February 2007 Archives

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Macroeconomics is just like nutritionism

Have you read that Michael Pollan article on nutritionism yet? You really should. Here's a chunk:

Most nutritional science involves studying one nutrient at a time, an approach that even nutritionists who do it will tell you is deeply flawed. “The problem with nutrient-by-nutrient nutrition science,” points out Marion Nestle, the New York University nutritionist, “is that it takes the nutrient out of the context of food, the food out of the context of diet and the diet out of the context of lifestyle.”
If nutritional scientists know this, why do they do it anyway? Because a nutrient bias is built into the way science is done: scientists need individual variables they can isolate. Yet even the simplest food is a hopelessly complex thing to study, a virtual wilderness of chemical compounds, many of which exist in complex and dynamic relation to one another, and all of which together are in the process of changing from one state to another. So if you’re a nutritional scientist, you do the only thing you can do, given the tools at your disposal: break the thing down into its component parts and study those one by one, even if that means ignoring complex interactions and contexts, as well as the fact that the whole may be more than, or just different from, the sum of its parts. This is what we mean by reductionist science.

Does this remind you of anything? Macroeconomics, say? Economists like nothing more than to isolate different bits of the economy – housing starts, say, or durable goods orders, or initial jobless claims, or any one of hundreds of other statistical series – and try to work out how those numbers fit into what they invariably think of as the "economic cycle". As far as I can make out, a large part of the reason why Alan Greenspan now thinks there's a small chance of a recession in 2007 is simply that there hasn't been one in 63 months, and therefore a recession is probably overdue. Which idea, of course, is utter codswallop, so he tries to dress it up by pointing to all manner of his beloved "indicators".

The fact is that a manufacturing recession is a harbinger of a recession in much the same way as a diet high in monounsaturated fats is a harbinger of obesity. It might be, but, on the other hand, it might not be – and really, carving the economy up into little chunks and looking at the little chunks as indicators of what the whole insanely complex thing might do makes no more sense than carving a diet up into "nutrients" and looking at the nutrients as indicators of how the whole insanely complex body might react. Nutritionists and economists do this because it's all they can do – no models have even come close to replicating the human body or the macroeconomy in all its chaos. But most of the time we're all better off simply ignoring them.

Posted by Felix at 15:04 EST | Comments (3)

Mortality bonds and longevity bonds

You can bet on people dying: Liam Pleven and Ian McDonald in the WSJ have a good overview of how life-insurance companies are increasingly turning to the capital markets to hedge the risks they bear of insured individuals dying too soon. But can you bet on people living? The power team of Gillian Tett and Joanna Chung in the FT has a long and fascinating article about the other side of the coin: bonds issued by pension companies to hedge the risks of annuity holders, say, living too long.

The big problem is that at the moment all these instruments are largely targeted at sophisticated hedge funds, who want such large expected returns that issuance simply doesn't make sense for the life insurers and the pension companies. In fact, a spate of mergers between pension companies and life insurers makes much more sense, since then the risks tend to cancel each other out. But such mergers aren't easy: life insurers make their money by being constructive on mortality, while pension companies take the opposite view.

All the same, I've long been surprised at how unpopular annuities are. Pension plans usually wind up giving a recently-retired person a lump sum, and it would seem to make all the sense in the world to simply convert that lump sum into a guaranteed payment for life. But relatively few people do that, and so they run the risk of outliving their money. Maybe what's needed is a combination annuity and health insurance product, which guarantees not only an income but also to pay all those dreadful medical expenses which can arise at the end of life. But there are precious few companies with the breadth of expertise to offer such a thing. Cue further insurance-industry consolidation!

Posted by Felix at 14:39 EST | Comments (2)

Will Goldman Sachs help absorb subprime losses?

According to a rumor over at Dealbreaker, one of the big losers in the subprime mess is none other than Goldman Sachs:

“Not sure if this is on your radar, but a Goldman trader took a $1B (yes, that is $1 Billion) position in a sub-prime mortgage index last week. He was fired today after the position suffered a roughly 35% decline. I can’t verify if it was closed out yet, but the loss thus far stands at about $350M. Talk about a bad week.”

This is bad for GS, of course. But it's also really good news for anybody worried about the systemic risks associated with all these newfangled synthetic debt products. In the old days, banks wrote mortgages and took the associated risks. Then they started securitizing those mortgages, spreading the risk more thinly across bond investors. And then investment banks started creating products based on mortgage indices, which meant that the bond investors could offload a lot of their risk even further onto CDOs and hedge funds and prop desks at Goldman Sachs. Basically, the more money that Goldman loses, the less money that people who can't afford it are losing. So, thank you, unnamed Goldman trader!

Posted by Felix at 13:36 EST | Comments (2)

Metaphor of the day

"If it walks, ducks and quacks like garbage it passes the smell test of being garbage."
–Nouriel Roubini

Posted by Felix at 12:51 EST | Comments (0)

Why the XM-Sirius merger might not be so good for consumers after all

The WSJ had a wonderful Reply-All (think a techy version of Econoblog) yesterday on the subject of whether the XM-Sirius merger would be good for consumers. Mark Cooper, a consumer advocate, said no; Donald Russell, a former DoJ lawyer, said yes. If you want to see a really strong debate on both sides, go check it out.

Before I read the debate, I was on Russell's side, but Cooper is very persuasive. And as I was reading it, another thought occurred to me. Russell makes a big deal of the fact that XM and Sirius are both losing money, and that consumers would benefit from the lower costs of a merged company.

But what happens if the companies don't merge, and continue to lose money? Eventually, presumably, some kind of bankruptcy or restructuring, which would allow the company concerned to get out from under its enormous debt burden, not to mention the huge contracts they've been signing with the likes of Howard Stern and Oprah Winfrey. Presto – a competitive company again, without having to go through an illegal merger!

I'm reminded of federal bailouts of US airlines, such as the one following 9/11. It's not the job of the government to save companies who have racked up too much debt, either by bailing them out with cash or by allowing them to merge and create a monopoly. Why not let bankruptcy work its magic?

Posted by Felix at 12:43 EST | Comments (0)

Is there any reason to still care about the Dow?

Here's the chart of yesterday's price action in the Dow, the S&P 500, and the Nasdaq. Note anything crazy? Like a whopping great big down-250-points-in-one-tick plunge in the Dow at about 3pm?

As you can see from the broader stock indices, there wasn't some market-wide moment of panic. So was there something which hit the 30 Dow stocks in particular? No. This from Dealbreaker:

"The market's extraordinary trading volume caused a delay in the Dow Jones data systems," said Dow Jones spokeswoman Sybille Reitz. "We decided to switch over to the backup system, and the result was a rapid catch-up in the published value of the Dow Jones industrial average."

In other words, a computer glitch.

So to the obvious question: Can someone please just take the Dow behind the shed and shoot it, already? It's an average, not an index, which makes it profoundly useless for measuring what stocks in general are doing. It comprises the grand total of 30 stocks, which makes it far from representative of the broader market in any case. And, as we saw yesterday, it can't even calculate itself reliably. Is there any purpose for this anachronism whatsoever?

UPDATE: The WSJ (published by Dow Jones, whose computers went FUBAR yesterday) has a very good, and free, overview of what went wrong.

Posted by Felix at 10:57 EST | Comments (1)

Stern replies to Leonhardt

Remember last week, when the world was carefree, and all we had to worry about were minor things like the fate of the planet? David Leonhardt's Economix column bravely entered the world of discounting – and managed to get it wrong. John Quiggin, who really understands this stuff, tried to explain it on his blog, but now we have Nick Stern himself explaining it on the NYT letters pages, with astonishing lucidity.

My analysis places much lower weight on a future dollar than a dollar now, for the ethical reasons that future generations may have higher consumption and that there is a (small) possibility of extinction, for example from a meteorite.
Professor Nordhaus advocates further discounting for the dubious reason that those born later have less significance. But reasonable people can differ on ethical issues.

Now there's a really good explanation to use in future when someone like Leonhardt starts getting confused between delta and eta.

Posted by Felix at 10:16 EST | Comments (0)

Can one day's fall mean the market is getting bearish on the US economy?

Brad Setser says that "I thought Leonhardt was better than usual" today – and he's right. David Leonhardt's Economix column comes on a Wednesday, which is perfect timing to look at the economic fundamentals, insofar as there are any, behind the stock-market fall on Tuesday.

Wall Street was caught off guard when the Commerce Department reported yesterday morning that orders for durable goods — big items like home computers and factory machines — plunged almost 8 percent last month...
Is the entire United States economy in danger of going the way of the manufacturing sector? Is it possible that we’re headed for a real recession?
For months now, the economy seemed to shrug off the forces weighing on it and just kept on growing. But those forces never went away. If anything, a number of them have gotten stronger. And that’s the most worrisome part of the bad news from the nation’s factories: it fits into a larger story...
the manufacturing downturn stems from a couple of larger economic problems. One, of course, is the housing slump, which has caused a big drop in new construction and much less demand for doors, windows, countertops and a lot of other things that kept factories busy in recent years...
The second big problem for manufacturers is the series of interest rate increases that the Federal Reserve has imposed since 2004.
The economic news certainly isn’t all bad. The housing problems still haven’t turned into a crisis, thanks in part to interest rates that are still not high by historical standards. So the most likely situation is not a full-blown recession (often defined as two consecutive quarters of a shrinking economy)...
But for all the attention that formal recessions get on Wall Street, they are not really the benchmark that matters to most people. A significant slowdown that falls short of a recession can do a lot of damage to stock prices, profits and wages.

I do have a couple of issues with this. One is the emphasis on recession, when even Leonhardt ends up hedging his bets and deciding that we'll probably just end up with "a significant slowdown", whatever that might be. For what it's worth, it looks as though Nouriel is back onto his recession call: "These bad economic news from the US suggest that the US will enter into a recession this year - as I predicted last summer - as early as Q1 or Q2." (He neglects to mention that only a few weeks ago he was talking about only a "growth recession".) I'm sticking to my belief that if the market and an economist say two different things, you should go with the market every time. And on Tuesday the Intrade recession contract did rise – all the way to 22.

But more to the point, you can't just say that "the economy seemed to shrug off the forces weighing on it and just kept on growing," as though it's some kind of pubescent boy. Economic growth is what happens when the positive forces outweigh the negative forces in an economy. And although there are always negative forces, the positive forces have been very strong – something which a lot of economists have been very wrong about. If the economy were as dependent on home building and manufacturing as many people seem to think, we'd be in a full-blown recession already.

