of his predecessors had. That takes no little skill, given that Citigroup is one of the banking world’s most labyrinthine bureaucracies, complete with quarreling dukedoms in various different countries, regions, and asset classes. For instance, Eavis suggests that Corbat might take a leaf out of Santander’s book, and sell a minority stake in its very successful Mexican subsidiary. Corbat’s on-the-record response to that suggestion, on the call yesterday, was “I’ll look at those things and see what the numbers say”. But in reality, there’s no way that Corbat is messing around with Banamex unless and until he can get Manuel Medina-Mora on board — and that’s not going to happen for a while, given that Medina-Mora is probably a little bit sore that he didn’t get the CEO job himself.

As a result, if Corbat is going to succeed in executing on O’Neill’s vision, he’s not going to be able to rush things. The trick is to move with vision and purpose in the right direction, rather than trying to pursue some kind of magical overnight transformation. You can’t transform a company as large and old as Citigroup in a short amount of time: it’s simply not possible, and Corbat would be foolish to try.

Eavis says that “Corbat may have to impress quickly, given the pent-up frustrations among shareholders”. But the fact is that if he tries, he’ll fall flat on his face — and he knows it. Shareholders, and O’Neill, are going to have to be patient here. Given time, Corbat may (or may not) be able to turn Citigroup into a coherent and efficient global banking franchise. But if he feels the need “to impress quickly”, then failure is certain.


Very insightful post….I was a MD in the “old” Citi’s Global Relationship Bank on the product side (Structured Products Division)…the pre-Sandy John Reed perspective on the whole GRB was very negative….compared to the Consumer Bank….the commercial bank was always viewed as event risk just waiting to happen by Reed…

He didn’t get rid of it it was thought because of the need for the Consumer Bank especially in the emerging markets to project the aura of bigness and globality…(“heavy stone”)…which at the end of the day they did not think they could do if they weren’t banking, say, IBM globally…even if at a loss…

The problem was that plain vanilla commercial banking for the Fortune 1000 was a loser in ROE terms, especially when compared to the opportunities to deploy capital in the Consumer Bank….the strategic discpline imposed was to manage a relationship for return….so that awful products like standby revolvers required by the client were offset with…”structured” products or fee businesses….both very like an IB relationship….derivatives were important as were executing capital markets transactions…

So I would say that Corbat will have a tough time making the commercial bank work without some IB offerings.

Your comments about the managwement issues are spot on….

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Conspiracy Jack

Felix Salmon
Oct 10, 2012 02:00 UTC

Why has Jack Welch doubled down on the false, inflammatory, and slanderous tweet that he sent out five minutes after the jobs report came out on Friday?

I was one of thousands who called Welch out on this at the time, both in terms of its substance and in terms of its hypocrisy — coming, as it does, from a particularly notorious earnings massager. Others took his side, or at least suggested that there might be something to what he was saying. And undoubtedly the fact that we’re in the final month of a presidential election campaign served to make everything rather more feverish than it might normally be.

But surely that was only to be expected. When someone of Welch’s stature accuses a sitting president of deliberately manipulating economic statistics for political purposes, just a month before an election, you have to live in a pretty astonishing bubble of flattery and denial not to know exactly what’s going to come next.

The thing about Twitter is that it has a way of piercing such bubbles. Welch is active on Twitter: he has tweeted 1,717 times since he joined Twitter on April 28, 2009. That’s an average of 1.4 tweets per day — and all of them were written by Welch personally, rather than coming automatically from some robot. He particularly likes bashing the Obama administration and supporting Republicans like Herman Cain; what’s more, he has even attacked the unemployment rate, in the past, as being the “most political number out there”.

Such activity, along with his quasi celebrity status, means that he has accumulated more than 1.3 million followers, many of whom are quite vocal. So when he tweets like the grumpy Republican partisan he is, he will immediately see a pretty angry stream of at-replies. Those replies will come from Democrats, of course; but they will also come from people who think that it’s a good idea to have some evidence before accusing the president of a felony that could result in a jail term and/or impeachment; and generally from technocrats on both sides of the aisle who have great respect for the excellent job that the Bureau of Labor Statistics does every month in an enormous and highly complex economy. On TV, Welch is treated with a modicum of respect; on Twitter, he sees real people’s real feelings about him. That’s likely a new experience for him.

A humble man, in such a situation, might have backtracked, realizing that he had gone way too far. But Jack Welch is not a humble man, and so instead he decided to bluster his way through. Hence the bizarre references to Soviet Russia and Communist China, and the way in which he describes his critics as “mobs of administration sympathizers”. (In fact, of course, only in highly autocratic societies could a business leader expect respectful agreement at all times, no matter how stupid his statements.) Hence the brazen — and clearly false — declaration that the reference to “these Chicago guys” in his tweet was in no way about the Obama administration or the White House. And hence his decision to depart the reality-based outlets of Fortune and Reuters, and move instead to the editorial page of the Wall Street Journal, where he can offer up his opinions to the right-wing echo chamber rather than to the public at large. Welch’s choice to appear on the WSJ editorial page — underscored by a declaration that he’ll get better “traction” that way — is a demonstration that Welch is embarking on a new career as a mascot of the right, rather than trying to stretch out his fading post-retirement career as would-be management guru. Welch has chosen the WSJ editorial page much in the way that he hand-picked the Office of Thrift Supervision to supervise GE Capital back in the day: it’s the place where he’ll get maximum  adulation and minimum pushback.

Welch devotes much of his WSJ op-ed explaining why he considers America’s 7.8% unemployment rate to be “implausible”. That’s fine — economic statistics are always inexact, and Welch might well have some insight as to why the real unemployment rate is higher than that. Except, as it turns out, Welch’s unique insight here is wonderfully self-centered and incoherent:

I sat through business reviews of a dozen companies last week as part of my work in the private sector, and not one reported better results in the third quarter compared with the second quarter. Several stayed about the same, the rest were down slightly.

Is there any reason to believe that the dozen companies Welch looked at are representative of the US economy as a whole? Is Welch really saying that looking at these 12 companies gives a better insight into the economy than the official establishment survey, which looks at 141,000 businesses covering 486,000 different worksites? And that aside, if businesses were indeed hiring again, and using their cashflow to employ people rather than just sending it into an ever-growing bank account, you’d expect their profits to go down rather than up. Welch didn’t say that the companies he looked at weren’t hiring; he just said they were making less money in net profit. Which could well be a positive sign.

Welch has statistical-methodology quibbles, too; these are nothing new. Indeed, as he points out in his column, as long ago as 2003 Austan Goolsbee was explaining in the NYT how Democrats and Republicans both have swelled the rolls of the disabled, with the effect that millions of people don’t turn up any more in the official unemployment rate. If you’re collecting disability, you don’t count as unemployed — and the number of people collecting disability today is much greater than it was 30 years ago. As a result, it’s difficult to compare today’s unemployment rate with 1982′s.

But that kind of stats geekery will never set off the kind of Twitter firestorm that greeted Welch on Friday. The slanderous part of Welch’s tweet was his assertion that the White House both could and did “change the numbers” for political gain. Not change the methodology, in some kind of public manner which statisticians could argue about — but instead pull some kind of shady Chicago political move, and release headline unemployment rate just under 8% in much the same way that Welch would regularly release earnings a penny above expectations.

And on that front, Welch is not apologizing in the slightest. Instead, he’s just grudgingly diluting the suggestion a tiny bit:

If I could write that tweet again, I would have added a few question marks at the end, as with my earlier tweet, to make it clear I was raising a question.

Does he have any evidence that the Chicago guys might be manipulating data? No. Does he think it’s even possible for the Chicago guys to be manipulating the data? Evidently, he does. What makes him say that? He won’t say. But is it a legitimate question to raise? In Welch’s eyes, absolutely, yes. If you’re Jack Welch, it seems, any time there’s US data which makes the government look good, the question can and probably should be raised: might the data be wrong? Or, might the government be manipulating it?

The paranoid style in American Politics is nothing new: it was famously diagnosed by Richard Hofstadter in 1964. It has a storied and ignoble history, and Welch is merely the latest in a very long line of American conspiracists. (And yes, of course, you can count Donald Trump in as a bedfellow.) Sometimes the paranoiacs are mostly on the left; these days, they’re mostly on the right. But as with all conspiracy theories, nothing they say can ever be constructive: these are people who will attack empirical evidence long before they use it to help shape their view of the world.

