March 2007 Archives

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Incomprehensible charts in the NYT

I very much admire the anonymous chart-makers at the New York Times. They generally do a magnificent job of presenting information in a clean, easy to understand, and often very clever manner. I wouldn't be surprised to learn that they'd hired Edward Tufte as a consultant. But boy did they screw up today.

The story that the chart is attached to is perfectly fine. It's by Damon Darlin, and it's essentially keyed off the Chris Cagan report which I blogged about a couple of weeks ago. But the chart is dreadful, and the first indication that it's dreadful is that none of the numbers in the chart are referred to in the story. So even if you read the whole thing, which is 1,500 words long, you're still none the wiser as to what the chart is supposed to mean.

Anyway, here's the chart: see if it makes any sense to you. I puzzled over it a long time before giving up – or, rather, before taking another look at Cagan's report to see if I could work out there what the chart meant.

I applaud the NYT's willingness to print charts which don't have time along the x-axis. Such charts are often very interesting, but a lot of newspapers think their readers won't understand them, and ban them entirely. That's a bad policy. There are lots of clear charts which don't have time on the x-axis. But if you don't have time on the x-axis, you need to take extra care that your chart is clear. And no one did that here.

Anyway, what are these two charts about? The headline should give us a clue: "Teasers Become Burdens", it says, and the text below it talks about mortgages which were originated between 2004 and 2006 and which are being "reset at higher rates". So presumably the charts show how people with adjustable-rate mortgages are going to see a spike in rates? Er, no. In fact, the charts don't even cover mortgages taken out between 2004 and 2006, as is implied by the text. They only cover mortgages taken out in 2005. How do we know this? Because at the top of each chart it talks about "mortgages originated in 2005 resetting through 2010". Except even that is not really accurate. In fact, the charts only show two things: mortgages originated in 2005 and resetting in 2005 (the yellow line) and mortgages originated in 2005 and resetting in 2007 (the red line). Mortgages resetting in 2006 or 2008 or 2010 aren't shown at all.

So what's going on in the first chart? Remember, it only covers loans taken out in 2005. The yellow line shows that over 400,000 such loans had a teaser rate of less than 2%. That's scary, right? Just think of what those borrowers will be paying when their loans reset! Oh, hang on, the yellow line is loans which reset in 2005 – two years ago. All those borrowers have already been paying the higher, adjustable rate for well over a year at this point. If you look at the red line, which is the loans resetting this year, it turns out that most of them already carry an interest rate of between 6% and 9%. Which means that when the loans reset to a market interest rate, the increase in mortgage repayments will be much smaller.

In no way does the chart show that "millions of borrowers took out adjustable-rate mortgages with low teaser rates that are being reset at higher levels" – if by "are being reset" you mean "are being reset this year" rather than "were already reset in 2005". In fact, the chart shows that most of the mortgages which are being reset this year had pretty normal initial interest rates in the 6% to 9% range.

A much more relevant chart would show the number of loans originated with teaser rates which are resetting in 2007 – without worrying about when those loans were taken out. But that's not the chart we're given.

And what about the second chart? That one actually makes even less sense than the first. It seems that loans with very high initial interest rates make up a very high percentage of loans resetting in 2007, and a very low percentage of loans resetting in 2005. Or something – it's incredibly unclear, and in fact I would say it's impossible to work out what the chart is really showing, unless you can see the chart from which it has been taken. (Which I'm helpfully providing below.)

The chart shows that if you take all the 2005-vintage loans with teaser rates below 2%, more than 80% reset that same year, in 2005, while none of them are resetting in 2007. In fact, if you take all the 2005-vintage loans with teaser rates below 5%, the vast majority of them have already reset, and very few are resetting this year. Meanwhile, if you're someone who took out an adjustable-rate mortgage in 2005 which carried an initial interest rate of more than 10% (!) then there's a very good chance it will reset this year. What use is this information? None, as far as I can tell. And it certainly isn't particularly germane to the subject-matter of the story.