I also think that the connection between the strength of the economy and the strength of the stock market is probably weaker now than it's ever been, given the amount of high-tech financial engineering which increasingly underlies both corporate capital structures and stock trades. Obviously, when stock markets around the world fall, the pundits will immediately look to find reasons why the US or global economy might be faltering. You can't blame Leonhardt for that. But it might also be worth asking what has kept the US economy growing for so long, whether those forces are now weakening, and if so, why now.

Posted by Felix at 1:33 EST | Comments (5)

No one knows why the market fell, and it doesn't matter anyway

Dan Gross gets it. Andrew Leonard gets it too. In fact, any halfways-decent financial journalist gets it, and, if honest, would simply write a story saying "the market went down and we don't know why". But instead we're inundated with "explanations", from an assassination attempt on Dick Cheney (Daily Intelligencer: "Are investors balking because Cheney was attacked? Or because he wasn't hurt?") to a drop in one of the most boring economic series in the US. (Go on – quick – tell me what a durable goods order even is.)

One thing worth noting: Risk assets got hit, and the riskier the asset, the bigger the hit. Equities were hurt, and emerging-market equities were hurt more than US equities. Riskier bonds went down, safer bonds went up. In general, the markets behaved entirely rationally, and there didn't seem to be much if any panic selling. Things are working the way they're meant to work. If markets can go up – and they've been going up a lot over the past few years – then they should be able to go down too.

When the Dow hit its all-time high in October, there was a certain amount of commentary pointing out that high stock prices are mainly good for stock-market investors rather than for the economy as a whole. I wonder if anybody's going to point out that a modest drop in the stock market is not really bad news for anybody – even stock-market investors are still sitting on healthy profits at this point.

Posted by Felix at 21:52 EST | Comments (3)

The world of Aaa debt just got a lot more interesting

It seems that no one has a pleasant word today for Moody's, except maybe investors in Icelandic bank bonds. The ratings agency went on a triple-A spree yesterday, bringing pretty much every Icelandic bank up to Aaa status. Landsbanki was upgraded from A2: an incredible 5-notch upgrade.

John Glover at Bloomberg:

Moody's Investors Service was blasted by Royal Bank of Scotland Group Plc, Dresdner Kleinwort and Societe Generale SA for new criteria that rank Iceland's three biggest banks as better credits than ABN Amro Bank NV...
Last year, Kaupthing's 23 billion euros ($30 billion) of bonds lost as much as 11 percent in value after Fitch Ratings cut the country's credit outlook on concern economic growth and levels of borrowing were unsustainable.
``The market will be stupefied,'' Tom Jenkins, an analyst at Royal Bank of Scotland in London, said in an interview after publishing a note titled ``Moody's Lose The Plot Completely'' earlier today. ``Creating Aaa rated banks across the board essentially means that there is no risk in investing in financials, and that buying a senior Kaupthing bond, for example, is effectively risk-free. It isn't.''
The yield on Kaupthing's 150 million euros of 5.9 percent bonds with no set maturity fell by a record 22 basis points to 155 basis points over German government bonds, the lowest in a year, according to Royal Bank of Scotland. The spread on ABN Amro's 1 billion euros of 4.25 percent notes due 2016 is 27 basis points.

Alex Chambers, at Euromoney, pulls even fewer punches:

Most bank analysts are up in arms, while investors are dumbfounded. Here's just one typical reaction: "We believe that the capital markets should ignore Moody's entirely... Nothing has changed except that Moody's credibility is lower and lower by the week" said BNP Paribas analysts in a note to investors this morning...
Moody's ratings were once a great shortcut to good analysis, now they risk being seen merely as a detour.

Moody's stock certainly took a beating in the wake of the upgrades, falling more than 5%, knocking roughly $1 billion off the company's valuation. Ouch.

It is possible to see where Moody's is coming from here. No major European bank has defaulted in living memory, which hardly squares with all those single-A credit ratings. It's silly to pretend that banks won't get bailed out in a crisis when in fact they always do. But on the other hand, Moody's prides itself on including some kind of market risk in its ratings, and clearly, with Kaupthing debt trading at 155bp over, there's a lot of risk priced in there.

The problem is that if you're a CDO investing in triple-A securities, suddenly your world has been turned upside-down overnight. Should you just dump everything and invest in Icelandic bank debt? What's going to happen to all those triple-A indices?

My take on all this is that if Moody's had just stopped one notch short of Aaa and rated the Icelandic banks Aa1, then much of the uproar could have been prevented. But triple-A is a magical and special rating, and people get very offended when it's handed out willy-nilly.

Posted by Felix at 14:42 EST | Comments (1)

VC narratives of our times

Steven Johnson explains today why he ended up accepting money for his Web 2.0 venture from VCs:

The assumption had always been that we would not seek out venture capital funding for the company -- at least in its first year of life... we didn't have any capital-intensive needs... we had no shortage of interest from angel investors...
So why are we -- very happily -- announcing a new round of financing today, with THREE venture funds participating? It begins with my friend Ed Goodman... When I started work on outside.in, Ed asked me to come in to talk about it with his partners. They had some great feedback on the concept, and Ed encouraged me to meet with Fred Wilson and Brad Burnham over at Union Square Ventures...
When we sat down for the first time, I was really just blown away by how well they understood the problems we were wrestling with... And -- amazingly -- they didn't talk like VCs. They never once mentioned leveraging the incremental end-to-end value chain, or whatever. (Perhaps they did this for my benefit, and resumed picking the low-hanging fruit once I left the room -- either way, it was a good show.) They said they could act much more like angels -- investing smaller amounts than usual, with less restrictive terms...
And then in the closing days of the deal, my old partner from the FEED/Plastic days, Bo Peabody -- one of the people I most admire in the Web investment world -- asked if his fund Village Ventures could participate as well, so I couldn't say no to that.
We've still got a great list of angels involved as well. Marc Andreessen just wrote in out of the blue to say that he really liked the site, and to ask if he could help out with the financing. Esther Dyson, John Borthwick, George Crowley, and Richard Smith -- it's a fantastic list of people to have behind you. (Along with our other founding investors, John Seely Brown, Mark Bailey, and Andy Karsch.)

In other words, Johnson already has money from Esther Dyson and Marc Andreessen and the like, but he now gets money from Fred Wilson as well, because Fred Wilson asked really nicely.

It's very boring to talk about how much VC money is floating around the technology world these days, and at least in this case if outside.in works, it has the ability, in theory, to bring in insane amounts of money. But still, I have a feeling that outside.in is something which is very clever in theory, but which is going to be very difficult to make work in practice. Certainly it's not simple enough for me to navigate intuitively. I really would love a great online guide to what's going on in my immediate neighborhood. But whether outside.in will ever be that guide, I'm not sure.

Posted by Felix at 12:42 EST | Comments (0)

Negative equity datapoint of the day

I'm slowly becoming convinced that 95% of talk about negative equity comes either from anecdote or from extrapolation, and that there are actually few if any reliable statistics on how much negative equity there really is in the US.

But Noelle Knox of USA Today had an interesting story last week:

Here's an alarming fact about Sacramento's housing market: About one of every five existing homes on the market is a "short sale." That means the home is worth less than the value of the mortgage, and the lender is willing to accept less than full repayment of the loan to avoid foreclosure, says Tracey Saizan, president of the Sacramento Association of Realtors.

Now, USA Today is notoriously unreliable when it comes to economic reporting, so I'm not taking this fully at face value. On the other hand, this sort of number doesn't seem like the sort of thing that the president of the Sacramento Association of Realtors would just make up.

So let's assume the number is true. That's still no reason to panic. Read on a bit further, and you'll find out that the total number of homes on the market in Sacramento is actually slightly lower than average, which means that 20% of a small number is a very small number. Now remember that subprime mortgages taken out at the beginning of 2006 are by far the worst performing subprime mortgages in living memory: a lot of them went straight into default, especially in California.

In that situation, it makes sense for a borrower to try to sell his house in distress, rather than go through foreclosure. But once these houses are sold, the problem is largely in the past.

It's worth remembering, too, that many subprime mortgages capitalized interest payments at the beginning, when the buyer was incurring the biggest expenses associated with moving house. So it's entirely possible that the house might be worth less than the mortgage even if the house hasn't actually fallen much in value. According to the USA Today article, Sacramento prices are down 4.3% from a year ago – painful, to be sure, but hardly catastrophic. There's no particular reason to believe they'll continue falling, either: after all, New York, another bubblicious city, has a housing market on fire right now.

Posted by Felix at 11:39 EST | Comments (1)

Antarctica in the New York Post

If you're in New York (or LA, I think), you might be interested in a 2-page article on Antarctic cruises in the New York Post today, which was written by, er, me. It's online too, though not nearly as pretty: the main piece is here, and the sidebar is here.

Posted by Felix at 10:48 EST | Comments (0)

Markets rediscover volatility

So Chinese stocks fell by 9%, Alan Greenspan uttered the word "recession", US stocks are down, credit spreads are widening, and emerging-market bonds are being hit. It's time to take a step back. The Intrade recession contract is at an all-time low, showing a recession probability of just 16%. Spreads are widening, yes, but off of all-time lows themselves. The biggest risk in emerging markets is – well, there isn't one, really. Maybe the Latvian currency peg. US inflation expectations are falling steadily. In other words, there's no reason for a bloodbath. Chances are that prices will go down, and then they'll go back up again. As you were.

Posted by Felix at 10:30 EST | Comments (0)

Disagreement Case Study

Robin Hanson asks for disagreement case studies. When I was at RGE, I developed a bullish, trust-the-market persona to act as a foil to Nouriel Roubini's ultrabearish position. Brad Setser was kinda in between. The interesting thing to me, which I'm sure will come as no surprise to Hanson, is that I ended up believing my own posts so easily and so quickly. I wasn't putting voice to positions I'd held for a long time – but by putting voice to those positions, I ended up holding them. Similarly, after writing 5,500 words in defense of vulture funds, I'm now more well-inclined towards them than I was.

But in any case, let me try to answer Robin's questions with regard to the disagreement between me and Nouriel on whether weakness in the US housing market would drive the US economy into recession. Says Robin, by way of introduction:

You realize that both your opinion and theirs may result in part from defects, such as thinking errors or not knowing something that the other knows.

This is surely true. So to answer his questions:

Do you conclude just from the fact that they disagree that they must have more defects?
No.

Do you think they realize that they can have defects, such as thinking errors or knowing less?
Yes. Nouriel's reasonably good at admitting when he was wrong. And if asked, I'm sure he'd say that there were some defects in his reasoning in those cases.