And so, with one unretracted tweet, Welch has effectively rendered himself irrelevant in the so-called thought-leadership world he has dominated for so long. It’s fine to have unusual or minority opinions. What’s not fine is to base those opinions on nothing but ideology, and admit of nothing which could make you change your mind. At that point, you’re not a thinker any more; you’re a theologian. Welch has clearly decided that he would much rather be a pastor, preaching to a like-minded flock of WSJ op-ed page dogmatists, than a participant in substantive debate. The sad thing is that he received much more attention for his outbreak of crazy than he received in response to any of his less-bonkers pronouncements. Which is probably only going to encourage him, going forwards.


This article was link to make conservative look like conspiracy theorist…..except they were proven right….HA!

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Who is to blame for Ina Drew’s downfall?

Felix Salmon
Oct 3, 2012 15:47 UTC

Susan Dominus has a big 7,500-word NYT Magazine feature on the rise and fall of Ina Drew, featuring a couple of bland quotes from Jamie Dimon but nothing — nothing on the record, at least — from Drew herself. (We’re told explicitly about four different people who declined to comment when approached by Dominus, including “London Whale” Bruno Iksil and his boss Achilles Macris; Drew is not one of the four.)

The story, as Dominus presents it, is a tragic one. Drew was a highly competent and highly successful trader, who used her deep knowledge of the markets to stay one step ahead of the quants and the rocket scientists who coveted her job. But then she decided that she needed a group of quants and rocket scientists herself, and after she came back from her year-long battle with Lyme disease, which kept her out of the office for most of 2010, she never really regained full control or understanding of what the London office was getting up to.

Dominus actually puts forward two subtly different narratives of what went wrong. The first is that the quants ultimately managed to snow her — that in her final months at JP Morgan, Drew basically didn’t know what was going on in London, and was out of her depth:

At some point in December of last year, a former executive from the group says, Drew checked in with Macris and Martin-Artajo about the position while the two men were in New York. They answered, but the executive, who understood the trade, remembers thinking that they did not give as full an answer as they could have. “I think they glossed over details to the point where Ina knew the product, the size they were trading, but she did not know what the true P.& L.” — profit and loss — “impact could possibly be in a stressful scenario,” he said. She was asking the right questions, he said, but did not seem to be picking up on what was not being said…

By the second week in May, the stress had taken a toll. A colleague saw Drew walking around the executive floor, her mascara smeared. A slight tremor in her hand left over from her illness seemed worse, a physical symbol of her emotional state. Although she still came to work dressed impeccably, she had lost weight and looked somber, almost shut down. The week that the bank decided to make a public disclosure, 20 senior people gathered in a meeting room on the 47th floor. Everyone went around the room and spoke about what they had found out and what still needed to be learned. After about 45 minutes, with the meeting drawing to a close, Drew, uncharacteristically, still had not said a word. Finally, John Hogan, the chief risk officer for the bank, asked: “Does anyone need anything? Need some help?” Drew raised her hand. “I need help,” she said. It was a white flag.

But there’s a second narrative, too — which is that the trades were actually not completely stupid, that they could actually have worked out OK in the end, and that it wasn’t the markets so much as “complicated, interlocking human dynamics” which ultimately did Drew in:

Maybe Drew still believes — as Macris does, according to people at the bank — that the position could have worked out given enough time. Maybe if she had asked the right questions sooner, her traders would have been forced to clarify or she would have sensed danger before it went out of control. Many systems failed and perhaps, too, her judgment.

Drew was someone known for her grasp of the big picture, for internalizing historical trends and economic cycles to the point where her gut instincts were almost always right. She was also someone known for having a personal touch. But in this instance, she seemed incapable of grasping the complicated, interlocking human dynamics that can’t be measured by reassuring models — the idea that a position could be leaked, that the press might bear down, that the regulatory environment could compound all those problems.

This narrative is much less believable. For one thing, pretty much all positions work out “given enough time”. But markets are all about timing. This argument sounds suspiciously similar to the testimony of Joe Cassano to the Financial Crisis Inquiry Commission: hey, if you hadn’t forced me to unwind my positions, my positions would have ended up making money! It’s a pretty silly argument from anybody who’s been in the market for more than about five minutes, and it’s especially silly were it to come from someone like Drew who has been a trader for decades.

And more generally, the whole point of being a trader with gut instincts, rather than a quant staring at computer models, is that you’re reacting to the whole world — the real, messy world, where hedge funds will leak your positions to the WSJ and Bloomberg, and where regulators don’t like nasty surprises — rather than just to the easily-tractable numbers in a VaR model.

With hindsight, it’s clear that Ina Drew was in some ways a human version of one of those clever financial strategies which works until it doesn’t. She was by all accounts an excellent manager with incredibly loyal staff — except when she set up the London office of the CIO, which managed the lion’s share of her billions, and which didn’t respect her at all. As a trader, Drew was extremely attuned to the vicissitudes of the markets — at least until she took her leave of absence, after which her fabled spidey-sense seems to have deserted her.

What’s missing from Dominus’s story is any indication of whether or how Drew was actually managed. Over her years at Chemical Bank, as it slowly transformed and grew into today’s JPMorgan Chase, Drew amassed ever-increasing quantities of money and power. Eventually, as Dominus says, she “had direct control over more money than most players on Wall Street — on the level of the top asset managers in the country, including BlackRock and Pimco”. The trader had become an asset manager, and in a very real sense she was competing with the rest of the bank: before anybody at JPMorgan could lend out a single dollar, they essentially had to persuade Jamie Dimon that the risk-adjusted returns from doing so would exceed the returns which he could get by just giving that dollar to Ina.

Drew was very good at managing and investing the money she was given, and the reward for that skill was that she got given ever-greater amounts of money — over $350 billion, in the end. But at that point, her job had changed both qualitatively and quantitatively from the job she had proven herself good at. Qualitatively, much less of her job involved trading rates in New York, and much more of it involved highly-complex derivatives trades in London, something she was never particularly comfortable with. And quantitatively, running $350 billion is both a blessing and a curse. On the one hand, you can “whale” on the market and push your counterparties around, much like a poker player with a monster stack. On the other hand, if you ever do get forced to unwind your position, you’re toast.

The big difference between Drew and pretty much everybody else on Wall Street is that she never needed to unwind anything: during the crisis, when everybody else was panicking and deleveraging, her positions only grew. In many ways, she was one of the biggest recipients of everybody else’s forced unwinds. But then, when the tables were turned, she proved to be just as human as everybody else.

One man, more than anybody else, had the job of looking at that $350 billion pot of money and wondering whether it was simply too big. And there’s no indication that Jamie Dimon ever did that. Bank clients, borrowers: they had position limits. But Ina Drew never did: she would happily accept all the money Dimon funneled her way. In a weird way, she wasn’t just Dimon’s employee, she was also his counterparty: she was the person with whom he would entrust JP Morgan’s balance sheet when he had nothing better to do with it. And it doesn’t seem that anybody at JP Morgan was worried about that particular counterparty risk — not even when Drew was out of the office for a year, and especially not when she returned to increasingly fractious internal politics.

If there’s a villain in this story, then, it’s not Iksil or Macris or anybody in London: it’s Dimon. The buck stops with him, and yet he’s somehow emerged largely unscathed, with a stock price back in pre-Whale territory and a glossy double-page Annie Leibovitz portrait in Vanity Fair. Dimon’s ego has only grown since the whale crisis: “Honestly, I don’t care what second-guessers say in life,” he tells Dominus. “If anyone in the company knew, they should have said something.”

The question, of course, is whether Dimon would have listened. Dimon needed his own spidey-sense: he needed to be able to tell the difference between vicious internal politics and back-stabbing, on the one hand, and genuine reports of risk-management failures, on the other. When it came to the CIO, he couldn’t do that. And it’s far from clear that he’s learned his lesson.


Smart post. I’m still not quite getting why the $6b hiccup was such a big deal, given the $350b pot. Trading, a two percent loss is not a good day at all, but not the end of the world. Until it is, I guess.

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Victimized billionaires

Felix Salmon
Oct 1, 2012 15:27 UTC

Why do billionaires feel victimized by Obama? Chrystia Freeland asks that question in the New Yorker this week, and comes back with answers we’ve all heard before: in short, it’s not the policies, it’s the rhetoric.

Of course, this doesn’t stand up to scrutiny; it never did. If the rhetoric is getting overheated on either side, it’s definitely on the side of Obama’s opponents, rather than Obama himself. Chrystia finds multiple violations of Godwin’s law, not among foaming-at-the-mouth Tea Party types, but even from cosmopolitan financiers:

Some of the harshest language of this election cycle has come from the super-rich. Comparing Hitler and Obama, as Cooperman did last year at the CNBC conference, is something of a meme. In 2010, the private-equity billionaire Stephen Schwarzman, of the Blackstone Group, compared the President’s as yet unsuccessful effort to eliminate some of the preferential tax treatment his sector receives to Hitler’s invasion of Poland. After Cooperman made his Hitler comment, he has said, his wife called him a “schmuck.” But he couldn’t resist repeating the analogy when we spoke in May of this year. “You know, the largest and greatest country in the free world put a forty-seven-year-old guy that never worked a day in his life and made him in charge of the free world,” Cooperman said. “Not totally different from taking Adolf Hitler in Germany and making him in charge of Germany because people were economically dissatisfied. Now, Obama’s not Hitler. I don’t even mean to say anything like that. But it is a question that the dissatisfaction of the populace was so great that they were willing to take a chance on an untested individual.”