What I fear is that people will look at that graph and panic, thinking that it means that lots of loans are resetting to interest rates in the double digits. But that's not what it means at all. In fact, if you look at it correctly, it's reasonably reassuring: it shows that people who are seeing their 2005-vintage mortgages reset this year generally do not have low teaser rates. But there's really no way to work that out just by looking at it.

In any case, here are the tables from which the charts are drawn. I honestly have no idea whatsoever why the New York Times chose these tables rather than any number of more germane other ones from Cagan's report. For instance, table 10 could have generated a chart of all the loans originated between 2004 and 2006 which are resetting in 2007, along with their initial interest rates. That would have been interesting and useful. These ones are neither.

Posted by Felix at 11:36 EST | Comments (1)

What would Goldilocks make of Q4 GDP?

Economists are pretty bad at predicting the future (how fast will the economy grow next quarter?). They're also pretty bad at predicting the present (how fast is the economy growing this quarter?). And, it turns out, they're equally bad at predicting the past (how fast did the economy grow last quarter?)

In January, economists reckoned that fourth-quarter GDP growth would be 3.0%, but in fact the advance figure came in at 3.5%. In February, that number was revised down to 2.2% – it seems that even in January we really didn't know what had happened between October and December. And then today, the final number came out. The markets were expecting 2.2% again, but in fact the number is 2.5%. Notes Barry Ritholtz:

Markets rallied on the news that 4 - 6 months ago, GDP was bad, but not quite as bad as previously believed. (So much for the market as a forward looking discounter).

Want to get even more confused? Read Kash Mansori explaining that the upward revision is actually a bad thing: a lot of the upward revision can be attributed to the fact that inventories rose at an annual rate of more than $22 billion. So companies were making things, which boosted GDP; they just weren't selling them.

Still, all these revisions do put me in mind of Goldilocks. The first report was too high, the second report was too low... could it be that 2.5% is just right?

Posted by Felix at 11:50 EST | Comments (3)

Stock or Not

Some kind of genius: Stock or Not? Josh Reich has written a lovely little web app which puts two charts side by side. One is a real stock, the other is randomly generated. Can you tell which is which? I couldn't:

Mathematically, one would expect half the people taking this test to get scores over 50%, and half to get scores under 50%. I wonder what it would mean if a significant majority of people, like me, got scores well under 50%? (In fact, I got only one of the first five right: at that point I was down at 20%.)

NB: The app never ends: You can keep on clicking for as long as you like, and it will give you a cumulative total. The more you click, the more accurately the percentage reflects your stock-chart-picking prowess.

Posted by Felix at 11:31 EST | Comments (1)

Alex Ross live!

If you're under the age of 35, reading this blog, and free on Sunday, I'm pretty sure that the last thing you want to do is schlep up to 92nd Street at the tender hour of 11 in the morning. But you should: the brunch with Alex Ross looks like it's going to be very good, and they have a special $10 for we young 'uns (yes, I'm under 35 for a few weeks yet). The 92y blog has a Q&A with Ross, who's also blogging himself on what the brunch will bring:

I will look at the poetic roots of two works that forever altered the musical landscape: Debussy’s Prelude to "The Afternoon of a Faun" and Schoenberg’s Second Quartet. In Debussy’s case inspiration came from Mallarmé’s gloriously enigmatic long poem “The Afternoon of a Faun" — “the motionless and weary swoon / Of stifling heat" — and in Schoenberg's case it was Stefan George's "Rapture": "I feel the wind of another planet.... I dissolve in sounds, circling, weaving...." I’ll discuss how conventional harmony crumbled underfoot as the composers chased these elusive images.

Ross's book, for which this event is a very early plug, looks like it's going to be really good; it grew, I believe, out of this piece of his, which is well worth reading. In any case, I'm the kind of person who judges books by their covers, and this one reminds me of one of my favorite books of all time. I suspect it will have the same great quality of being a reference one can dip in and out of, too.

(Full disclosure: I, too, was a bit hesitant about getting up to 92nd Street on a Sunday morning, but then I found out that Alex Ross had included me alongside such luminaries as Terry Teachout and Lizzie Skurnick as a Blogger Worth Inviting – so at that point I felt compelled to go.)