Should the fact that you disagree be a clue to them about their defects? Is it a clue about yours?
My disagreement probably should be a clue to Nouriel about his defects, but it's easy to understand why it isn't: for one thing the disagreement came out of a deliberate attempt to disagree with him, and for another thing I have no economic qualifications. On the other hand, after spending a lot of time around Nouriel it's very easy to see my own arguments the way he sees them. So I think I'm relatively clued-in about the defects in my own arguments.

Do they adjust their estimates enough for the possibility of their defects? If not, why not?
Yes and no. If you look at Nouriel's estimates, he generally gets to his predictions by doing a bunch of economics, coming to an insanely bearish world-is-coming-to-an-end conclusion, and then diluting the result enormously for no obvious reason until it comes to a point where it's still an outlier but at least it's not a massive outlier. If lots of other very smart people were all more bearish than his official estimates, I think his estimates would be much more bearish than they are – so yes, I think he's adjusting his estimates in the light of extant disagreements. On the other hand, his adjustments are quantitative, not qualitative. He doesn't assume that he might be wrong; he remains very sure that he's right.

What clues suggest to you that they have more defects, or under-adjust for them?
Nouriel has achieved no small measure of fame and notoriety from being as bearish as he is – his bearish position has given him a large number of groupies who hang on his every word, and a widely-read blog which drives traffic to his for-profit website. So in that sense he has every incentive to under-adjust for defects in his arguments. Also, as an economist coming more from the academy than from the market, he's more likely in my view to overweight arguments based on economic theory and less likely to look at the frequency with which predictions based on such theories have spectacularly failed to come true. He also cherry-picks datapoints, but we all do that.

What clues suggest to them that you have more defects, or under-adjust?
I have little if any equity in being right: I'm blogging to have fun, jumping into the debate with both feet. I know that my opinions aren't particularly considered, even though I do believe them to be right. Also, I'm not an economist, so I'm quite unqualified to opine on matters economic – not that that ever stopped me.

Do you both have access to these clues, and if so do you interpret them differently?
Yes. But I think that Nouriel underestimates the degree to which frequently reiterating a bearish position serves to overstrengthen the arguments for it in his mind and decrease whatever objectivity he might have. I wouldn't have believed it myself, if I hadn't observed it in myself at first-hand: the way in which I became a bull simply by writing a bullish blog.

Do you each realize some clues might be hidden?
Probably not.

Does your inability to answer any of these questions suggest you have defects?
I've never claimed that I didn't have defects.

Consider all these questions again for your meta-disagreement about who has more defects.
I'm really quite uninterested in who has more defects, mainly because which of us has more defects has no bearing at all on which of us is right. I'm quite sure that Nouriel has more good arguments which favor his position than I do favoring mine. I just think that my arguments are right and that his aren't. Mostly, our disagreement comes down to theory vs the market. Nouriel bases his arguments on theory, and if there are bearish signals in the market, then he'll use them to bolster his case; otherwise, the market is wrong. Me, I start from a position of ignorance with respect to much economic theory, and simply look empirically at the fact that when economists say the market is wrong, the vast majority of time it is the economists who are wrong and the market which is right. So I do the opposite to Nouriel: I base my argument on what the market is saying and if there are economic arguments I'll use them to bolster my case; otherwise, the economists are wrong. I think that I have the edge here, and Nouriel thinks that he has the edge; it probably all comes down to what timeframe you want to look at. If Nouriel's bearish for long enough, eventually he'll be right. But only people without any money in the market can afford the luxury of being wrong until they're right.

Posted by Felix at 22:45 EST | Comments (4)

Was LTCM a lower-tail event?

I have to admit I'm a bit vague on the specifics of what happened in the LTCM blow-up. In my mind, it has always been inextricably linked with Russia's debt default, although this many years later I'm not even sure that LTCM owned any Russian debt. (Maybe LTCM simply owned spread product, which gapped out in general in the wake of Russia's default.) In any case, the general consensus, at least as I've understood things, has been that LTCM had a strategy which worked until it didn't – that they were picking up small profits and leveraging those into large profits, while leaving themselves open to a large market reversal associated with some kind of event risk.

But here's Eliezer Yudkowsky:

While LTCM raked in giant profits over its first three years, in 1998 the inefficiences that LTCM were exploiting had started to vanish - other people knew about the trick, so it stopped working.
LTCM refused to lose hope. Addicted to 40% annual returns, they borrowed more and more leverage to exploit tinier and tinier margins. When everything started to go wrong for LTCM, they had equity of $4.72 billion, leverage of $124.5 billion, and derivative positions of $1.25 trillion.

This actually rings much more true to me. The real killer of LTCM was not Russia, it was the fact that their strategies simply weren't working any more. And that rather than look for other strategies, they reacted by piling on the leverage. Does anybody know if this is true? Did LTCM's leverage rise sharply in its final year of operation?

Posted by Felix at 21:36 EST | Comments (4)

Was LTCM a lower-tail event?

I have to admit I'm a bit vague on the specifics of what happened in the LTCM blow-up. In my mind, it has always been inextricably linked with Russia's debt default, although this many years later I'm not even sure that LTCM owned any Russian debt. (Maybe LTCM simply owned spread product, which gapped out in general in the wake of Russia's default.) In any case, the general consensus, at least as I've understood things, has been that LTCM had a strategy which worked until it didn't – that they were picking up small profits and leveraging those into large profits, while leaving themselves open to a large market reversal associated with some kind of event risk.

But here's Eliezer Yudkowsky:

While LTCM raked in giant profits over its first three years, in 1998 the inefficiences that LTCM were exploiting had started to vanish - other people knew about the trick, so it stopped working.
LTCM refused to lose hope. Addicted to 40% annual returns, they borrowed more and more leverage to exploit tinier and tinier margins. When everything started to go wrong for LTCM, they had equity of $4.72 billion, leverage of $124.5 billion, and derivative positions of $1.25 trillion.

This actually rings much more true to me. The real killer of LTCM was not Russia, it was the fact that their strategies simply weren't working any more. And that rather than look for other strategies, they reacted by piling on the leverage. Does anybody know if this is true? Did LTCM's leverage rise sharply in its final year of operation?

Posted by Felix at 21:36 EST | Comments (1)

Are private companies more environmentally responsible?

TXU is one of the most environmentally unfriendly companies in the world, and the enormous amount of bad press that it's been getting as even spilled over onto banks such as Citigroup, Merrill Lynch, and Morgan Stanley.

Now, of course, TXU looks as though it's going private, in what will be, if it closes, the largest private-equity deal of all time. Makes sense, no? Public companies get damaged by shareholder activism – TXU's share price fell from $67 to $53 largely as a result of worries over the PR risks involved with TXU's plans to build 11 new coal-fired power stations. Private companies, on the other hand, tend to be more immune to such pressures.

But in an interesting twist it turns out that the private-equity buyers of TXU, which include Goldman Sachs and Texas Pacific, are into saving the environment too. Reports Andrew Ross Sorkin:

Goldman Sachs has been a longtime proponent of reducing carbon emissions. Its former chief executive, Henry M. Paulson, now the secretary of the treasury, was also the chairman of the Nature Conservancy, an environmental activist group.
Texas Pacific’s co-founder, David Bonderman, is member of the board of the World Wildlife Fund, and Mr. Reilly is chairman emeritus. Mr. Bonderman called Mr. Reilly to help work on the deal and create what they ultimately called The Green Group, a committee of advisers that included Mr. Reilly, Roger Ballentine of Green Strategies and Stuart E. Eizenstat, the former chief domestic policy adviser for President Jimmy Carter.
"We didn’t want to be on the wrong side of history," said a person involved in the bidding group who was not authorized to talk about the transaction before its formal announcement.

If TXU gets taken private, most of those 11 new coal-fired plants will be scrapped. Coal-fired plants will still be built, of course, but at least the most egregious offender on that front – TXU – won't be nearly as much of the problem as it would have been if it stayed public.

Posted by Felix at 13:11 EST | Comments (0)

Explaining Zagat grade inflation

New York magazine's Grub Street blog points me to a piece at smartmoney.com about the Zagat guides, which has some interesting datapoints:

When the Zagats started selling their 1983 New York restaurant guide, it was no mean feat for a chef to score a food rating of 20 or higher, the benchmark for "very good to excellent" in Zagat terms. Only one in four New York restaurants did so at the time. Today fully 70% reach those heights. It's as if the bottom tier dropped out: Just over a decade ago 189 out of 1,300 New York restaurants rated 15 or below; today only 23 do, despite the fact that the guide now rates more than 1,500 restaurants.

Is this a function of the Zagats being too cozy with the restaurants they cover? Grub Street, which once edited the Long Island guide, thinks not:

Most people who provide quotes to Zagat eat frequently in just a few restaurants, which they wildly overrate. In the Long Island guide, nearly every sushi restaurant was praised as having (we’re making these up, because we’re clever that way) “sushi so fresh you’ll think you’re swimming in the ocean,” and every local Italian restaurant has “pasta to die for.” The respondents go wild with the numerical ratings as well. The Zagats may well be power mad, and the way they do business may not exactly project an aura of incorruptibility, but the Zagat respondents need no help driving the ratings up through the roof.

I'm sure this is true – but although it explains the high scores in the Zagat guides today, it doesn't explain the lower scores in the Zagat guides of old. Why the grade inflation?

I think the main reason is hinted at by Grub Street: people used to send in surveys as a service to Zagats, in return for which they received the next year's guide. Both the surveyers and the company benefitted from this arrangement. Today, however, Zagat is seen as a corporate behemoth, and the number of people who think that sending in a survey is some kind of public good is shrinking dramatically. So the main reason to send in a survey is now different: it's to do a favor to one's favorite restaurant, by making it look as good as possible and to see if one can help it beat the competition.

Zagat's three-point system exacerbates the problem. The scores are given on a 30-point scale, but a score of 25, say, is actually just an average rating of 2.5, multiplied by 10. People naturally give their favorite restaurant a score off 3/3, and then score other restaurants off that benchmark. So if you're doing a guide to an area where peoples' favorite restaurants aren't particularly great, then the scores are likely to inflate. Which may or may not help to explain why the Cheesecake Factory in Las Vegas is rated 21, while the Cheesecake Factory in San Jose is rated 16 – the kind of people who go to the Cheesecake Factory in Las Vegas are more likely to think of it as their favorite restaurant than the kind of people who go to the Cheesecake Factory in San Jose. (And, yes, the fact that the Las Vegas branch has a score over 20 does mean that a significant number of reviewers gave it that 3/3 rating.) As the Zagat guides become increasingly popular, the reviewers cease to be fine diners, and start becoming much more like the general population. As a result, fine dining establishments such as Jean Georges are no longer the benchmark by which other restaurants are judged.