There’s a limit to how far you can go asking people to justify their Hitler analogies, so Chrystia asks Cooperman about his “never worked a day in his life” comment. It turns out that by “working”, Cooper means that Obama “never made payroll. He’s never built anything”. In other words, this is very much the Romney version of the great-men-of-history worldview: one where a handful of visionary builders use their skills to create jobs for the masses and wealth for themselves. Recall Nick Lemann, profiling Romney in last week’s New Yorker:

He talks to voters businessman to businessman, on the assumption that everybody either runs a business or wants to start one. Romney believes that if you drop the name of someone who has built a very successful company — Sam Walton, of Wal-Mart, or Ray Kroc, of McDonald’s — it will have the same effect as mentioning a sports hero.

If you’re the billionaire principal of a business you built yourself, then you are very likely to see the world through this lens — and as a result, you’re very likely to be very supportive of Romney’s candidacy. In that sense, it’s hardly a surprise that the Romney campaign, and its affiliated Super PACs, has raised more money than the Obama campaign: Romney, more than any presidential candidate in living memory, aligns himself completely with the views and interests of the 0.01%. And given how much discretionary cash the 0.01% has lying around, getting the support of that key group can give a candidate a serious fundraising advantage.

This, I think, is one third of the answer to the question of why billionaires feel victimized by Obama. In America’s two-party system, you’re given a simple choice: this guy, or the other guy. If you find yourself in wholehearted agreement with one of the two, then the other one becomes the enemy, the obstacle standing in the path leading your guy to the White House. And under the rule of the narcissism of small differences, everything which separates your guy from the other guy becomes a monstrosity to be fought at every turn, and a grievance to be nursed and rehearsed ad nauseam. (Liberals, in truth, are even better than conservatives at this kind of thing: just remember what they thought of Reagan, whose policies were not particularly to the right of Obama.)

You can’t ascribe all of the billionaires’ grievances back to Romney — after all, they predate his candidacy. But Leon Cooperman’s letter is dated November 2011; I don’t think it’s entirely a coincidence that it was written just as Romney’s InTrade odds of winning the Republican nomination had surged to about 70%. So I see something else going on here — the second third of the answer. And that’s the way that after the stock market rebounded sharply in 2009, financiers switched rapidly from Fear mode to Greed mode.

During the 2008 election, Obama received significantly more Wall Street money than McCain, for one very good reason: Wall Street trusted him and his egghead technocrat advisers to do whatever was necessary to prevent their world from imploding. And that’s exactly what they did. Geithner, Bernanke, Summers, and the rest of the Obama economic team threw everything they could at the markets: they were the liquidity provider of last resort, they took that role seriously, and they did exactly what was necessary to save the US — and, for that matter, the global — financial system. McCain, by contrast, never came across as being particularly competent on that front, treating the financial crisis more as an excuse for political stunts than as a serious existential threat.

After 2009, however, Wall Street felt that the crisis was over. Yes, unemployment was still unacceptably high, growth was unacceptably low, and the real economy was still struggling. But never mind that: Wall Street profits were enormous, corporate profits were hitting record highs, and bonus season was just around the corner. America’s financiers no longer needed Washington to save them from ruin; now all they wanted was for Washington to get out of the way, and to let them prosecute their profit-making strategies as aggressively as they wanted. And they were in no mood for gentle reminders from Washington that if it wasn’t for the public sector they’d all have been wiped out.

It’s notable that all of the 0.01% moaning about Obama in Chrystia’s piece are financiers of one stripe or another. The financial sector was the first to rebound out of the crisis, and in many ways is the sector of the economy least exposed to the plight of the 47%. Hedge fund managers like Leon Cooperman don’t make their money from little people; indeed, it’s quite amazing how rich you need to be before people like Cooperman think you actually have money. For instance, Cooperman tells Chrystia, of a cardiologist friend of his who has accumulated some $10 million in savings, that “it was shocking how tight he was going to be in retirement”, especially since “he needed four hundred thousand dollars a year to live on”.

Which brings me to the final third of the answer to the question of why America’s billionaires are feeling so victimized: I think that in fact most of them simply don’t. Most billionaires are not financiers — and you don’t see Mark Zuckerberg or Mike Bloomberg or Larry Page kvetching about how Obama hates them. Neither do you see a lot of old money (the Waltons, the Mars family) pouring money into Super PACs. They might be conservative; they’ll almost certainly vote for Romney. But they’re not airing grievances in the way that Chrystia’s financiers are doing. The rhetoric that Chrystia is picking up on started I think with Jamie Dimon, and then spread around his environs; but it’s not particularly contagious outside Wall Street circles.

Financiers are among the most alpha of all billionaires, the most aggressive, the most attuned to the idea that no matter how rich you are, if you’re not making money then you’re losing. And from a purely tactical perspective it makes all the sense in the world for them to go on the offensive against Obama. After all, they might have it good now, but they’d have it even better under Romney, and at the margin the more they move public opinion in their direction — and especially the opinion of the 535 members of the public who sit in Congress — the better off they are.

So my feeling is that the sense of victimization is one part narcissism, one part greed, and one part tactical. It’s not a very pretty sight, and it’s not very easy to feel particularly righteous about. Which is one reason that people like Anthony Scaramucci — an early high-profile Romney supporter — set up echo-chamber dinners where such feelings can be stroked and reinforced. What’s depressing is that the likes of Al Gore and Antonio Villaraigosa are happy to attend those dinners, and provide little if any pushback.


I make a great living,in the top 5% of the US. I’m not a billionaire and at 62, it looks like I will have to keep on working for many years, as I don’t have enough to retire, unless i want to live a very meager lifestyle. I agree that billionaires possibly should pay more, but I know that that is not going to happen. Instead the empty rhetoric about billionaires will be translated down to people making 250,000, er 200,000,er 150,000, oh hell 75000 and they will be the ones to bear the brunt of the tax burden. We should have a low flat tax with absolutely no loopholes or exceptions from the top income to the bottom income levels, a level playing field and no room for the pols to complicate the issues to buy their next election. We should also have term limits.

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Sheila Bair against the world

Felix Salmon
Sep 27, 2012 00:16 UTC

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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


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

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

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Bob Rubin’s legacy

Felix Salmon
Sep 20, 2012 14:44 UTC

Bill Cohan’s profile of Bob Rubin doesn’t have much if any new information in it, but is fascinating all the same, not least for the way that Rubin reacted to Cohan’s interview requests.

After an April event at the Council on Foreign Relations, Rubin appeared in the building’s Park Avenue lobby. His white Brooks Brothers shirt was fraying, and his gray suit looked rumpled enough that he might well have slept in it the night before. He was carrying an old-fashioned Redweld legal folder, filled with papers, when he pulled me aside. “I have been working hard to try to balance my work-life issues,” he said, explaining why he’d deliberated for months about whether to talk on the record. “I have been really busy, and I am not sure I have the right balance.” A few weeks later a representative conveyed that it was a close call, but Rubin would be heeding advisers who urged him not to speak. Instead, he dispatched his friends to speak for him.

This is weird on many levels. Firstly, why has the famously well-tailored Rubin suddenly started wandering around CFR in a rumpled suit and fraying store-bought shirt? (I have no idea what Cohan’s source is for the Brooks Brothers factoid, but well done to him for getting it.) Secondly, when did the hard-charging former Goldman executive start talking about the importance of work-life balance, as though he has to hold down a full-time job while bringing up a family? (In reality, he has no day job, and his kids — including Obama adviser James Rubin — have long since left the nest.) Thirdly, wouldn’t it just be easier to grant an interview, rather than spend months dithering? Rubin is many things, but he’s never been considered a ditherer. Finally, and most revealingly, who are the “friends” that Rubin felt comfortable dispatching to “speak for him”? Sheryl Sandberg, Peter Orszag, Larry Summers, Bill Clinton. Rubin might not have time to talk to Cohan, but he’s happy asking Sandberg and Clinton to carve chunks out of their diaries?