Posted by Felix at 12:08 EST | Comments (0)

Economics 101

I think we should implement a new corollary to Godwin's Law – call it McArdle's Law, after this blog entry at Free Exchange – saying that any time someone mentions "Economics 101" in a debate, they've automatically lost. The point of the Free Exchange blog is that people who criticize arguments as being "Economics 101" are generally on the wrong side of the argument. But then again, people who praise arguments as being "Economics 101" are generally equally wrongheaded. For instance:

With rising distressed sales of foreclosed homes and of homeowners unwilling or unable to service their mortgages, the future supply of existing homes will go up this year and next and, given downward price adjustment, the equilibrium level of existing home sales will increase over this year and next. Thus, observation of increases in the sales of existing homes over time - as long as existing home prices fall - will be signs of further distress in the housing market, not improvement. Basic economics 101 suggests that.

Yes, if you've taken Economics 101, then a rise in existing home sales is a sign of distress in the housing market. (Does this mean that a fall in existing home sales would be an indication that everything was tickety-boo?) I can see the argument: demand can rise as prices fall, so rising sales can be consistent with housing-market distress. But it's a bit of a leap from that to saying that they're a sign of housing-market distress. And it's a jump of Knievel proportions to say that such an inference is "Economics 101" – and I'm quite happy saying this despite the fact that I've never taken an Economics 101 course.

It seems to me that the housing market is not all that different from the stock market in some respects. If you want a good gauge of how the stock market is doing, you look at prices and volumes in the secondary market, not the IPO market. Similarly, existing home sales are a good indication of how the housing market is doing: it's worth remembering that every homeowner in the country lives in an existing home, which means that it's the market in existing homes that they're really invested in. And if existing home sales rise, surely that's a good thing, ceteris paribus, for the housing market as a whole: it shows that housing prices, even if they're depressed, are at least realistic and set at a market-clearing level.

Posted by Felix at 13:57 EST | Comments (2)

Felix Salmon to blog for Portfolio

It's in WWD, so I guess that makes it public: I've signed on as the finance blogger for portfolio.com, which goes live in mid-April. It's a big commitment for me – it really is a full-time job, although I don't need to go into the office, or anything like that – so from here on in blogging at felixsalmon.com is necessarily going to be more infrequent. More news on permalinks, RSS feeds, etc when it all happens.

UPDATE: Just to be 100% clear about this, I'm blogging for Portfolio, the new Condé Nast business magazine. I am not blogging for Women's Wear Daily. Sorry for any confusion.

UPDATE 2: Some people seem to fear that I will be hidden behind some kind of subscriber firewall. Fear not! Portfolio.com will be utterly free to all. And I have asked to have a full, untruncated RSS feed, too.

Posted by Felix at 7:03 EST | Comments (7)

Counterfeiting statistics, New Yorker edition

As any regular reader of this website knows, all counterfeiting statistics are bullshit. Larissa MacFarquhar's profile of Harley Lewin in the March 19 issue isn't online, but it's a prime example of the problem. I'm sure that what happened is that MacFarquhar got some numbers from trade organizations, and passed those numbers on to the fact checkers, who checked nothing beyond the fact that the trade organizations said what MacFarquhar said they were saying. Only the problem is that MacFarquhar doesn't attribute her statistics to trade organizations, she simply presents them as plain fact: 2% of all airplane parts installed each year are counterfeit, she says, and 10% of all pharmaceuticals are counterfeit. And, my favorite example of numbers pulled out of thin air suddenly transmogrifying into New Yorker-endorsed fact:

The world market in counterfeit goods in the mid-eighties was only a hundredth of the size that it is now.

Yeah, right. I'll happily give $1,000 to anybody who can plausibly demonstrate that.

Occasionally MacFarquhar will actually cite a named source, but even then she does so in an utterly credulous way:

"I don't think it's an exaggeration to say that counterfeiting is an enormous threat to the future economic health of the US," Rick Cotton, chairman of the United States Chamber of Commerce-led Coalition Against Counterfeiting and Piracy, says. "Industries driven by intellectual property account for nearly half of our economic growth and drive sixty per cent of the growth of our exports. If the counterfeiting trend continues, it is going to ravage our economy and undermine our future."