But it's also surely true that some of the grade inflation is simply due to the fact that restaurants now are better than they were in 1983. Does anybody really deny that?

Posted by Felix at 10:00 EST | Comments (1)

In defense of vulture funds

Greg Palast is an admirably bulldoggish reporter. Pop over to his blog, and you'll see that the last six entries are all on the subject of vulture funds in general, and the Donegal vs Zambia case in particular. Palast reported on the subject for BBC's Newsnight: You can see the full video here, or get essentially the same gist in text form here.

At the same time, the Guardian's Ashley Seager has been following the news of the case from a decidedly Palastian perspective. Here are some of his recent headlines, which give a pretty good idea of the tone he's taking:

'Vulture' feeds on Zambia
Court lets vulture fund claw back Zambian millions
Bush could block debt collection by 'vulture' funds

All of this reporting is predicated on the basic notion that vulture funds are inherently evil things, doing things which can and should be banned. (This notion is not confined to leftist journalists, by the way. It is shared by sophisticated international economists, such as Anne Krueger, the former first deputy managing director of the IMF.)

I am broadly sympathetic to where people like Palast and Seager and Krueger are coming from: I think that debt relief for heavily-indebted poor countries is a very good idea, and I think that poor Africans struggling under their governments' enormous debt burdens care little about distinctions between different types of creditors and other matters which I'm going to discuss here.

At the same time, however, I've seen the vulture funds get almost no defense in the press, and there are in fact quite a lot of reasons why they perform a good and useful function. (In this respect, they're rather similar to the birds after which they're named.) So read Palast if you want the argument against the vultures: What I'm going to write here is a deliberately one-sided defence of what they do and how they do it. With luck, I'll be able to get Palast to respond.

(One big hat-tip before I start, to Andrew Leonard, whose blog entry on the subject I read just as I was heading into a completely unconnected meeting with Palast's wife on Thursday. Another participant in the meeting asked for a "primer" on all this: I think between Palast's stuff and my own, we should be most of the way there – assuming that the length of this entry doesn't disqualify it from primer status.)

So. What is a vulture fund? Here's Palast's definition (actually, I should be accurate here – the byline on the piece is actually Newsnight's Meirion Jones, who was the producer on Palast's report):

Vulture funds - as defined by the International Monetary Fund and Gordon Brown amongst others - are companies which buy up the debt of poor nations cheaply when it is about to be written off and then sue for the full value of the debt plus interest - which might be ten times what they paid for it.

There's a lot of stuff to unpack here. But to begin at the end, vulture funds – or distressed-debt investors, as they prefer to be known – are no great fans of litigation strategies. Yes, they do sue countries in US and UK courts, on occasion. But there are lots of other ways they can make their money. For instance, consider a vulture distressed-debt fund which bought Ecuadorean Brady bonds at 25 cents on the dollar in 1999 after that country defaulted, and then tendered into Ecuador's 2000 debt exchange, in which bondholders were given securities worth about 70 cents on the dollar. That was a highly lucrative trade, which involved no legal fees and which probably made more money, in terms of annualized return net of fees, than most if not all of the litigation strategies which vulture funds get into.

As for debt which "is about to be written off", that might be true in the Donegal-Zambia case, but it is far from being the norm. In fact, I don't know of any other distressed-debt situation in which a vulture fund "swooped in" (sorry, these things are unavoidable) and bought debt which was about to be cancelled. I daresay there might be one or two situations that I don't know about, but such trades are emphatically not the norm. In the vast majority of situations, vulture funds buy debt from investors who, for whatever reason, no longer want to hold it. And in doing so, they provide a very useful service.

Consider this: You're an investor, and you buy the bonds of the sovereign nation of Ruritania for 100 cents each. The bonds pay their 7% interest for a couple of years and you're happy, until one morning Ruritania decides it is going to default and not pay you anything. Now what do you do? "Oh well," you can say to yourself, "easy come, easy go, I guess I lost all of my money". You could say that, but that would be pretty unlikely, because you're a bond investor – and bond investors tend to be reasonably risk-averse. If you wanted to risk losing all your money, then you would have invested in something much riskier, like stocks.

But that's not your only option. A bond is, after all, a legal contract, and Ruritania is contractually obliged to pay you your interest and principal in full and on time. Just as your bank can sue you if you stop making your mortgage or credit-card payments, you can sue Ruritania if it stops making its coupon payments.

But there's a problem here. Legal fees are expensive, and you don't have any money. What's more, Ruritania has high-powered lawyers of its own, such as William Blair QC, Tony Blair’s brother, and can call at will on the awesome might of huge international law firms such as Cleary Gottlieb Steen & Hamilton. There's no way you can even retain, let alone afford, that kind of legal firepower – and in any case you have no appetite for a drawn-out legal fight which could last for years. What's more, even if you win the legal fight, there's still no guarantee that Ruritania will have any more respect for a court judgment in your favor than it had for the original bond contract. In other words, you could win in court and still be no better off than you were to begin with – worse off, in fact, since you'd be down all those legal fees.

Back to square one, then, it would seem: You've lost all your money. Except – there is one more option. Bonds, after all, are securities, which can be bought and sold. At any point in time, including now, any bondholder is free to sell his bonds to the highest bidder (or anyone else). And it turns out that in the market for Ruritanian bonds, there is a bid at 50 cents on the dollar. Rather than losing your entire 100-cent investment, you can sell your bonds for 50 cents instead, and lose only half rather than all of your money. Ruritanian debt hardly turned out to be a fabulous investment, but at least it didn't wipe you out completely.

Who would pay 50 cents on the dollar for Ruritanian debt? Well, bonds in default are known as "distressed debt", so by definition anybody buying such a thing is a distressed-debt investor. Or, to use the more abusive term, a vulture. From the point of view of bondholders, however, these particular vultures look more like white knights. Many large institutional investors will never pursue legal strategies against deadbeat debtors: that's simply not their skill-set. And most of them aren't even allowed to hold defaulted debt in the first place: they're forced to sell their bonds if an issuer defaults. So what they need in such a situation is a market in such instruments which will give them some kind of non-negligible recovery value on their defaulted paper. Without such a market, there's a good chance that they would never take the risk of investing in any foreign country's debt in the first place.

I can hear Palast in the back of my head already. "Good!," he's saying. "Countries shouldn't run up burdensome debts which will ultimately have to be repaid, with interest, by poor future generations." Well, Palast is entitled to think that – if, indeed, that's what he thinks. There's certainly a case to be made that development institutions such as the World Bank should move away from loans and towards more grants to poor countries. I'm not going to get into that debate here. I'm simply going to point out that ever since the 18th Century, successful nations have been those which have been able to finance themselves through the issuance of debt securities. (See James Macdonald for much, much more on this idea.)

More generally, debt is a Good Thing. On a personal level, few of us would ever be able to buy a car or a house without some kind of debt finance – and on a sovereign level, countries which desperately need roads or ports or schools or hospitals can build them today, rather than having to save up for years before being able to build them, only because they can raise debt capital. Obviously, too much debt is a bad thing – that's what "too much" means. But every democracy in the world borrows money, and it's the worst type of paternalism to tell poor countries that they can't or shouldn't do something which all countries do and which its own citizens have voted for.

For debt finance to work, you need three things: a borrower, a lender, and a contract. The contract can be as simple as a verbal agreement that "I'll pay you back tomorrow," or it can be an inch-thick loan agreement with repayment schedules and covenants and negative pledges and waivers of sovereign immunity. But the important thing is that the borrower contracts to repay the lender. And one of the interesting things that lenders have learned over the years is that abstract sovereign entities, such as governments, are actually more reliable in this respect than sovereign individuals, such as kings or emperors. Governments can and do repay their debt for ever. (Britain started issuing perpetual bonds in 1853, and by 1935, perpetual bonds made up more than 60% of the UK's debt issuance.) Individuals, by contrast, die – and when they do, it's often impossible to collect on their unsecured debts. Today, the safest debt instruments in the world are US Treasury bonds – the sovereign debt of the US government. Indeed, the rate of return on Treasury bonds is known as the "risk-free rate".

So there's nothing obscene about the idea that governments should owe individual creditors money, and there's nothing remotely unusual about those debts being enforceable in a court of law. Pretty much every government in the world, with the possible exception of Cuba, has implicitly accepted the fact that they are responsible for the debts incurred by previous governments – and that, in turn, they can compel future governments to make certain repayments. Every so often, sovereign debts become overwhelming, and they are restructured by the mutual agreement of the debtor and its creditors. But outright repudiations of outstanding debt are very rare – and even when they do happen, as in the case of Cuba, the bonds continue to trade on the secondary market for 30 cents on the dollar or more – in the expectation that, sooner or later, a future Cuban government will finally make good on the debt.

If a government defaults on its obligations, then, the debt doesn't simply disappear. It's still there – and, sooner or later, it will have to be dealt with. Vulture funds are long-term investors who buy defaulted debt and then try to persuade the issuer to deal with it. Because they buy the debt cheap, they're often willing to settle at much less than face value – in the famous case of Elliott vs Peru, for instance, the vulture fund, Elliott Associates, made numerous attempts to settle with Peru at a discount, all of which failed. So Elliott resorted to litigation, and eventually got paid off, by Peru, in full.

Here's how Palast puts it (it's worth knowing that Paul Singer is the founder of Elliott Associates):

Newsnight went to New York to try to interview Paul Singer - the reclusive billionaire who virtually invented vulture funds.
In 1996 his company they paid $11m for some discounted Peruvian debt and then threatened to bankrupt the country unless they paid $58m. They got their $58m.
Now they’re suing Congo Brazzaville for $400m for a debt they bought for $10m.

I have some idea where the $400 million number comes from – I'm very familiar with the Congo case, having written about it at length in the September issue of Euromoney. I think that here Palast is wrong, and that he's confusing the amount that Elliott is claiming from Congo with the amount that Elliott is claiming from French bank BNP Paribas in a separate, if related, case. And as for Elliott threatening "to bankrupt" Peru – what does that even mean? The only thing that Elliott threatened was that they would try to attach payments which Peru was making to other creditors. Elliott's position was simply that Peru shouldn't be able to get away with paying some of its creditors in full and on time, while ignoring the claims of other creditors of equal or greater seniority. How that's related to bankruptcy, I have no idea.