Given all this, it’s reasonable to assume that pretty much everybody that Cohan quotes — including these three — talked to Rubin beforehand, and said what Rubin wanted them to say. Including Summers, who explains, for instance, that the repeal of Glass-Steagal was no big deal, since “there were virtually no restrictions on the investment banking activities of the major banks after the Federal Reserve’s undertakings during the decade before Glass-Steagall was repealed”. Or, here’s Summers on the decision to quash Brooksley Born, then at the CFTC, when she had the temerity to propose regulating derivatives:

Summers thinks  he and Rubin were right to fight Born’s power grab. “Our concerns were not with respect to the desirability of derivatives regulation,” Summers says. “Career lawyers at the Fed, the SEC, and the Treasury insisted that the CFTC’s proposed approach would raise potentially grave questions about the enforceability of existing contracts.” Born, Summers adds, didn’t know what she was attempting to regulate.

This is astonishingly weak sauce, in both cases: basically saying that hey, there were some undesirable facts on the ground (commercial banks doing investment banking, in the first instance; existing derivatives contracts, in the second), and that Treasury had no business trying to change or regulate those facts, and that in fact it was pretty much Treasury’s job to fiddle with regulations to make it less onerous for Wall Street to do what it was doing already. But, of course, it’s entirely in line with what Rubin has said elsewhere: he told David Rothkopf, for instance, that the liberalizations of the 1990s were the right policies, and that he would argue the same things today.

I have my own long list of reasons why Rubin deserves more blame for the financial crisis than any other individual in the world. But Cohan adds a few more reasons to the list, mostly regarding Rubin’s actions — or lack thereof — during the crisis itself. “If Rubin disavowed any role in enfeebling Citigroup,” writes Cohan, “he was nearly invisible in the frantic year between November 2007, when Chuck Prince resigned in the wake of billions of dollars in Citigroup losses, and November 2008, when the federal government bailed out Citigroup.”

What’s more, the one thing that Rubin did do looks pretty craven:

There was one errand Rubin was asked to handle. On Nov. 19, 2008, as Citigroup’s prospects were deteriorating rapidly, Rubin called Treasury Secretary Hank Paulson. According to Paulson’s memoir, On the Brink, Rubin “put the public interest ahead of everything else” and “rarely called me,” so the “urgency in his voice that afternoon left me with no doubt that Citi was in grave danger.” Rubin told Paulson that “short sellers were attacking” Citigroup’s stock, which had closed the day before at $8.36 per share and was “sinking deeper into the single digits.”

In his testimony to the FCIC, Rubin disputed Paulson’s recollection. “I don’t think that mine was a Citi-specific call,” Rubin said. He claimed his intent was to represent all the bank stocks being pecked to death by short sellers, and to alert Paulson to the severity of the problem. “I think mine was a general call.”

These two accounts aren’t necessarily contradictory. Rubin might have kidded himself that he was making “a general call” about the banking system as a whole, on the grounds that if bad things were happening to Citi, they were surely happening to all the other banks as well. And Paulson, hearing the urgency in Rubin’s voice, would have immediately grown even more concerned about Citi — especially when Rubin started blaming short sellers. (As a general rule, there’s no greater indication that a company is in genuine fundamental distress than when its executives start pointing the finger at short sellers.)

Cohan’s biggest beef with Rubin is that he didn’t do more: “Nobody’s perfect,” he concludes. “But for $126 million, they ought to show up.” For me, that’s not such a big deal: by the time the crisis rolled around, it was genuinely too late for Rubin — or anybody else outside the government — to be of much help. And because he was so deeply enmeshed in Citigroup’s senior management, it would have been quite wrong for the government to seek his advice.

Still, Rubin has had an incredibly long career at the highest levels of finance and policymaking, and if he reflected honestly on his mistakes, his thoughts could be extremely valuable. Instead, he has retreated into a cone of silence, accepting interview requests only from people who can be trusted not to ask him any tough questions, and sending out the likes of Sandberg, Summers, and Clinton to act as emissaries on his behalf, defending a man whose only sign of regret or distress to date is that rumpled wardrobe.

It’s not too late for Rubin to come clean. His reputation will never recover, we know that — but if he really cares about America and its public, then he should be much more honest about the crisis, and his role in it. Instead, he’s in cowering self-preservation mode. It’s an improbably ignoble end to a storied and high-powered career.


Quote-check girl?

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Annals of dubious research, 401(k) loan-default edition

Felix Salmon
Aug 13, 2012 05:13 UTC

Bob Litan, formerly of the Kauffman Foundation and the Brookings Institution, has recently taken up a new job as director of research for Bloomberg Government, where he’s going to have to be transparent and impartial. But one of his last gigs before moving to Bloomberg — a paper on the subject of people borrowing money from their 401(k) accounts — was neither of those things.

To understand what’s going on here, first check out Jessica Toonkel’s article from Friday about Tod Ruble and his company, Custodia.

Tod Ruble is trying to sell retirement plan insurance that employers say they do not want and their employees may not need.

But the Dallas-based veteran commercial real estate investor is not letting that stop him. Since late 2010, he has started up a company, Custodia Financial, and spent more than $1 million pushing for legislation that would allow companies to automatically enroll employees who borrow from their 401(k) plans in insurance that could cost hundreds of dollars a year.

Once you’ve read that, go back and check out a spate of stories that hit a series of major news outlets in July. Alan Farnham of ABC News, for instance, ran a story under the headline “401(k) Loan Defaults Skyrocket”:

A new study estimates that such defaults might total $37 billion a year, a sharp increase from 2007, when defaults totaled only $665 million.

Similarly, check out Walter Hamilton, in the Chicago Tribune (and LA Times): the headline there is “Defaults on 401(k) loans reach $37 billion a year”. At Time, Dan Kadlec also ran with the $37 billion number, saying that “the default rate on these loans has skyrocketed since the recession”. Similar stories came from Blake Ellis at CNN Money (“Loan defaults drain $37 billion from 401(k)s each year”), Mitch Tuchman at MarketRiders (“401k Loan Default Time Bomb Is Ticking”), and many others.

The only hint of skepticism came from Barbara Whelehan at BankRate. She noted that the study cited Kevin Smart, CFO of Custodia Financial, as a source — and she also noted that “it would be a boon for the insurance industry to get the rules changed, and it is working behind the scenes to do just that. In April, Custodia Financial submitted a statement to the House & Ways Committee arguing for automatic enrollment into insurance coverage for 401(k) loans.”

Whelehan also smelled something fishy in the way the paper was paid for:

This paper by Navigant Economics, which made a big splash in the press, was financially supported by Americans for Retirement Protection. That organization has a website, ProtectMyRetirementBenefits.com, but no “about us” link. It does give you the opportunity to sign a petition demanding protection of retirement funds through insurance. Take a look at it, and see if you think the website was created by average Americans or by the insurance industry.

Whelehan was actually breaking news here: there’s no public linkage between Americans for Retirement Protection, the organization which paid for the paper, and the astroturf website. In fact, Americans for Retirement Protection seems to have no public existence at all, beyond a footnote in the paper, which was co-authored by Bob Litan and Hal Singer.

Enter Toonkel, writing her story about Custodia. In the course of her reporting, she discovered — and Custodia confirmed — that Americans for Retirement Protection, and ProtectMyRetirementBenefits.com, are basically alter egos of Custodia itself. Custodia would welcome other organizations joining in, but that’s unlikely to happen, because Custodia owns the patents on the big idea that the paper and the website are pushing — the idea that 401(k) loans should come bundled with opt-out insurance policies.

Once you’re armed with this information, it’s impossible not to look at the Litan-Singer paper in a very different way. Its abstract concludes: “We demonstrate that the social benefits of steering (but not compelling) plan participants towards insurance when they borrow are likely positive and economically significant.” And yet nowhere in the paper is there any indication that it was bought and paid for by the very company which has a patent on doing exactly that.

And what about that $37 billion number? Are defaults on 401(k) loans really as big a problem as the paper says that they are? After all, the smaller the problem, the less important it is to introduce an expensive fix for it.

The simple answer is no: 401(k) loan defaults are not $37 billion per year. But the fact is that nobody knows for sure exactly where they are, which makes it much easier to come up with exaggerated estimates. As the paper itself admits, “the sum total of 401(k) defaults ought to be an easily accessible statistic, but it is not”. And the $37 billion, far from being a good-faith estimate, in fact looks very much like an attempt to get the largest and scariest number possible.

So how did Litan and Singer arrive at their $37 billion figure? Let’s start with the only concrete numbers we have — the ones from the Department of Labor, whose most recent Private Pension Plan Bulletin gives a wealth of information about all private pension plans in the country. Every pension plan has to file something called a Form 5500, and the bulletin aggregates all the numbers from all the 5500s which are filed; the most recent bulletin gives data from 2009.