Which assumes, of course, that Rick Cotton knows what the "counterfeiting trend" is. He doesn't. No one does. But in any case, if these industries are really accounting for half of our economic growth, that's kinda prima facie evidence that they're not being "ravaged" by counterfeiting, no? Of course, MacFarquhar never presents any kind of skepticism. If I were being cynical, I'd say that was because she was writing in the Style Issue of the New Yorker, and that such sentiments might risk annoying advertisers. But actually I think that journalists in general simply don't bother to question these statistics – this is laziness, not conspiracy.

Posted by Felix at 14:33 EST | Comments (2)

Sell-side analysis wants to be free!

Merrill Lynch is worried that too many people are reading its research.

Yes, too many. Reports DealBook:

Merrill Lynch said it plans to eliminate all access to its research from nonclients and to put new restrictions on the media’s access to the research. It will also replace some licensing agreements that “erode the value of our written product” with new arrangements that put a fairer price on its reports.

[Update: The statement is here.]

In other words, Merrill is trying to put the toothpaste back in the tube. Rather than embracing the digital era, Merrill is trying with all its might to pretend that nothing has changed, and that it can distribute digital copies of its research to tens of thousands of clients while still somehow ensuring that no one else gets to read it.

How silly.

As for the "fairer price", does anybody, anywhere, actually pay for Merrill Lynch research? As in a simple cash-for-research transaction? I doubt it, somehow. This is a classic example of something being free to those who can afford it, and utterly inaccessible – at any price – to those who can't.

What Merrill should be doing is to follow the example of, say, Morgan Stanley's Global Economic Forum, which has been freely available online for over a decade now. The problem is that sell-side shops like Merrill like to think of their stock research as being actionable: if Merrill puts a "buy" rating on the stock, then the idea is that a large number of Merrill's clients, impressed with Merrill's analytical expertise, will rush out and buy the stock. If that's true, then they would rightly want the research to go to as few people as possible, so that the inevitable uptick in the wake of the rerating wouldn't move the stock too far. Or something.

The problem, of course, is that sell-side analysts aren't used as outsourced stock-pickers by buy-side clients. They're used as sources of information – analysts often have better access to corporate executives than the buy-side has – and as sources of interesting ideas. But the headline "buy" and "sell" ratings are largely ignored. Besides, the few sell-side analysts who do prove particularly adept at picking stocks usually find themselves lured to the buy-side sooner rather than later in any event.

I look forward to the day when the first large investment bank is bold enough to put all its research online for free. That would be the really smart move. Merrill, on the other hand, is simply wrong when it says that the value of its research goes down the more people who read it. That's not true of the Wall Street Journal, and it's not true of sell-side research either. Good information is often actually more valuable if it's widely read.

Posted by Felix at 14:30 EST | Comments (3)

Banks' real-estate exposure: Nothing to worry about

Whenever there's a banking crisis, there seems to be a very good chance that preceding it came some kind of property bubble. Banks have a habit of assuming that secured loans are secure loans, and loaning out enormous chunks of their balance sheets to property owners – if the property market crashes, banks can be left in a world of pain.

The problem is that banks never want to turn down large quantities of profitable business, and during a housing boom, mortgages are both profitable and very numerous. If they're not careful, banks end up with an uncomfortably large proportion of their assets in real-estate loans.

Kash Mansori put a very good post up yesterday entitled "Can Banks Weather the Real Estate Storm?". He's relatively sanguine about their financial strength: here's his conclusion.

Banks are reasonably healthy, though perhaps not as healthy as you might think; it will take a really big wave of mortgage defaults to hurt them significantly, though, unfortunately, not one that is beyond the realm of possibility given the current state of the housing market and household finances; and if the economy slows down more generally at the same time that the mortgage default rates climb significantly, it seems very possible that banks could be in for a rather rocky period.