But back to Donegal vs Zambia. In this case, Donegal and Zambia signed an agreement in April 2003, enforceable under UK law, under which Zambia would make certain debt payments to Donegal. Prior to that, in 1999, Zambia had officially recognized Donegal as a legitimate creditor. In the 2003 agreement, Donegal settled its $44 million debt for 33 cents on the dollar, to be repaid over the course of 36 monthly payments. Does that sound to you like they sued for repayment in full? Not at all: they were perfectly happy to take 33 cents on the dollar, and signed a legally binding agreement to that effect. It was only after Zambia defaulted on the 2003 agreement that Donegal took Zamiba to court, under the terms of the same legally binding agreement that had allowed Zambia to pay Donegal just 33 cents on the dollar.

It's worth bearing in mind, here, that if Zambia had simply paid Donegal the payments it agreed to make in 2003, neither Palast nor anybody else would even have noticed, let alone cared. A country making debt repayments is simply not news. But when Zambia stopped paying and Donegal sued, then, suddenly, Zambia making the debt payment is tantamount to Donegal killing children, or at the very least preventing them from being educated. In the BBC piece, Palast finds a Zambian who says that if the country makes the payment, "you are talking about in excess of 300,000 children being prevented from going to school" – as if the payment is coming out of Zambia's education budget, which it clearly isn't. (In fact, it's coming out of Mofed, a UK company owned by the Zambian ministry of finance.)

Half of the outrage against Dongeal comes from the fact that it is pursuing a legal strategy against Zambia – that it's using a UK court to force Zambia to pay up. But it's worth bearing in mind here that Zambia has broken its legally binding promises with regard to this debt not once but three times. It defaulted on the original debt it owed to Romania and which it promised to pay Romania in 1979; it broke its 1999 agreement with Donegal that it would recognize the transfer of the debt from Romania to Donegal; and it broke its 2003 agreement with Donegal setting out a repayment schedule at a highly discounted rate.

Zambia's apologists would have you believe that we should pay no attention to the country's previous promises. Zambia is poor, they say, and therefore it should be able to break its promises with impunity. But that simply doesn't work. Countries need debt finance in order to be able to grow. That original debt, for instance, was used to buy tractors – material of immediate financial benefit to the Zambian economy. Zambia either didn't have the money to buy the tractors outright, or it felt it had better use for that money, so it borrowed the money instead. But if it can't pay for its tractors in the present, all that means is that it has to pay for the tractors in the future. If Zambia wants to invest in its economy today, it will similarly have to borrow money. But no one will lend the country anything if Zambia can simply decide on a whim to stop repayment agreements made as recently as 2003.

There's a fascinating subplot running through the Donegal-Zambia case about corruption. The anti-Donegal types mutter darkly about the fact that Zambians may or may not have accepted bribes from people who may or may not have had association with Donegal, before signing the 1999 and 2003 agreeements. As a result, they say, any repayment obligations associated with those agreements are null and void. (Or, to use the legal term, ex turpi causa, known in the US as "unclean hands".) The world of distressed debt is secretive and shadowy, and in his 134-page ruling, Mr Justice Andrew Smith spends a lot of time trying to unpack who paid what to whom, and when and why. Although he finds Donegal's evidence unreliable on many occasions, ultimately he does side with them. And the main allegation of outright bribery relates to a payment of just $4,000 – which, as the judge says, "seems to me a very modest payment if the Acknowledgment [the 1999 agreement] had the value to Donegal that Zambia assert."

Palast tends to ignore the $4,000 payment and concentrate more on a much larger payment of about $2 million in debt that Donegal made to Zambia's Presidential Housing Initiative (PHI) in 1999. This payment is very much in line with the kind of thing that Donegal's principal, Michael Sheehan, used to do before he founded Donegal, when he worked at an American not-for-profit corporation called Debt-for-Development Coalition, Inc. The idea behind the non-profit was exactly the same as the idea behind more contemporary calls for debt relief: that if a country owes money to a creditor, then the creditor writing off the debt has the same kind of development effects as the creditor donating money to the country in question. Donegal's donation was debt relief, which makes it kinda ironic that Palast is so keen to portray it as a bribe.

It's worth noting that Zambia's PHI was a real development initiative, and that Donegal's donation of $2 million in debt was not a bribe to any individual. It's true that Donegal's donation was not entirely selfless. When Zambia accepted the donation, it acknowledged formally and legally that Donegal did indeed own the debt that it was donating, and that the debt was legitimate. Both of these things were true. But from a tactical legal standpoint, the acknowledgment was something of a mistake, because until that point Donegal would have found it very difficult to successfully sue Zambia for recovery of the money it was legitimately owed.

Yet even after getting that formal acknowledgement, still Donegal did not sue Zambia for anything. Instead, it looked for debt-to-equity conversion opportunities: swapping its debt for ownership of a Zambian lottery, or a local bank, or Kafue Textiles, or other parts of the Zambian privatization program. It was only when these ideas went nowhere that Donegal started negotiating with Zambia for repayment in cash. Naturally, Donegal threatened legal action should they not come to an agreement, and indeed did eventually start to sue Zambia in the British Virgin Islands. While that litigation was pending, in 2003, Zambia and Donegal signed an agreement whereby Zambia would pay Donegal back 33 cents on the dollar.

Zambia made a few payments under the 2003 agreement before defaulting again. And so yet again Donegal started negotiating with Zambia. Donegal could have declared default as early as October 2003, thereby trebling the amount of money they were owed – but they didn't, preferring intead to negotiate in good faith with Zambia for the arrears that Zambia owed under the agreement they had signed just a few months earlier. It was only when it became abundantly clear that Zambia had no interest in remaining current on the agreement that Donegal finally declared Zambia in default, ultimately giving rise to the proceedings which culminated in the court case in London.

Much of the literature on this case makes it seem as though Donegal simply bought debt from Romania for about $3.3 million, then turned around and sued Zambia for over $50 million, including legal fees. In fact, Donegal spent many years in negotiation with Zambia before it ever sued anybody for anything. It is Zambia, not Donegal, which has most egregiously violated its legal agreements, and it is Zambia which has chosen to spend its money on expensive lawyers rather than simply follow through on its own promises. Really, it's the Zambians, not Donegal, who decided on a litigation strategy. It turns out that their strategy was not successful, and that they would have been better off simply paying Donegal what they agreed to pay Donegal in 2003. That's not Donegal's fault – it's Zambia's.

Palast also tries to explicitly tie the money that Donegal is receiving as a result of these court proceedings to the debt relief that Zambia has received from rich countries under the Heavily Indebted Poor Countries (HIPC) initiative. He asks Donegal's Sheehan, in an ambush interview, "aren’t you just profiteering from the work of good people who are trying to save lives by cutting the debt of these poor nations?". But in fact Sheehan's court case against Zambia has no relation whatsoever to the HIPC initiative, and would surely have gone ahead whether or not Zambia received debt relief from the Paris Club of creditor nations or the World Bank or the IMF or anybody else. If Gordon Brown gives Zambia debt relief and Michael Sheehan doesn't, that doesn't mean that Michael Sheehan is "profiteering" from Gordon Brown's work. It just means that Zambia doesn't need to repay Gordon Brown on top of what it needs to pay Michael Sheehan.

There's one other big beef which Palast, and Leonard, and Seager, and other journalists covering the case, seem to have with Sheehan: that he's making a profit on his transaction. Well, yes, he is. But profit, in and of itself, is not a bad thing. There are plenty of other financiers who are making much more money than Sheehan, and some investors, such as Warren Buffett, are treated not as villains but as heroes for their ability to make money.

It's also worth noting that Sheehan's profit isn't nearly as large as most of the journalists are making out. The stories concentrate on the $55 million that Donegal is claiming, rather than the $20 million or so that Donegal is likely to actually receive at the end of the day. And they tend to ignore the fact that Zambia really did borrow a lot of money back in 1979 to buy tractors – money on which it agreed to pay interest. If you take the $15 million or so that Zambia borrowed, and add on any reasonable interest rate on top of that, the result will take you to far more than the $20 million that Donegal is going to receive in settlement of that debt, including its own non-negligible legal costs. The real loser in this whole case is not Zambia but Romania, which sold its $30 million debt for $3.3 million. Even there, however, Donegal is a hero: Romania was in negotiations to sell the debt back to Zambia, but because there was another bidder involved (Donegal), Romania ended up receiving roughly twice as much money as it would otherwise have been able to receive.

Donegal's opponents like to portray Zambian sovereign debt as debt of the Zambian people. Here's Peter Otto:

While the judge was bound by the law to find in favour of the vulture fund, it is disappointing that he did not give a more imaginative decision. Remembering the judge in The Merchant of Venice, it would have been more to the point to require Michael Sheehan of Donegal International to collect the money "owed" in person from each of the Zambians, in cash. I think $7 per head is about right. And to add a clear explanation to each one as to why they should not eat for the following week would make the "justice" more personal.

Does Otto really think it would be more just for Donegal to force individual Zambians to pay $7 each in cash than for Donegal to receive $20 million from a company owned by the Zambian ministry of finance? ($7 multiplied by Zambia's population of 11.5 million comes to over $80 million, so maybe $1.75 might have actually been more apropos.) Does he think that forcing individuals to starve is a good way of paying sovereign debts? Because certainly Zambia can pay this debt without forcing any Zambians to go without food.

And more to the point, does it make sense to think of a sovereign debt as being owed by the citizens of that country severally? Let's say that the US government owes China $1 trillion. Should the Chinese government try to collect more than $3,000 from each US citizen, in cash? Maybe it should just go to each person and collect $150 or so in annual interest payments? Sovereigns, and sovereigns alone, have the ability to demand payments from their citizens. (They're called taxes.) And so far, there has been no indiation whatsoever that Zambia will raise taxes as a result of this judgment. So let's be a little bit careful with the rhetoric.

And let's not take articles like this one from Ashley Seager, claiming that "President Bush could come to the aid of Zambia," too seriously either. If you've come this far in this blog, you'll be able to pick out the weaknesses in the report quite easily. For instance, Seager says that

Donegal bought the debt, with a face value of $30m, from Romania in 1999 for less than $4m. Zambia agreed to pay Donegal $15m in return for a payment to the then president's favourite charity. This payment, exposed by Mr Palast but which Mr Sheehan denies was a bribe, could mean Donegal falls foul of the US Foreign Corrupt Practices Act.