This bulletin has two datapoints which are germane to this discussion. First of all, there’s Table A3, on page 7 of the bulletin (page 11 of the PDF). That shows that loans from defined-contribution pension plans to their own participants totaled $51.7 billion in 2009. Secondly, there’s Table C9, the aggregated income statement for the year. If you look at page 32 of the bulletin (page 35 of the PDF), you’ll see a line item called “deemed distribution of participant loans”, which came to $670 million for the year. If you borrow money from your 401(k) and you don’t pay it back, then that money is deemed to have been distributed to you, and counts as a default. So we know that the official size of 401(k) defaults in 2009 was $670 million — a far cry from Litan and Singer’s $37 billion.

Now the $670 million figure does not account for all 401(k) defaults. Most importantly, in some situations, if you default on a 401(k) loan after having been fired from your job, then the money is counted as an “actual distribution” rather than as a “deemed distribution”.

The Litan-Singer paper goes into some detail about this. “According to a recent study by Smart (2012),” they write, “although Form 5500 reflects actual distributions, there is no way to determine the amount of actual defaults.” They then look in detail at Smart’s figures, footnoting him five consecutive times, and treating him as an undisputed authority on such matters. Their citation is merely “Kevin Smart, The Hidden Problem of Defined Contribution Loan Defaults, May 2012.”

Where might someone find this paper? Here, since you ask: it’s helpfully hosted at CustodiaFinancial.com. And on the front page of the paper, Kevin Smart is identified as the “Chief Financial Officer, Custodia Financial”.

There’s no indication whatsoever in the Litan-Singer paper that the “Smart” they cite so often is the CFO of Custodia Financial, the company which has the most to gain should their recommendation be accepted. And there’s certainly no indication that he’s essentially their employer: that Custodia paid them to write this paper. In fact, the name Custodia appears nowhere in the Litan-Singer paper at all.

It’s instructive to look at the Smart paper’s attempt to estimate the magnitude of the 401(k) default problem. I’ll simplify a little here, but to a first approximation, Smart assumes that 12% of people with 401(k) loans lose their jobs. He also assumes that if you lose your job when you have a 401(k) loan, there’s an 80% chance you’ll default on that loan. As a result, he comes up with a 9.6% default rate on 401(k) loans. He then multiplies that 9.6% default rate by total 401(k) loans of $51.7 billion, adds in some extra defaults due to death and disability, and comes up with a grand total of $6.2 billion in loan defaults per year, excluding the “deemed distributions” of $670 million. Call it $7 billion in total, of which $6 billion could be protected by insuring loans against unemployment, death, and disability.

Now remember that this is a paper written by the CFO of Custodia Financial — someone who clearly has a dog in this race. It’s in Smart’s interest to make the loan-default total look as big as possible, since the bigger the problem, the more likely it is that Congress will agree to implement Custodia’s preferred solution.

But when Litan and Singer looked at Smart’s paper, they weren’t happy going with his $6 billion figure. Indeed, as we’ve seen, their paper comes up with a number six times larger. So if even the CFO of Custodia only managed to estimate defaults at $6 billion, how on earth do Litan and Singer get to $37 billion?

It’s not easy. First, they double the total amount of 401(k) loans outstanding, from $52 billion to $104 billion. Then, they massively hike the default rate on those loans, from 9.6% to 17.9%. And finally, they add in another $12 billion or so to account for the taxes and penalties that borrowers have to pay when they default on their loans.

It’s possible to quibble with each of those changes — and I’ll do just that, in a minute. But it’s impossible to see Litan and Singer compounding all of them, in this manner, without coming to the conclusion that they were systematically trying to come up with the biggest and scariest number they could possibly find. It’s true that whenever they mention their $37 billion figure, it’s generally qualified with a “could be as high as” or similar. But they knew what they were doing, and they did it very well.

When the Chicago Tribune and the LA Times say in their headlines that 401(k) loan defaults have reached $37 billion a year, they’re printing exactly what Custodia and Litan and Singer wanted them to print. The Litan-Singer paper doesn’t exactly say that defaults have reached that figure. But if you put out a press release saying that “the leakage of funds in 401(k) plans due to involuntary loan defaults may be as high as $37 billion per year”, and you don’t explain anywhere in the press release that “leakage of funds” means something significantly different to — and significantly higher than — the total amount defaulted on, then it’s entirely predictable that journalists will misunderstand what you’re saying and apply the $37 billion number to total defaults, even though they shouldn’t.

But let’s backtrack a bit here. First of all, how on earth did Litan and Singer decide that the total amount of 401(k) loans outstanding was $104 billion, when the Department of Labor’s own statistics show the total to be just half that figure? Here’s how.

First, they decide that they need the total number of active participants in defined-contribution pension plans. They could get that number — 72 million — from the Labor Department bulletin: it’s right there in the very first table, A1. But the bulletin isn’t helpful to them, as we’ve seen, so instead they find the same number in a different document from the same source.

That’s as much Labor Department data as Litan and Singer want to use. Next, they go to the Investment Company Institute, which has its own survey, covering some 23 million of those 72 million 401(k) participants. According to that survey, in 2011, 18.5% of active participants had taken out a loan; Litan and Singer extrapolate that figure across the 401(k) universe as a whole.

Finally, Litan and Singer move on to Leakage of Participants’ DC Assets: How Loans, Withdrawals, and Cashouts Are Eroding Retirement Income, a 2011 report from Aon Hewitt which is based on less than 2 million accounts, of the 72 million total. According to the Aon Hewitt report, which doesn’t go into any detail about methodology, when participants took out loans, “the average balance of the outstanding amount was $7,860″. Needless to say, that number was never designed to be multiplied by 72 million, as Litan and Singer do, to generate an estimate for the total number of loans outstanding.

If you want an indication of just how unreliable and unrepresentative the $7,860 number is, you just need to stay on the very same page of the Aon Hewitt report, which says that 27.6% of participants have a loan. If Litan and Singer think that the $7,860 figure is reliable, why not use the 27.6% number as well? If they did that, then the total number of 401(k) loans outstanding would be $7,860 per loan, times 72 million participants, times 27.6% of participants with a loan. Which comes to $156 billion.

But of course we know that there were just $51.7 billion of loans outstanding in 2009; evidently Litan and Singer reckoned that it just wouldn’t pass the smell test if they tried to get away with saying that number might have trebled in a single year. So they confined themselves to merely doubling the number, instead.

Litan and Singer give no reason to mistrust the official $51.7 billion number, except to say that it’s “outdated”. But if it’s outdated, it’s only outdated by one year: it’s based on 2009 data, while the much narrower surveys that Litan and Singer cite are generally based on 2010 data. At one point, they cite the ICI survey to declare that there is “an estimated $4.5 trillion in defined contribution plans”, despite the fact that the much more reliable Labor Department report shows that there was just $3.3 trillion in those plans as of 2009. This, I think, quite neatly puts the lie to the Litan-Singer implication that the problem with the Labor Department numbers is merely that they are out of date, and that when we get numbers for 2010 or 2011, they might well turn out to be in line with the Litan-Singer estimates. There’s simply no way that total DC assets rose from $3.3 trillion to $4.5 trillion in the space of a year or two.

In other words, whatever advantage the ICI and Aon Hewitt surveys have in terms of timeliness, they more than lose in terms of simply being based on a vastly smaller sample base. Litan and Singer adduce no reason whatsoever to believe that the ICI and Aon-Hewitt surveys are in any way representative or particularly accurate, despite the fact that the discrepancies between their figures and the Labor Department figures are prima facie evidence that they’re not representative or particularly accurate. If the ICI and Aon Hewitt surveys were all we had to go on, then I could understand Litan-Singer’s decision to use them. But given that the Labor Department already has the number they’re looking for, it just doesn’t make any sense that they would laboriously try to recreate it using less-reliable figures.

It’s true that the Labor Department’s figures do undercount in one respect: they cover only plans with 100 or more participants — and therefore cover “only” 61 million of the 72 million active participants in DC plans. If Litan and Singer had taken the Labor Department’s numbers and multiplied them by 72/61, or 1.18, that I could understand. But disappearing into a rabbit-warren of private-sector surveys of dubious accuracy, and emerging up with a number which is double the size of the official one? That’s hard to justify. So hard to justify, indeed, that Litan and Singer don’t even attempt to do so.

That, indeed, is the strongest indication that the Litan-Singer paper can’t really be taken seriously. For all their concave borrower utility functions and other such economic legerdemain, they simply assert, rather than argue, that they “believe” it is “more appropriate” to use private-sector surveys rather than hard public-sector data. Such decisions cannot be based on blind faith: there have to be reasons for them. And Litan-Singer never explain what those reasons might be.