I look at the same data as Kash and am actually even more constructive. For one thing, Kash includes about $1 trillion of mortgage-backed securities among banks' real-estate assets. That's fair enough, but he doesn't make allowances for the fact that most of those bonds are issued by Fannie and Freddie, and therefore very, very safe; a lot of the rest are likely to be AAA-rated too. So the risky part of banks' real-estate exposure is certainly smaller than Kash lets on.

Kash also uses a chart of bank equity divided by banks' total real-estate exposure – a ratio currently standing at about 23% – to conclude that "the huge amounts of capital that banks have at their disposal right now are not that huge compared to their real estate exposure". I don't know how he comes to that conclusion, however: the 23% figure seems pretty large to me. I have a feeling he's looking not at the number, however, but at its first derivative: back in the late 90s, the number was almost 26%. But if the number's high, it doesn't really matter if it's falling, and the propensity of banks to lend to businesses rather than into real-estate in the late-90s shouldn't be held up as some kind of really great idea. After all, the very next chart from Kash shows banks' loan write-offs soaring a couple of years later when all those non-real-estate loans went bad – and remember that recovery values on unsecured loans are always much lower than recovery values on secured loans.

Kash reckons that real-estate-related write-offs in a housing downturn could reach $50 billion per quarter, or $200 billion per year. Let's look at Kash's own numbers: total residential real-estate exposure is $1.89 trillion. Let's call it a round $2 trillion if you include risky MBSs. Let's say that overall delinquency rates reach 10%, and that 30% of delinquent loans go into foreclosure. Let's further say that the bank takes a loss of 10% on non-foreclosed delinquent loans, and a loss of 50% on foreclosed delinquent loans. (I'm taking all these numbers from the top of my head, so do feel free to offer something more realistic.) Then you have $200 billion of delinquent loans, which suffer a total of $30 billion of losses on the foreclosed loans, and another $14 billion in losses on the non-foreclosed loans, for a total of $44 billion. How Kash gets to $200 billion, I have no idea.

In other words, the banks are fine. And we don't need to worry about a credit crunch.

Posted by Felix at 11:59 EST | Comments (4)

Classical music sales: booming or collapsing?

Journalism, like any other field, is shy when it comes to admitting ignorance. If a journalist wants to write about a subject, he'll search and search for a self-proclaimed expert until he finds someone who will opine with enough certainty to be able to form the basis of a story. But the truth, both ontologically and epistemically, is messier than that. And so three cheers for Alex Ross, who has done a serious investigation of the market in classical music, and concluded that "Nobody has the slightest idea what's going on."

Ross fingers Brendan Koerner and Bob Tedeschi as journalists all too willing to jump to the conclusion that classical music sales are plunging, even though there's quite a lot of reason to believe that they're not. Certainly things like Amazon's Classical Blowout store are almost irresistible for the classical-music lover: you can find popular fare like Itzhak Perlman playing Vivaldi for $4.99; you can find classic recordings such as Leonard Bernstein conducting the New York Philharmonic in Aaron Copland for $6.97; you can even get Carlos Kleiber conducting the Vienna Philharmonic playing Beethoven 5 & 7 for $8.97. There are dirt-cheap Chopin CDs for $2.98; there's even a 20-CD set of "Classical Masterpieces of the Millennium" for $29.97. Simon Rattle conducts John Adams for $9.97, and there's a 2-CD set of Yehudi Menuhin playing no fewer than 12 Bartok violin pieces for the ridiculously low price of $8.97. (That's a no-brainer for my mother.) If you want Rorem or Hindemith or even Heinrich Schütz's German Requiem, you'll find all that more obscure stuff here, too. No wonder that Amazon's classical sales are booming, especially, as Chris Anderson points out, since the store is expressly designed to carry classical music (with composers, orchestras, soloists, conductors and so forth) rather than trying to use an Artist-Album-Song paradigm.

The classical music world will surely never see another Karajan, who sold 200 million records (and rising). But my gut feeling is that it's far from dead.