The idea that Zambia agreed to pay Donegal "in return for a payment to the then president's favourite charity" is profoundly silly. After all, the payment to the charity was in the form of the very debt which Zambia was agreeing to pay. If the debt was worthless, then the donation to charity was worthless. And the payment was hardly "exposed by Mr Palast" – it's all there in Zambia's defense papers, and I'm sure that Palast was simply given the information on a plate by William Blair, QC.

(For the record: I have spoken to nobody about this subject since the Zambia news started coming out. All of my information comes from publicly-available sources, primarily the court judgment in the UK. I have never spoken to Michael Sheehan or any of his colleagues. I have spoken to some of the principals at Elliott Associates in the past. But since my story on their Congo case, I seem to have persona non grata status there, and I doubt that they would consider me particularly friendly to vulture funds in general.)

But back to that alleged bribe. Here's some of what the judge has to say about the payment to PHI, and Zambia's claim that Donegal's offer to make a payment to PHI was tantamount to a bribe:

There is no reason to suppose that [PHI] was inherently an improper scheme or that it was set up with improper motives or that Donegal did or should have supposed at any relevant time that the PHI was other than a worthy scheme...
Mrs Chibanda was aware, before the debt was assigned by Romania to Donegal, that the purchasers of the debt had indicated that they might contribute, or that they proposed to make a contribution, to the PHI... However, there is no reason to suppose that that information was given to Mrs Chibanda covertly, ...and it is apparent from Mr Mbewe’s evidence that she did not keep that information secret. It has been suggested that the information was given to Mrs Chibanda in order to influence her to obstruct the delegation’s proposal, and so was something in the nature of a bribe or improper inducement... I am unable to accept that. The mischief of bribes, or secret commissions, is that they are secret. It might be that Mrs Chibanda thought that the prospect of support for the PHI was attractive, and it might be that... Mrs Chibanda thought that the potential benefit to Zambia of having finance for housing those on low incomes was something properly to be weighed when deciding upon the relative benefits of Zambia buying back the debt and allowing it to be bought by a third party. I am unable to conclude that it was in itself improper for Mrs Chibanda to be made aware of the possibility that Donegal might contribute to the PHI.

In other words, nothing improper happened.

As for the idea in the Guardian article that "Mr Bush has the power to block collection of debts by vulture funds, either individual ones or all of them, if he considers it to be at odds with US foreign policy," I'm not entirely clear where that comes from. Apparently Congressman John Conyers thinks that "the Foreign Corrupt Practices Act and the comity doctrine brought from our constitution allows the president to require the courts defer in individual suits against foreign nations" – and that's something I simply don't understand.

In any case I'm quite sure that Treasury, if and when they get wind of such a proposal, would swiftly squash it. There are hundreds of billions of dollars of dollar-denominated sovereign bonds traded under New York law, and all of them include a waiver of sovereign immunity. It seems to me that Conyers is asking Bush to reinstate precisely that sovereign immunity which the bond issuers have voluntarily waived – and that's something that no debt-issuing country would want. If countries reverted to having absolute sovereign immunity in New York courts, then none of them could ever borrow money in dollars again. Capital flows to emerging-market countries would dry up overnight, and there would probably be an enormous rush to dump any bonds issued under New York law – creating a monster liquidity crisis in the financial markets, and probably consigning most of Latin America, at the very least, to another brutal recession like that seen in 1998. So the chances of anything like this happening are precisely zero, even if it were constitutionally possible, which I doubt it is.

The fact is that private-sector capital flows to emerging markets are vastly larger and more important for development than public-sector flows from the likes of the World Bank. All of those private-sector capital flows are predicated, ultimately, on contract law. When trillions of dollars in flows are based on contract law, eventually some contracts are going to end up in court. And when a country gets taken to court, sometimes it will lose.

But if you add up all of the judgments awarded against all of the emerging-market countries which have ever been sued in the history of the international capital markets, the final number would be so minuscule in comparison with the magnitude of international capital flows to emerging-market sovereigns that it would barely constitute a rounding error. And yet the tiny outside chance that a country might one day be taken to court is absolutely crucial if that capital is to continue to flow. Big institutional investors don't like doing the work of suing sovereigns, so they essentially outsource that work by selling their defaulted debt to vulture funds. People might not like what the vulture funds do, but what they do is utterly necessary for everything else to function smoothly.

Oxfam has launched a campaign against Donegal entitled "Don't let the debt vultures make a killing". They should remember that vultures don't kill anything. There are lots of reasons why Zambians are living in abject poverty today, and Donegal's lawsuit is not one of them. Vulture funds create the conditions under which countries like Zambia can raise money for investments in health, education, and infrastructure. Maybe Oxfam should consider sending them a thank-you letter instead.

Posted by Felix at 23:00 EST | Comments (24)

Armory

Sorry about the lack of posts today – I spent the morning working on a long piece about vulture funds (coming soon!) and the afternoon at the Armory Show. The fact that it's all in one place now, rather than being spread over two piers, is great.

It's a good one, this year – largely thanks to the Brits, who really stand out. (Keith Tyson at Haunch of Venison, Ceal Floyer at Lisson, and, much as I hate to admit it, Damien Hirst at White Cube spring to mind.) One gallery I hadn't come across before (it's been a long time since I've really done the galleries in London) is Timothy Taylor, who has a huge collection of all-stars on his list but who devoted a lot of wall space to Ewan Gibbs, whose small drawing on graph paper of the Empire State Building is just lovely. Also from London is Alison Jacques, who was showing an utterly gorgeous Catherine Yass Lock. And, of course, there are my great friends Christabel Stewart and Darren Flook, of Hotel, showing for the first time this year, and whose Rita Ackermann was much better than the one mirroring it at Almine Rech next door. That said however, Rech has a really great neon piece by Nathaniel Rackowe which is one of the standouts of the Armory. Michelle's favorite piece, I think, was Mark Dion's piece about stuffed polar bears at Tanya Bonakdar. My favourite pieces might well have been the Tony Fehers at D'Amelio Terras and PaceWildenstein, if only because they were such a pleasant change from all the freneticism elsewhere. Oh, and a message from Michelle: Sean Kelly's getting fat. So anyway. Must get back to those vulture funds...

Posted by Felix at 20:09 EST | Comments (0)

Why expanding Sarbox doesn't make sense

I'm a little bit late to the game, here, but let me point you to the latest piece from Thomas Palley, entitled "Expand Sarbox, Not Shrink It". The idea is that US shareholders need more protection, not less, and Palley has no fewer than eight reforms which he thinks should be mandated by the US government, including

• Require that the CEO and Chairman of the Board be different persons.
• Stop share buy-backs.
• Make it obligatory for management to hold vested options for a period of three years.

Etc., etc. Talk about a recipe for decimating the public markets altogether. Hasn't Palley stopped to wonder what it is that's driving the private-equity industry? No one in the world would love these reforms more than Steve Schwartzman and his like. Corporate governance is all well and good. But just because something is desirable doesn't mean it should be mandated. If shareholders don't really care about these things (as reflected by the share price), then why should the government start getting all paternalistic and protective of them? Let them take the risks, say I.

Posted by Felix at 17:09 EST | Comments (0)

No, Bush isn't at fault for the subprime crisis

I'm still waiting for Dean Baker's blog entry on why the risk of a credit crunch means that we should start importing more white collar professionals now. But in the mean time, enjoy this, from the New York Times leader column:

More than 20 percent of global private debt securities is now tied to housing in the United States. That works out to $7.5 trillion — far larger than the market for United States Treasuries. So if America’s mortgage market heads south, the losses could be widespread.
The odds of a global financial crisis are still low, according to Mr. Zandi and Mr. Licari, but they are rising. There is not a lot now that can be done about the risks in the mortgage market. But the growing possibility of hard times ahead is another argument for rolling back many of the recent excessive tax cuts, so the government will have more resources available to respond if a crisis comes.

Of course, the Times doesn't mention that an enormous chunk of that $7.5 trillion is made up of agency bonds from Fannie & Freddie, which are simply not at risk. Why be honest when you're taking a running jump at an anti-Bush punchline? Bush has not been a great president, but I don't think you can blame lax lending standards in the subprime mortgage market on him. Hell, thanks to his fiscal policy, interest rates are probably higher than they would otherwise be.

Posted by Felix at 16:55 EST | Comments (1)

Fortune profiles Steve Schwarzman

Have you read Nelson Schwartz's profile of Steve Schwartzman? The best quote in the piece goes to Schwartzman himself: "I'm in it because I like to be excellent and to win." Schwartzman is painted as yet another humorless billionaire financier – a breed that the world is creating far too many of, these days.

Posted by Felix at 16:48 EST | Comments (0)

How does bad news affect share price?

I've been looking a bit at JetBlue, and what happened to its stock price over the past 10 days or so.

The airline was hit very badly by New York's snowstorm on Wednesday the 14th: that day, and the following days, passengers were stranded and the press surrounding the company was atrocious.

So what happened on the 14th? JetBlue's share price rose, from $12.98 to $13.23. And what happened on Thursday the 15th, the day JetBlue made the front page of the New York Post in the worst possible way? The stock opened higher still, at $13.67, and closed at $13.85, after breaking the $14 level intraday. The markets didn't care about weather delays, they cared about the fact that George Soros had amassed a 9.7% stake in the airline.

The stock stayed strong on Friday, closing at $13.56, but then it opened much lower – at $12.57 – on Tuesday, after the long weekend. Why? No news, really, but there was an analyst downgrade from Morgan Stanley. The stock recovered a bit over the course of the day, closing at $12.90, and then opened sharply higher on Wednesday, at $13.30. Why? This is a bit weird: JetBlue released guidance saying that the storm would cost it $30 million in revenues in the fourth quarter, and would lose money in the first quarter as well. But clearly that news was better than the market was betting on.

Some hint of what's was going on can be seen from a WSJ Marketbeat entry from Tuesday, entitled "JetBlue’s Blues Good for Shorts":

All told, 22.8% of the public float of 147.6 million shares is currently being sold short for the airliner. There are only 13 other issues on the Nasdaq with a larger number of shares sold short — but JetBlue has a larger percentage of its shares held short than any of them.

The WSJ's David Gaffen obviously saw that as a bearish sign rather than a bullish sign – but in fact it set the ground for a nice little short-covering rally the following day.

Here's the JetBlue share price over the past 10 days:

As you can see from the volume chart, there was almost no interest in JetBlue during the storm on Wednesday, or during the aftermath on Thursday and Friday. But volume at the beginning of this week, when there was much less in the way of news, has been enormous. And in the grand scheme of things, the JetBlue share price is still more or less in the same place as it was before all of this happened. In fact, the whole storm in a teacup is utterly irrelevant in the context of where JetBlue's stock has traded over the past six months:

Which all makes me think that news is much less important for share prices than many people think, and that if you try to trade on the basis of news, you're not likely to get very far. The only time that JetBlue's share price fell in the wake of the bad news was almost a week after the storms – and the drop only really lasted for one day. Good luck trying to trade that.