Now the move from public-sector to private-sector data merely doubles the total size of the purported problem, while Litan-Singer are much more ambitious than that. So their next move is to bump up the default rate on loans substantially.

There’s no official data on default rates at all, so Litan and Singer, following Smart’s lead, decide to base their sums on a Wharton paper from 2010. Once again, they have to extrapolate from a very small sample: the Wharton researchers had at their disposal a dataset covering 1.5 million plan participants (just 2% of the total). Looking at what happened over a period of three years, from July 2005 to June 2008, the researchers found that the number of terminations, and the number of defaults, remained pretty steady:


These are the numbers that Smart used in his paper: roughly 12% of loan holders being terminated each year, and roughly 80% of those defaulting on their loans.

But these are not the numbers that Litan-Singer use. Instead, they notice that the overall default rate, as a percentage of overall loans outstanding, was roughly double the national unemployment rate at the time. And so since the unemployment rate doubled after June 2008, they conclude that the default rate on outstanding 401(k) loans probably doubled as well.

Do they have any evidence that the default rate on 401(k) loans might have doubled after 2008? No. Well, they have a tiny bit of evidence: they look at the small variations in default rates in each of the three years covered in the Wharton study, and see that those variations move roughly in line with the national unemployment rate. Never mind that the default rate fell, from 9.9% to 9.7%, between 2006 and 2008, even as the unemployment rate rose, from 4.8% to 5.0%. They’ve still somehow managed to convince themselves that it’s reasonable to assume that the default rate today is nowhere near the 9.6% seen in the Wharton survey, and in fact is probably closer to — get this — 17.9%.

This doesn’t pass the smell test. The primary determinant of the default rate, in the Wharton study, was the percentage of loan holders who wound up having their employment terminated, for whatever reason. And so what Litan-Singer should be looking at is the increase in the probability that any given employee will end up being terminated in any given year.

Remember that in any given month, or year, the number of people fired is roughly equally to the number of people hired. When the former is a bit larger than the latter for an extended period, then the unemployment rate tends to go up; when it’s smaller, the rate goes down. But the churning in the employment economy is a constant, even when the unemployment rate is very low.

When the unemployment rate rose after 2008, that was a function of the fact that the number of people being fired was a bit higher than normal, while the number of people being hired was a bit lower than normal. But looked at from a distance, neither of them changed that much. In terms of the Wharton study, what we saw happening to the unemployment rate is entirely consistent with the percentage of loan-holders being terminated, per year, staying pretty close to 12%. Of course it’s possible that number rose sharply, but it’s really not possible that number rose as sharply as the unemployment rate did. And so I find it literally incredible that Litan and Singer should decide to use the national unemployment rate as a proxy for the number of people whose employment is terminated each year.

Well, maybe not literally incredible — the fact is there’s one very good reason why they might do that. Which is that they were being paid by Custodia to use any means possible to exaggerate the number of annual 401(k) loan defaults.

Litan and Singer do actually provide a mini smell test of their own: they say that their hypothesized rise in 401(k) loan defaults is more or less in line with the rise in, say, student-loan defaults or in mortgage defaults over the same period. But those statistics aren’t comparable at all, because Litan and Singer are already assuming that the default rate on 401(k) loans, among people who lose their job, was a whopping 80% before the financial crisis. There’s a 100% upper bound here: you can’t have a default rate of more than 100%. Remember that the whole point of this paper is to provide the case that people taking out 401(k) loans should insure themselves against unemployment: any rise in the default rate from people who don’t lose their job (or die, or become disabled) is more or less irrelevant here. And when your starting point is a default rate of 80%, there really is a limit to how much that default rate can rise; it’s certainly going to be difficult to see it rise by more than 85%, even if you allow a simultaneous increase in the number of people being terminated.

All of this massive exaggeration has an impressive effect: if you take $104 billion in loans, and apply a 17.9% default rate, then that comes to a whopping $18.6 billion in 401(k) loan defaults every year. A big number — but still, evidently, not big enough for Litan and Singer. After all, their number is $37 billion: double what we’ve managed to come up with so far. We’ve already doubled the size of the loan base, and almost-doubled the size of the default rate, so how on earth are we going to manage to double the total again?

The answer is that LItan and Singer, at this point, stop measuring defaults altogether, and turn their attention to a much more vaguely-defined term called “leakage”. Once again, they decide to outsource all their methodology to Custodia’s CFO, Kevin Smart. The upshot is that if you borrowed $1,000 from your 401(k) and then defaulted on that loan, the amount of “leakage” from your 401(k) is deemed to be much greater than $1,000. Litan and Singer first add on the 10% early-withdrawal penalty that you get charged for taking money out of your plan before you retire. They also add on the income tax you have to pay on that $1,000, at a total rate of 30%. (They reckon you’ll pay 25% in federal taxes, and another 5% in state taxes.) So now your $1,000 default has become a $1,400 default.

How does that extra $400 count as leakage from the 401(k), rather than just something that gets added to your annual tax bill? Smart explains:

Most participants borrow from their retirement savings because they are illiquid and do not have access to other sources of credit. This clearly demonstrates that participants who default on a participant loan do not have the financial means to pay the taxes and penalty. Unfortunately, their only source of capital is their retirement savings plan so many take the remaining account balance as an additional early distribution to pay the taxes and penalty, further increasing the amount of taxes and penalties due. These taxes and penalties become an additional source of leakage from retirement assets.

Smart’s 16-page paper has no fewer than 24 footnotes, but he fails to provide any source at all for his assertion that “many” people raid their 401(k) plans in order to pay the taxes on the money they’ve already borrowed. In any event, Smart (as well as Litan and Singer, following his lead) makes the utterly unjustifiable assumption that not only many but all 401(k) defaulters end up withdrawing the totality of their penalties and extra taxes from their retirement plan. And then, just for good measure, because that withdrawal also comes with a penalty and taxes, they apply a “gross-up” to that.

By the time all’s said and done, the $1,000 that you lent yourself from your 401(k) plan, and failed to pay back in a timely manner, has become $1,520 in “leakage”. Add in some extra “leakage” for people who default due to death or disability (apparently even dead people raid their 401(k) plans to pay income tax on the money they withdrew), and somehow Litan and Singer contrive to come up with a total of $37 billion.

It’s an unjustifiable piling of the impossible onto the improbable, and the press just lapped it up — not least because it came with the imprimatur of Litan, a genuinely respected economist and researcher. Custodia hired him for precisely that reason: they knew that if his name was on the front page of a report, that would give it automatic credibility. But for exactly the same reason, Litan had a responsibility to be intellectually honest when writing this thing.

Instead, he never even questioned any of the assumptions made by Custodia’s CFO. For instance: if you’re terminated, and you default on your 401(k) loan, what are the chances that the money you received will end up being counted as an “actual distribution” rather than as a “deemed distribution”? Smart and Litan and Singer all implicitly assume that the answer is 100%, but they never spell out their reasoning; my gut feeling is that it’s not nearly as clear-cut as that, and that it all depends on things like when you lost your job, when you defaulted, and who your pension-plan administrator is.

Custodia’s business, and the Litan-Singer paper, are based on the idea that if people who borrowed money from their 401(k) plans had insurance against being terminated from their jobs, then that would have significant societal benefit. In order for the societal benefit to be large, the quantity of annual 401(k) loan defaults due to termination also has to be large. But right now, there’s not a huge amount of evidence that it actually is: in fact, we really have no idea how big it is.

I can say, however, that Custodia has already won this battle where it matters — in the press. “Protecting 401(k) savings from job loss makes a lot of sense,” said Time’s Kadlec in his post — and so long as Custodia can present lawmakers with lots of headlines touting the $37 billion number and supporting their plan, Litan and Singer will have done their job. The truth doesn’t matter: all that matters is the headlines, and the public perception of what the truth is.

Come to think, maybe this makes Litan the absolutely perfect person to run the research department at Bloomberg Government. On the theory that it takes a thief to catch a thief, Bloomberg has hired someone who clearly knows all the tricks when it comes to writing papers which come to a predetermined conclusion. And he also has a deep understanding of the real purpose of most of the white papers floating around DC: it’s not to get closer to the truth, but rather to stamp a superficially plausible institutional imprimatur onto a policy that some lobbyist or pressure group desperately wants enacted. I can only hope that in the wake of using his talents in order to serve Custodia Financial, Litan will now turn around and use them in order to serve rather greater masters. Like, for instance, truth, and transparency, and intellectual honesty.



It must have taken a helluva long time to research all that. Either you are paid by the minute and receive bonuses per the written word or you are trying to serve greater masters.+

Litan clearly has contrived data to serve his own goals.