Posted by Felix at 10:35 EST | Comments (2)

The $600,000 parking spot

In a post last year, I looked at the value of parking spaces in Manhattan – at least there was a lot of discussion on that subject in the comments. The general upshot was that parking spaces seem to be surprisingly cheap here.

Well, not at 200 Eleventh Avenue they're not. It's a new 16-unit condo development where 14 of the units have what the developers are calling an "en-suite garage". Check out the animation on the website – basically, you drive your car into the building, it goes up in an elevator, and you then drive it into your apartment.

There's about 300 square feet of apartment space devoted to this en-suite garage. The cheapest apartment in the development right now is priced at $4.7 million for 2,353 square feet – which would value the en-suite garage at $600,000. Now that's a serious amount of money to pay for a parking spot!

Posted by Felix at 9:52 EST | Comments (1)

Conventional wisdom debunker, cooking with wine edition

"Never cook with a wine you wouldn’t drink."

You know that, right? It's drilled into even those of us who don't cook very much, and from an early age.

But, it turns out, it's kinda – well, it's bullshit. The NYT's Julia Moskin, bless her, actually did some empirical testing, and it turns out that tannins, for instance, which can be great in wine for drinking, "become unpleasantly astringent when cooked". Hence this delight:

The final test was a three-way blind tasting of risotto al Barolo...
I made the dish three times in one morning: first with a 2000 Barolo ($69.95), next with a 2005 dolcetto d’Alba ($22.95), and finally with a jack-of-all-wines, a Charles Shaw cabernet sauvignon affectionately known to Trader Joe’s shoppers as Two-Buck Chuck. (Introduced at $1.99, the price is up to $2.99 at the Manhattan store.)
Although the Barolo was rich and complex to drink, of the seven members of the Dining section staff who tasted the risottos, no one liked the Barolo-infused version best. “Least flavorful,” “sharp edges” and “sour,” they said.
The winner, by a vote of 4-to-3, was the Charles Shaw wine, which was the youngest and grapiest in the glass: the tasters said the wine’s fruit “stood up well to the cheese” and made the dish rounder. “It’s the best of both worlds,” one taster said, citing the astringency of the Barolo version and the overripe alcoholic perfume of the dolcetto. The young, fruity upstart beat the Old World classic by a mile.

I love any situation where cheaper is better, and cheapest is best. They don't come along very often, but this is clearly one of them.

Posted by Felix at 16:52 EST | Comments (4)

Driving the wrong way down the street

Can New Yorkers drive the wrong way down one-way streets with impunity?

I've certainly seen this happen many times. One very frequent place it happens is the south side of Delancey Street, alongside the Williamsburg Bridge between Clinton and Ridge. There's a lot of free on-street parking on that block, and evidently quite a few of those cars want to go back over the bridge to Brooklyn. In order to do so legally, they need to drive down Delancey to Willett, down Willett to Grand, up Grand to Norfolk, and then finally turn from Norfolk back onto Delancey and over the bridge. If they're OK driving the wrong way up Delancey, however, they just cruise back to Clinton and make a U-turn straight onto the bridge. This happens all the time.

You also see cars driving the wrong way down Great Jones Street, between Lafayette and Bowery, although not all the way. The reason is that cars pull in to the car park on Great Jones and Lafayette, whose owners also run the smaller car park on Great Jones between Lafayette and Bowery. Rather than drive all the way around via 4th Street, they move cars from the bigger car park into the smaller by simply driving the wrong way down Great Jones.

And then there are the more one-off occurrences. Once, I was biking down Grand Street between Thompson and West Broadway when a car started coming down the street at me, driving west, the wrong way. It was on the other side of the street from me, but I was still startled, and ended up foolishly getting a few bruises when I tried to brake with my left hand (the front wheel) while signalling to the driver with my right hand that he was going the wrong way. Of course it turns out he was well aware of that: he'd just seen a parking spot on Grand, and didn't want to risk it being gone if he drove around on Watts and Thompson to get there legally.

All of these examples, while being illegal, are not particularly unsafe. But sometimes you hear of something really egregious – and there's a magnificent example on Streetsblog today.