Posted by Felix at 12:29 EST | Comments (1)

Reading the EMTA volume survey

I love getting nerdy with EMTA's volume surveys, and now they've released the big annual survey for all of 2006. In case the press release has disappeared behind a firewall again, here's the gist:

Emerging Markets debt trading reached its highest annual level ever in 2006, according to a report published today by EMTA, the Emerging Markets debt industry trade association. Participants in EMTA’s Annual Survey of Emerging Markets debt trading reported volume of over US$6.5 trillion in 2006, a 19% increase compared with the US$5.5 trillion reported in 2005. Trading volumes exceeded the nearly US$6 trillion recorded in 1997, when local markets accounted for only 26% of overall EM trading activity.
EMTA also released the results of its Fourth Quarter 2006 Survey, which showed that trading stood at US$1.634 trillion in the final months of last year, compared with US$1.378 trillion in the fourth quarter of 2005 (a 19% increase) and US$1.599 trillion in the third quarter of 2006 (a 2% increase).

The FT's Joanna Chung gets the big picture:

Eurobond volumes rose by just 1 per cent year-on-year to $2,675bn in 2006 while trading volumes in local instruments jumped 42 per cent to $3,687bn.

In other words, although the headline $6.5 trillion number is impressive, the old-fashioned asset class of sovereign dollar-denominated bonds is rapidly becoming a thing of the past – and indeed its heyday was a full decade ago, in 1997.

EMTA hasn't quite caught up to the new realities yet, in that it breaks down volumes by instrument in the eurobond category, but not in the local-market category. So Mexico's MBono 20 might be traded more than many of the top 10 eurobonds, but we just don't know. (We do know, however, that Bonos in total traded an eye-popping $589 billion in 2006, so it's probably a safe assumption to make.)

Volumes on pretty much every individual eurobond except the Brazilian 2040 are pretty pathetic. And even the Brazil '40s saw their total volume traded plunge to $477 billion in 2006 from $576 billion in 2005. After that, the Russia '30s are in second place on $175 billion, and no other instrument cracks the $100 billion level. The top-traded Mexican eurobond, the 2017, traded less than $18 billion in 2006, and indeed all of Mexico's sovereign eurobonds put together traded less than $100 billion. Clearly, these things are sitting in buy-and-hold accounts, rather than being used on a daily basis to express opinions on where EM debt might be headed.

The Vene '27s are less popular too: they traded $59 billion in 2006 compared to $74 billion in 2005.

Meanwhile, local markets, especially Mexican local markets, are going from strength to strength. Mexico's numbers almost defy belief: the local markets in total traded $697 billion in 2005, and $1.25 trillion in 2006. In other words, Mexican local markets on their own account for almost 20% of all emerging-market bond trading globally.

The surge in Mexican local-market volumes, combined with the drop-off in the Brazilian 2040s, meant that Mexico has now overtaken Brazil to be the single most traded country in EM, with $1.53 trillion in total compared to Brazil's $1.42 trillion. In 2005, by contrast, Mexico had just $905 billion in total volume, compared to Brazil's $1.55 trillion. Obviously, Brazil has some catching up to do when it comes to local instruments, which grew to $518 billion in 2006 but which are now less than half the volume seen in Mexico. You'd think that the high yields in Brazil would attract traders, but the problem is really regulatory. It's time that the Brazilian regulators made Brazilian local debt easily tradeable anywhere in the world.

Posted by Felix at 11:30 EST | Comments (0)

Who to believe when it comes to systemic risks?

I've finally put Andrew Leonard in my RSS reader, despite the Salon firewall, because he really is worth reading. Still, he does have a habit of being a bit on-the-one-hand-on-the-other-hand when it comes to systemic risks and subprime lending and all that jazz. Last week he quoted people on both sides, but I'm going to go with this guy:

Kerr quotes Scott Simon, head of mortgage and asset-backed securities investments at Pimco, as saying, "We don't believe there is any systemic risk at all."

Why do I implicitly trust Simon on this one? Firstly, he actually has skin in the game, while the gloomsayers don't. And secondly, he's putting his neck on the line. If you say there's systemic risk and nothing happens, that doesn't mean you were wrong. But if you say there is no systemic risk and something does happen, then you look like a wally.

Now, I know the arguments on the other side. Buy-siders ignore lower-tail risks because they can't be blamed if something crazy and lower-tail happens. What's more, people who take such risks seriously tend to be too cautious, relative to those who don't, and underperform, and leave the industry. But the fact is that Scott Simon is a bond investor. And I've never met a bond investor who didn't spend his entire working day worrying about risks small and large. And if he's comfortable with the risks out there, I'm not going to lose any sleep.

Posted by Felix at 19:55 EST | Comments (0)

Even the World Bank doesn't like Summit Communications

Christine Bowers:

Let's cut to the chase. What are the absolute worst things countries can do as they build their image?

• Blow your budget on a fancy, one-time insert in a big newspaper for $250,000.

On which subject, the comments are still coming on my post about Summit Communications and AFA Press. But let's be clear, here: the budget isn't blown because the insert is fancy.

Posted by Felix at 19:35 EST | Comments (0)

Mutual funds: Is there correlation between past performance and future performance?

Free Exchange and Blodget agree: past performance is no guide to future results, when it comes to mutual-fund returns. Is this true? I posed the question back in 2004, when I wrote this:

When a rather obnoxious man at Citibank tried to sell me some mutual funds once, based on their outperformance, I actually spent quite a bit of time researching this issue. Companies like Morningstar generally group funds into quintiles: the top 20%, the next 20%, and so on. And there is in fact a certain amount of correlation between past performance and future performance. Not a lot, but a little. Funds in the bottom quintile will tend to underperform in the future, funds in the fourth quintile will underperform but not quite as badly, and funds in the top three quintiles are all roughly equally likely to outperform in the future.

This generated a little bit in the way of comments. Said Simian:

Actually the academic evidence points primarily to a random walk when it comes to mutual fund performance. Morningstar ratings - which are currently based on risk-adjusted, peer-relative trailing returns for various horizons (1 year, 3 year, 5 year, etc) - have generally been shown to be non-persistent (Blake & Morley). So prior good performance does not suggest that future performance will be particularly good or bad; it's merely noninformative. The studies which did find some, albeit not very strong, persistence (Warshawsky) suggested that economies of scale played a role. In other words, if a fund did well, assets poured into it, and a large fund is better able to control and allocate costs, to a degree which overcomes the increased market impact of its trades.

Which is actually the opposite of what Blodget is saying, which is that larger funds are less likely to outperform.

The big message, of course, is clear: don't buy mutual funds. And that's good advice even if it is followed by "every economist I have ever met," to quote the Economist's blogger. At the margin, however, is there some kind of correlation between past performance and future performance? I think Simian might have been referring to this paper, by Elton, Gruber, and Blake, but it says that "We find that past performance is predictive of future risk-adjusted performance".

Posted by Felix at 18:34 EST | Comments (0)

Hedge funds: Getting riskier?

So there's this Great Moderation, right? And the hedge funds are part of it. Look at all of them with their high alpha underperforming the S&P 500: in other words, by bringing down beta to incredibly low levels. Which is all well and good, but it's hardly exciting. We want activist investors like Patrick Degorce: high risk, high return! Or even, for that matter, Brian Hunter. A bit of excitement – you can lose your money or you can double it, treble it! And so: "Best Ideas" funds. Which are getting a bit of a bad rap. But the returns have to come from somewhere, right? One alternative: just lever up before you invest in that high-alpha, low-beta fund. But then you run the risk of losing more than all your money.

Posted by Felix at 14:42 EST | Comments (2)

Shareholder of the day: Patrick Degorce

The Children's Investment Fund sounds so cuddly, doesn't it? And in fact it does give a large chunk of its profits to charity. But it gets those profits by buying up stakes in undervalued companies and forcing management to shake them up – and the latest target is ABN Amro.

TCI was founded by Christopher Hohn, but the formal letter to ABN Amro, which is reprinted at Alphaville, was written by TCI partner Patrick Degorce. He's not pulling punches:

Since the current chairman of the Managing Board was appointed in May 2000 ABN AMRO has given shareholders a cumulative share price return of 0% (excluding dividends) compared to (a) the ABN AMRO selected peer group of approximately 44% and (b) the Dow Jones Euro Stoxx Banks Index of 44% (all numbers are for the period 1 June 2000 to 31 January 2007).This terrible shareholder return is a function of the fact that ABN AMRO’s underlying earnings per share has been broadly flat for around 6 years, during a time when nearly all banks globally have enjoyed a period of strong earnings growth.The Managing Board has presented several restructuring strategies over the last 6years which were supposed to accelerate earnings growth which would be reflected in a higher share price. In 2006 they again committed to cut costs and they have so far failed to deliver.

Degorce reckons that breaking up ABN Amro could "justify a price significantly in excess of EUR30 per share" – which isn't all that much higher than the €27.25 the bank is trading at in the wake of Degorce's letter becoming public. But the real impetus behind the letter, I think, is not to split up the banks in ABN Amro's "home markets" of Italy, Holland, Brazil and the US Midwest. Rather, it's to force ABN Amro to get its own house in order before embarking on a foolish and expensive acquisition of Capitalia.

On the other hand, other parts of ABN Amro, such as the capital markets and asset management businesses, might well get sold off, along with its Asian holdings. Either way, Degorce has managed, with one letter, to increase the value of ABN Amro by over $3 billion in one day, which is pretty impressive.

Posted by Felix at 13:34 EST | Comments (1)

Leonhardt gets Stern's discount rate wrong

Aaaaarrrrgh! Why is it that when the debate over discount rates and climate change finally makes it into David Leonhardt's NYT column, he gets it completely wrong?

The Stern Review assumed that a dollar of economic damage prevented a century from now (adjusted for inflation) is roughly as valuable as a dollar spent reducing emissions today.

This is not true. This is wrong.

John Quiggin has an invaluable backgrounder on all this, but basically Stern's choice of discount rate (eta = 1) means that he adjusts for income, not for inflation. Global income presently is about $7,000 per person, and global income in 2100 will be about $100,000 per person, according to Stern's projections. Using his discount rate and other assumptions, a dollar of economic damage prevented a century from now is roughly as valuable as 7 cents spent reducing emissions today. (In fact, it's less than that, because Stern adds another discount rate, called delta, on top of eta.)