Posted by breezinthru | Report as abusive

How Pimco works

Felix Salmon
Jul 31, 2012 17:08 UTC

There’s an anonymous troll on the internet who doesn’t like my latest Pimco post. And frankly it’s really hard to take any post seriously when it’s tagged “born last night, clown questions, gmafb, horseshit, STFU”. This kind of macho bullying posturing is everything I hate about Wall Street — a place which is still home to far too many overconfident frat boys with overstuffed paychecks.

So, why am I rising to the bait? Mainly because some people I respect are taking the post seriously. And also because, hidden behind the sophomoric grandstanding, there are actually a couple of substantive points being made.

To take them in order, then:

Firstly, does Bill Gross pay himself, or is he “paid by the parent company that bought his firm”? I haven’t seen a lot of reporting on this, but everything I know about Pimco says that it’s a very arm’s-length, largely independent unit of Allianz. It certainly dividends profits up to its parent, but I don’t actually believe nor have I ever seen it reported that Allianz executives make granular decisions on how much Bill Gross, or any other Pimco employee, gets paid on a year-to-year basis.

Is there a formula governing Gross’s remuneration, based on some combination of Pimco revenues, Pimco profits, and the performance of the funds he manages? I’m sure there is. And if you want to reverse-engineer a way for Gross to have been paid $200 million in 2011 despite massively underperforming that year, then that’s surely the way to get there. Pimco doesn’t want to encourage short-term gambling among its employees, and so its pay is based on long-term performance rather than year-to-year fluctuations; Gross’s long-term performance remains excellent, and he manages an astonishing amount of money. And on top of that, Pimco is attracting spectacular inflows these days.

Still, Pimco told me that the numbers in the original NYT article were “seriously inaccurate”, and I’m quite sure that Gross, given his position in the company, does have a certain amount of discretion when it comes to divvying up the remuneration pool. He might not “have to answer to congress or a goofball parade of Occupy Wall Streeters”, but he’s still a leader — and even if we don’t know for sure how much he got paid last year, a lot of big-time money managers in the company know exactly what example he is setting. If they would risk getting fired after turning in such dismal performance, then it would be downright hypocritical — and bad for the cohesion of the senior management team — were Gross to accept a $200 million paycheck in such a bad year.

And how about the people whose money Pimco is managing? Yes, it’s easy to say that they’re sophisticated investors who “pay an agreed upon and transparent management fee up front” — but that doesn’t mean they’re happy with the fees they’re paying, especially not if they start reading about $200 million paychecks. And in a world moving swiftly away from the fund model and toward the lower-fee ETF model, it behooves any long-only money manager to keep a very close eye on fees and costs. The level of money-skimming which maximizes your payday this year is not necessarily the best way to keep on building your company’s franchise over the long term, especially in a world where index investing is becoming increasingly popular.

As for the assertion that long-only “buy siders that actually run portfolios north of 200 billion are paid at this level” — well, name some names. It’s a very short list, of course. But if you can find one or two other people who were paid $200 million a year for managing funds, and who weren’t hedge-fund managers collecting 2-and-20, then I’d be much more likely to believe that Gross is paid that much, too.

Next up comes a question about Mohamed El-Erian’s tenure at Harvard Management Company. I quoted an article about how “Mohamed was having a heart attack” while he was there, because Larry Summers insisted on taking Harvard’s spare cash and investing it in an endowment which was designed to have a virtually infinite time horizon. As a result, El-Erian’s job when it came to liquidity management was made extremely difficult. But now I’m told “this isn’t true”, on the grounds that all El-Erian needed to do was “explain” to Summers and others “that their allocation was inappropriate”, and then sleep well at night since the “allocation was made by Harvard officials not by Harvard Management.”

Maybe anonymous Wall Street trolls think that way, and wouldn’t worry about Harvard’s liquidity needs even if Harvard was effectively using them as a checking account. But a responsible money manager worries about liquidity every day, especially in a situation where Harvard can and will ask for large sums of cash on a regular basis. In any case, my larger point was that El-Erian can’t be blamed for liquidity problems after he left HMC, and there doesn’t seem to be any disagreement on that front.

Then there’s the question of the degree to which El-Erian’s ubiquity in the media is a Pimco marketing strategy, responsible for the large increase in assets that Pimco is seeing these days. I’m informed that the answer is a simple yes — but if that’s the case, that has interesting implications. A large chunk of Fabrikant’s article was based on the premise that Pimco’s investors wanted Gross’s bond-trading expertise, rather than El-Erian’s technocratic global-macro insights. But if indeed El-Erian’s regular TV appearances and various op-eds are responsible for the hundreds of billions of dollars which continue to flow into Pimco, then it seems that there’s a lot of appetite out there for a macro-led, rather than a trading-led, strategy.

On top of that, it’s notable that Gross, the great bond trader, has started to underperform Pimco as a whole, where investments are based very much on the global macroeconomic outlook. Pimco’s more than big enough for both Gross and El-Erian, of course. But the idea, in Fabrikant’s piece, that Pimco is effectively still Gross’s shop, and risks withering away were he ever to leave — that idea is pretty effectively demolished if in fact El-Erian’s media strategy is responsible for bringing in enormous amounts of new money. Certainly El-Erian never talks about trading strategies in such appearances.

Finally, there’s the question of Blackrock, a much bigger fund manager than Pimco, where, incidentally, the CEO, Larry Fink, was paid $21 million in 2011. How did Blackrock grow so big? In large part by buying a lot of index funds, thereby diversifying into one of the fastest-growing investment strategies in the world. And also, in part, by being a public company. And so I asked a question, and received an answer:

In order for Pimco to effectively compete with Blackrock, will it too have to go public?

No. How is that even a question? They are a wholly owned subsidiary of a firm that is significantly larger than Blackrock which allows them tremendously cheap financing if they need it. Allianz’s insurance assets also provides them with 23% of their AUM. Does JP Morgan Asset Management, SSgA, or Deutsche Bank Asset Management (all well over a trillion in AUM) need to spin off and IPO to compete with Blackrock?

I wasn’t suggesting that Pimco spin off from Allianz. But Pimco already has “shadow equity” which is traded among Pimco employees; there’s no reason that it couldn’t get listed as some kind of tracking stock. And that tracking stock could be a very valuable acquisition currency as Pimco seeks to diversify away from its historical core competence of actively-managed bond funds. There are many reasons why Pimco might well prefer to do things that way, rather than asking Allianz for “tremendously cheap financing” for an acquisition.

I’m sure that Pimco gets lots of value from having Allianz assets at its core. But Pimco is also reported to be “seeking more independence from its parent”, and in any case I don’t think it’s true that Pimco is wholly owned by Allianz, which bought only 70% of the company back in 1999.

My point about Blackrock is that by having its own stock and being master of its own strategy, it has managed to diversify, and grow, more quickly and effectively than Pimco has. Here’s a germane quote, from last year:

“The history of the asset-management business demonstrates time and time again that the most successful asset-management firms are those who are dedicated to investing rather than subsidiaries of banks and insurance companies where there can be lots of tension,” Burton Greenwald, a fund-consultant based in Philadelphia, said in an interview. “Fund companies tend to be entrepreneurial, while banks and insurance companies tend to be bureaucratic.”

There’s a case to be made that Pimco has in fact thrived under Allianz’s ownership — but it’s unclear whether that’s a function of Allianz being a great owner, or whether it’s a function of the fact that those years saw the greatest fixed-income bull market of all time. That bull market is going to come to an end at some point. And when it does, Pimco wants to be positioned much more evenly across various different asset classes and strategies than it is now. In order to do that, it’s not a completely horseshit clown question to ask whether it might want to take a leaf or two out of Blackrock’s book.

Update: David Merkel adds some very useful facts to the debate.


I think people focus on the “amount” that Bill Gross gets paid rather than the value that he brings to PIMCO / Allianz or Bill’s opportunity cost (how much he could be making elsewhere). By these measures, I calculate he significantly is underpaid at $200M or less per year. While I made a lot of big assumptions, my back of the napkin math suggests that Bill Gross should be getting paid in range of $700 – $1 billion per year. The math is described in the article:

http://www.learnbonds.com/bill-gross-com pensation/

Also, we have a poll – how much do you think Bill Gross should be paid?

http://www.learnbonds.com/bill-gross-sal ary/

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Questioning El-Erian

Felix Salmon
Jul 30, 2012 04:38 UTC

When Geraldine Fabrikant decided to write a rather odd and meandering profile of Mohamed El-Erian for the NYT, she made sure to bury the lede, deep in the article’s sixth paragraph. But Clusterstock knew where the news value was (“KA-CHING: PIMCO’s Mohamed El-Erian Got Paid $100 Million Last Year”), while Bloomberg led with the revelation about El-Erian’s co-CIO: “Pimco’s Bill Gross Paid $200 Million Last Year, N.Y. Times Says”.