At 5:52 pm, a heavy-duty truck, probably in the 20,000-lb class, made an illegal left turn from Hudson Street onto Duane Street in lower Manhattan and drove west, the wrong way, on east-bound Duane Street to Greenwich Street. I estimate its speed to have been 20-22 mph. At the T-intersection of Duane with Greenwich, the truck slowed only enough to negotiate a left turn. This block of Duane Street, where I live, is heavily pedestrianized, and in fact pedestrians had to scatter to avoid being struck in the striped crosswalk running from the southeast corner of the T-intersection to the northeast corner.

The crazy thing about this is that it actually makes no sense. Apparently the truck was "fleeing a traffic jam" on Hudson Street – which means that it was trying to go north. But Greenwich Street goes south – which means the truck would have been better off going east, the right way, on Duane over to northbound Church. Alternatively, if he was trying to get to the West Side Highway, he could have just stayed on Hudson a few more blocks until he got to N Moore, and then taken N Moore all the way over. As it is, he probably had to take Greenwich south to Chambers and then Chambers over to West Street, which I can't imagine saved him much if any time.

In any case, the good news is that there was a pair of traffic cops standing right there, on the corner of Duane and Greenwich, who saw the whole thing. What are the chances? Well, it doesn't really matter, because the bad news is that they did absolutely nothing about it. When Streetsblog reader Charles Komanoff wrote to the NYPD asking, essentially, "WTF???," he was told that the traffic cops "were assigned to enforce parking regulations and were not trained to issue moving violation summonses."

In other words, New Yorkers can drive the wrong way down one-way streets, even if they're passing traffic cops, with impunity – the only thing they have to worry about, it would seem, is traffic cops in cars or on motorbikes, who are presumably "trained to issue moving violation summonses". And people complain about cyclists behaving badly.

Posted by Felix at 15:12 EST | Comments (1)

How can a retail investor borrow yen?

An interesting comment just appeared on an old blog of mine:

Can you explain, how can a individual investor borrow yen to buy CAD$?

It's a good question. The fact is that there is a huge universe of investment opportunities which are simply not available to individual investors, and the situation is getting worse. The financial markets love coming up with interesting and innovative new structures for investors to buy, often based on credit default swaps or mortality indices or something equally obscure – and while hedge funds pile in, individual investors are left out in the cold, stuck with crappy old equities. It's weird – there's pretty much no riskier investment than buying an individual stock, but retail investors can do that pretty easily, and can even, with a bit more difficulty, buy options on individual stocks. But if they want a much lower-risk investment like an AAA-rated tranche of a CDO, fuhgeddaboudit.

The carry trade is a bit like that: while borrowing yen is a no-brainer for a hedge fund, it's much harder for an individual. And even if your local bank was willing to lend you yen, I'm sure they'd do so only at a ridiculously high interest rate.

Even if you had a bank willing to do some kind of JPY-CAD swap for you, I still can't see how an individual can really do this trade with nothing but a bunch of margin. The long side is easy, of course – just go along to Everbank and open a foreign-currency account. But the short side is much harder. You'd think with all the crazy mortgages on offer in the US, someone would have had the bright idea of offering mortgages in yen. But so far, to my knowledge, that hasn't happened.

Posted by Felix at 14:07 EST | Comments (7)

NYT factoid of the day

In the case of breaking news, especially during daytime hours, stories are edited through our Continuous News Desk, which has a separate editing staff but no designated copy editors.

Which just makes me want to know who writes the headlines online.

Apparently this is changing, and will change more when the NYT moves into its new building. Even then, however, the website and the newspaper will be very much separate organisations.

Posted by Felix at 12:52 EST | Comments (0)

Is wine really an investment?

Via Alphaville, I found myself today at Decanter's wine investment guide – something which made for a very interesting read, given that I have just finished a book on Robert Parker. Parker will tell anyone who'll listen that they should never buy wine as an investment, but that doesn't stop guides like this being written, and millions of dollars being "invested" in wine by people who have no intention of ever drinking it. You can see why, when Decanter supplies them with prose like this:

In the last 20 years fine wine has also outperformed a number of equity and fixed income indices including the FTSE 100. For long term investors (as opposed to shorter term speculators) a well chosen and balanced wine portfolio should provide annualised returns of 10-12% per annum.
Wine is less volatile than stocks and shares, making it a less risky investment.