Leonhardt says that "spending a dollar on carbon reduction today to avoid a dollar’s worth of economic damage in 2107 doesn’t make sense" – but this is a straw man, since Stern never comes close to saying that we should do such a thing. Leonhardt also spends a lot of time on the academic qualifications of Stern's opponents, but neglects to mention that Stern himself, a former chief economist of the World Bank, is actually a real expert on discount rates, and understands them much better than most economists do.

Leonhardt says that Stern is "right for the wrong reasons", and says that "technically, Sir Nicholas’s opponents win the debate." The problem is that this is a very high-level and complex debate, which is not at all easy to follow. Leonhardt, with his talk of inflation, has shown that he is not up to following it. This is no great failing, since I'm not up to following it either, and most economists I know also can't follow it. But if you can't follow the argument, you certainly shouldn't be declaring winners.

Posted by Felix at 20:58 EST | Comments (4)

Gordon Brown: A true great?

David Smith (no Labourite he) on Gordon Brown:

It is hard to find too much to criticise in the macroeconomic record of the past 10 years. Any chancellor who leaves office having presided over growth in every single quarter can be proud (Kenneth Clarke did so too, but over four years, not 10). But unless the economy takes a dive in the next few weeks, that will be Brown’s achievement. Continuous growth has been accompanied by low levels of both inflation and unemployment.

Ten years at Number 11, with positive growth in every quarter? Brown has a lot to be proud of – and that's before you even start thinking about his leadership of the international financial community. His chairmanship of the IMFC (essentially the IMF's board's board) has been excellent, his constant pushing on development issues has been salutary, and his willingness to spend political capital on innovative ideas such as the IFF has been very impressive. I'm sure that he's more than ready to move next door. But he surely will go down in history as one of the great finance ministers of the modern era.

On the other hand? Ridiculous levels of debt in the UK economy, which might well prove to be unsustainable. A failure to make government spending more effective. Fiscal indiscipline after the first few years. But in the grand scheme of things, the positive surely outweighs the negative.

Posted by Felix at 18:38 EST | Comments (0)

Has London reached the limits of congestion charging?

On Monday, London's congestion zone doubled in size. The idea seems to be that if congestion charging is good (and so far the congestion charge has been a success), then more congestion charging is better. But John Kay explains cogently why that ain't necessarily so.

The western area of Belgravia and Kensington, Bayswater and Notting Hill is mainly residential. More people live than work there and most of the vehicles on its roads are private cars rather than vans and lorries. While most journeys in the east central zone begin outside it, most journeys in the western area begin within it. Most, perhaps all, of the revenues from the western extension will be absorbed in operating costs, since so many travellers pay the discounted residents’ charge. If they drive into the eastern part of the zone, they will begin to recreate the congestion in the commercial areas the earlier plan addressed.

In other words, there are a couple of hundred thousand residents of the new congestion zone who used to be incented not to drive into the old congestion zone, and who now can do so with impunity. Is this really a great idea? I guess we'll find out.

Interesting datapoint, from the Guardian:

The congestion scheme made revenues of £245m and a profit of £122m last year, most of which was invested in buses. This makes a slight dent in the £1.6bn per year running costs for TfL's bus network, which earned £961m from fares last year, leaving the taxpayer to cover a funding gap of just under £600m.
The new extension to the zone is expected to generate profits of up to £40m, but even then it would represent just a fraction of the cost of the bus network and 3% of TfL's total costs.

Posted by Felix at 17:52 EST | Comments (3)

Do huge university endowments attract donations?

The NYT's Geraldine Fabrikant had a long, loving profile of Yale's David Swensen on Saturday which says pretty much all the things you'd expect such a profile to say, including how noble he is to toil away for a mere $1.3 million per year. I think he's just maximizing his own happiness:

In 1985, Yale recruited Mr. Swensen to manage its endowment. “I took an 80 percent pay cut,” he recalls. “I was married, without kids. I was worried that I would miss the money, but then I didn’t. So I worried over nothing.”

Here's the bit which jumped out at me:

Mr. Swensen’s track record and his growing cachet have helped Yale attract donors who believe that their gifts to the university will be well deployed...
Two years ago, Yale’s president, Richard C. Levin, brandished a chart at a party celebrating Mr. Swensen’s 20th anniversary at Yale; during those two decades, the university’s endowment had grown to $14 billion from $1.3 billion. The chart showed a list of those who had made the most significant financial contributions to Yale, and included names like Harkness, Beinecke and Mellon. The name at the top of the list, however, was Swensen, with a $7.8 billion contribution — Yale’s calculation of the amount by which Mr. Swensen had outperformed average university endowments during his tenure.

I'm fascinated by the idea that Yale's gargantuan endowment ($20 billion and growing) can actually attract donors. If I were approached by Yale for a donation, I'd probably wonder how my few hundred or few thousand dollars could possibly make a difference considering that the endowment is growing by billions of dollars a year anyway. On the other hand, I can see the attraction in giving money which will grow, rather than simply disappear once it is spent.

(Via Knobel)

Posted by Felix at 11:09 EST | Comments (2)

Sirius-XM: When monopolies are good for consumers

It was inevitable sooner or later, and now Mel Karmazin, of Sirius, has finally decided to buy agreed to merge with his great rival, XM. The decision seems to have been made on the basis that it'll be easier to persuade the FCC to agree to the merger now than it would be under a future Democratic administration – why should that be the case? And if the problem is that the two companies are the only companies licensed to offer satellite radio in the US, why can't they just agree to the FCC issuing another license?

The deal reminds me of the Sky-BSB merger in the UK in 1990. (I'm showing my age here.) And like that merger, it makes sense both financially and at a common-sense level. Competition between the two companies does not keep the price of a subscription down – rather, both charge $12.95 per month, which is pretty much the maximum that Americans will pay for radio. A merged company would (presumably) have much more programming for the same price, which is a good thing for consumers.

Weirdly, it's the protectionist broadcasters, who are lobbying against the merger, who are playing the part of the big evil corporations here – and not the would-be monopolists. As the WSJ notes:

Two years ago, the National Association of Broadcasters lobbied hard against XM's effort to acquire WCS Wireless LLC for $195 million. The deal would have given XM additional radio frequencies and allowed it to expand its service.
Broadcasters, however, complained that XM would use the acquisition to provide local programming, which isn't allowed under its current license. Ultimately, the deal fell through after languishing without action at the FCC for nearly a year.

The NYT has the color on how the deal was done:

Anxious about Mr. Karmazin and Mr. Parsons being spotted together, the two sides decided to meet in an inconspicuous spot: the Upper East Side apartment of one of Mr. Parsons’s bankers, Dennis S. Hersch, a former lawyer who joined JPMorgan Chase two years ago.
Mr. Karmazin met with Mr. Parsons for several hours in Mr. Hersch’s living room one morning in late December, these people said. They sat on sofas flanked by their advisers, James B. Lee and Mr. Hersch of JPMorgan Chase, which represented XM, and Paul Taubman of Morgan Stanley, which worked for Sirius. The men decided to pursue a deal.

How did I know Jimmy Lee would be involved somehow?

Posted by Felix at 9:58 EST | Comments (3)

Ecuador pays, Zambia loses

I'm back! Didja miss me? I missed you. I was in England, mainly (when I wasn't stuck on the tarmac at JFK), where even cafés encrypt their wifi. Most annoying. But even if internet access was hard, I did get to pick up the Guardian – where the Zambia vulture fund story made the front page! If you want a great overview of the case and the issues, however, you should read Alan Beattie in the FT, who had the great good sense to talk to my friends Anna Gelpern and Brad Setser, both of whom really know their onions on this sort of thing. And while we're in the sovereign-debt part of the markets, I haven't even been able to mention here that Ecuador paid its bond coupon in full and on time! (Great headline in the IHT: "Ecuador's on-time bond payment confuses economists", over an AP story which quotes the perspicacious Ramiro Crespo describing Ecuador's debt policy as "erratic, arbitrary, capricious and manipulative".) I think Crespo might be right in seeing Venezuela's fingerprints all over the decision. Venezuela's public-finance technocrats are rather sophisticated, and know how much a debt default would amount to shooting oneself in the foot.

Posted by Felix at 9:26 EST | Comments (0)

Radio silence

Blogs are ridiculously addictive things. But I have a big story I have to write, like, now. And it seems the only way I can get it done is by closing my RSS reader and promising myself no blogging until it's written. Plus, I have to get on a plane to London later today. I'll be taking my laptop, but the wifi situation where I'm staying is decidedly suboptimal. (i.e., there isn't any). So we'll see what happens between now and then, but in any case normal service should resume on Tuesday.

BTW, I finally went to see Jenufa yesterday – the performance I wrote about back in April. I don't think I've ever gone to an opera with such high expectations, only to have them exceeded by so much. Without a doubt, my #1 operagoing experience of the past 10 years. Utterly heartbreaking – and not (just) because of the huge number of empty seats. The snow was surely partly to blame, but the opera wasn't even sold out, despite the fact that there were only five performances in total. Those who did make it, though, will not soon forget it. There are still tickets left for the final performance – Saturday's matinee. Go.

Posted by Felix at 8:59 EST | Comments (1)

Banking and credit for illegal immigrants

Historically, illegal immigrants in the US have always had access to some kind of credit, even if it was only loan sharks or payday lenders. The big problem has been access to banking: getting a simple checking or savings account where you can keep your money is non-trivial for legal immigrants, let alone illegal ones.

Bank of America, now, is doing something quite sensible: it's offering credit cards to immigrants who have managed to get themselves a checking account. In contrast to loan sharks and payday lenders, these credit cards help build up your credit history, which will make it easier to get more substantial credit, like car loans or mortgages, down the road. And although the interest rate is high, it's nothing by loan-shark standards.

Ooh, but Dan Gross doesn't seem to like it:

Miriam Jordan and Valerie Bauerlein report in the Wall Street Journal that Bank of America is pitching a credit card to illegal immigrants. And the company apparently put executives on the record to discuss it.

The weird thing that both the WSJ story and Dan Gross seem to miss is that this credit card is only available to people who have held a Bank of America checking account for three months. How many illegal immigrants do you know with a Bank of America checking account? Says the WSJ:

Most banks require a Social Security number or ITIN to open an account, but regulations also allow them to accept other government-issued forms of identification in some instances, including passport numbers, alien identification numbers or any government-issued document with photo showing nationality or place of residence.

"In some instances" is right. The average illegal immigrant can