Fabrikant’s source for both numbers is a single individual, “a person with knowledge of Pimco’s finances”. The whole thing was rather reminiscent, to me, of what happened last February, when Reuters reported that Pimco’s top partners are making an average of $33 million each, and Pimco responded by calling those numbers “wildly inaccurate”. So I asked Pimco what it thought of Fabrikant’s reporting, and got this back from a spokesperson:

The article contains numbers that are seriously inaccurate, as well as other factual errors.

Fabrikant spent a lot of time on this article — she says that her joint interview with El-Erian and Gross took place “earlier this year” — and so I suspect that she’s pretty confident in printing those numbers. That said, however, Gross, who’s already a multibillionaire and really doesn’t need the money, would have had to be utterly tone-deaf to pay himself $200 million in 2011.

2011 was the year, remember, in which he published a 3-page note entitled “Mea Culpa”: “I’m just having a bad year,” he said. “This year is a stinker.” He continued:

This is big league ball, where your ticketholders come to the park expecting not a circus Willie Mays catch but more wins than losses and a yearend performance that places your bond assets near the top of the standings.

That didn’t happen. Instead, Gross placed in the bottom 10% of bond-fund managers for 2011. Given that, it’s hard to see how he could justify extracting $200 million from Pimco’s investors, or three times the record $68.5 million that Lloyd Blankfein was paid in 2007.

Certainly that kind of payday is within the realms of possibility, given that his firm manages $1.8 trillion, and his Total Return Fund has $263 billion under management: $200 million is just 0.01% of the former, or 0.08% of the latter. On the long-only buy side, the way you get paid for performance is that your performance attracts new money, and the new money pays management fees. And so long as Pimco’s assets under management are going up rather than down, I can see how Gross’s pay might do likewise. But still.

I can’t say that the rest of the article makes it seem particularly reliable, either. Fabrikant lays out the case against El-Erian on two fronts: firstly that he isn’t much of a bond trader; and secondly that his tenure running Harvard’s endowment was “somewhat controversial”. Overall, she says, “his track record for managing money is mixed”.

But I can’t work out how Fabrikant comes to that conclusion. El-Erian has managed money at two places: Pimco (twice), and Harvard. In his first stint at Pimco, between 1999 and 2005, he managed emerging-market bonds through the Russian and Brazilian crises and the Argentine sovereign default; he ended up making an annualized return of 18.4%, which was very much, in Gross’s words, “near the top of the standings”. What’s more, he amassed a much larger emerging-market bond portfolio than any of his competitors: he was just as good at attracting funds as he was at generating alpha.

At Harvard, El-Erian also did well, at least in terms of published returns. Of course, there’s more to managing an endowment than maximizing annual returns: you also need to be assiduous about liquidity management. And after El-Erian left Harvard, the endowment ran into massive liquidity problems. Fabrikant says that “several experts on endowments”, none of whom are named, blame El-Erian’s investment strategy for those problems, along with his abrupt departure. But I see things differently: I think the real problem at Harvard was leadership, or rather the lack thereof.

El-Erian’s departure was indeed abrupt — but I suspect that had he been managed better by the university’s grandees, including Larry Summers and Robert Rubin, they could have done a better job of persuading El-Erian to put in place a considered succession strategy. And then, after El-Erian left, the endowment was left effectively headless for the best part of a year before Jane Mendillo was hired in July 2008. That’s not his fault.

Asset allocation is something endowments do on a very long timeframe: once El-Erian had worked out where he wanted the endowment’s money to be invested, it was probably OK to keep that same allocation until a new head could be found. But liquidity management is another thing entirely: that kind of thing can’t be run on autopilot, and has to be actively managed. Especially when Summers is busy losing $1 billion of the university’s money elsewhere. Remember this?

Through the first half of this decade, Meyer repeatedly warned Summers and other Harvard officials that the school was being too aggressive with billions of dollars in cash, according to people present for the discussions, investing almost all of it with the endowment’s risky mix of stocks, bonds, hedge funds, and private equity. Meyer’s successor, Mohamed El-Erian, would later sound the same warnings to Summers, and to Harvard financial staff and board members.

“Mohamed was having a heart attack,’’ said one former financial executive, who spoke on the condition of anonymity for fear of angering Harvard and Summers.

In other words, El-Erian was having a hard enough time on the liquidity-management front when he was in the office every day, thanks to the internal politics of the university; he can’t really be blamed for failures after he left.

Finally, El-Erian started managing money directly at Pimco again in 2009; since then, his funds’ returns, in Fabrikant’s words, have been “relatively lackluster”. But these are small funds, with just $10 billion between them — a rounding error, at Pimco. As CEO and co-CIO of the whole company, El-Erian should be properly judged on the whole company’s performance, and Pimco seems to show no deceleration whatsoever when it comes to the pace at which it is accumulating assets under management. Not that you’d learn that from Fabrikant’s story.

Instead, we get very silly stuff like this:

Mr. El-Erian was headed east and people were buzzing. Some wondered if he was taking the job to cultivate a relationship with Lawrence H. Summers, a former Treasury secretary who was then Harvard’s president, in the hope of finally landing atop the I.M.F.

Who are these “some”? We’re never told, of course. But since when has the president of Harvard had any say at all in who becomes the next head of the IMF? Summers did return to government eventually, but that was by no means a foregone conclusion, or even likely, in 2007. What’s more, even once he was in government, I don’t think that Summers played any real role in selecting the next head of the IMF — a choice which is made by Europeans, not Americans.

And what we don’t get, from Fabrikant’s article, is any real substance on the task facing El-Erian. If you’re writing a profile of him, here are some questions I look forward to you trying to answer:

To what degree is El-Erian in the process of replacing Gross, and to what degree is he doing something completely different? What will happen to the Total Return Fund when Gross retires? Does Pimco need to replace Gross with another great bond trader, or is it now a very different animal to the company that Gross founded, in need of someone who thinks on a more macroeconomic level? And how is El-Erian, who is CEO as well as CIO, as a manager?

How much time does El-Erian spend appearing on television, writing op-eds, and otherwise cultivating the media? Is that all part of some Pimco marketing push? To what degree does it distract from his day job? Same questions for Gross, too.

Finally, and most interestingly, how did Larry Fink manage to amass twice Pimco’s assets under management despite the fact that Bill Gross, the greatest bond investor of all time, had a more than 15-year headstart on him? What is the story of Blackrock vs Pimco, and how is it likely to play out in future? In order for Pimco to effectively compete with Blackrock, will it too have to go public? (Incidentally, Fink was paid $21.9 million in 2011.)

El-Erian is an interesting character, but it seems to me that the most daunting job facing him is the fact that he is being asked to run an enormous buy-side institution which he didn’t found. Many people have been asked to do that; very few of them have ever succeeded. What will it take to buck the trend? And will the world’s institutional investors stick around long enough to find out? Or will El-Erian finally get that IMF job, and move to Washington, before it comes to that?

But yeah, it would also be fascinating to find out how much he’s really being paid.


Interesting piece. For part of it I thought this might have been written by the PIMCO public relations team. The author’s take on how mangers are compensated on the buyside is idealistic and naive. Depending on how the sell agreement was negotiated with Allianz the compensation numbers may be correct as it’s not unusual for the selling firm to retain a % of the revenues and the autonomy to run the business as they see fit (i.e. they maintain control over the culture, comp, strategy, etc…) While Mr. Gross may have had a bad year I’m 2011 most investors recognize that he (and team) have consistently added alpha far above the benchmark on a relatively consistent basis (use rolling time periods to get a clear picture of the consistency). As a founder of on organization that might generate $7b in fees (assuming avg fee across structure of enterprise 50bps) and a 35% revenue sharing agreement (not that uncommon) is it that crazy to think 10% of the revenues may go his way? By and large this is a sticky business as long as you don’t consistently have major blow-ups. Indeed, the author tacitly acknowledges one of the strengths of their business model (and asset management in general) when he defends El Erian’s lackluster performance on relatively small funds for PIMCO ($10B -which is bigger than most asset mangement firms) by pointing out that they are still able to gather assets. That is the beauty of distribution and PIMCO has great distribution. The author points out that Mr. Gross is a multibillionaire, maybe a germane question would be how much of his net worth is in the fund, especially since he is not a big fan of equities.
I thought the author partially redeemed himself for the cheer leading exhibit in the first half of the article by asking some very great questions that weren’t addressed in the NYT article. Maybe one more to add to the list – how would a completely transparent, exchanged traded derivatives market affect PIMCO’s ability to mange the vast sums of fixed income assets they have?

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