That's right, I can get double-digit returns with lower volatility than the stock market – where do I sign up?

Of course, if you look at the guide with a critical eye, it seems much less impressive. Consider this kind of thing, for instance:

There are relatively few (perhaps only about 75 in total) investment grade labels... Bordeaux represents 90% of the wine investment market and should take the lion's share in any portfolio... the Rhone remains undervalued as a region and has yet to really establish its investment credentials... Port is no longer regarded as a good investment bet... New and Old World 'Cult' wines from California, Australia and Bordeaux 'garagistes' are not the darlings of the market that they once were and are best avoided in the current climate.

If you then look at Decanter's list of "10 great investment wines (and 10 not-so-good)", everything becomes a lot clearer. The great investment wines, by definition, are the wines which went up the most in price over the past two years. And – guess what – 2005 and 2006 were great years for anybody investing in Bordeaux, and were not so great for people investing in the Rhone, or in Port, or in New World wines. In general, the outperformers are the wines you've heard of (Lafite, Latour, Margaux), while the underperformers carry names like Conseillante, Valandraud, and Mondotte.

With hindsight, it's easy to construct a reason why this should have been the case: many of the newer buyers came from China and Japan, where buyers use Parker to pick the best vintages of the best Bordeaux, rather than to seek out obsucre garagistes. In California, a bottle of Araujo might have more cachet than a bottle of Lafite, because it's harder to find and, in California, being an international luxury brand is not necessarily considered a good thing. On the other hand, international luxury brands have no better market than Asia – so you can look at the recent rise in price of 1986 Lafite as a luxury-brand story as much as you can see it as a wine-investment story.

In any case, the idea that wine which is undervalued should not be bought as an investment just goes to show me, at least, that wine is not really an investment. A good investor tries to pick undervalued assets, while if you believe the Decanter article, the best thing to do in the wine market is to avoid them. In other words, wine investors are basically momentum investors, working on the greater fool theory. Which generally works until it doesn't.

But look on the bright side: at least all of this means that there are still lots of really good wines which aren't being "collected" and therefore bid up to $5,000 per case and beyond. Which in turn means that those of us who buy wine to drink it, rather than to make money, still have a wide range of very good values to choose from.

Posted by Felix at 22:59 EST | Comments (5)

Adventures in mortgage hype, Breaking Views edition

I popped over to Breaking Views just now to see what they had to say about Barclays buying ABN Amro, and what's the big top headline? "Subprime meltdown echoes dotcom death spiral".

The story itself is pretty smart and sober, as one would expect from its author (and friend of felixsalmon.com) Antony Currie. I have no idea whether Antony had any part in writing that headline, but for getting both "meltdown" and "death spiral" into one six-word hed, I hereby award Breaking Views the first Housing Hysteria Award (these, collectively, are known as the Nouriels). Congratulations Breaking Views!

Posted by Felix at 18:46 EST | Comments (4)

How long can nominal house prices fall?

Me, yesterday:

The chances of a nominal fall in house prices over the next five years are, I think, de minimis.

Well, I certainly seem to have got that one wrong. First dsquared and then BR, in the comments, pointed out that six-year periods of nominal house-price depreciation are by no means unprecedented. BR even points to a very useful page showing median house prices in Southern California, which is so interesting I've turned it into a graph:

Remember, this is Southern California, not bubblicious Japan. Indeed, compared to what's happened to prices over the past few years, the run-up in prices from 1986 to 1990 seems positively modest. And yet, between 1991 and 1996, the median home price in Los Angeles fell by 21% – and that's in nominal terms. In real terms, of course, the drop was even greater.

Now, one thing I really hate is people who look at charts and reckon they can work out what prices will do in the future based on what they have done in the past. They can't – and the chart above really tells us nothing about where house prices in Southern California or anywhere else are going. On the other hand, it does show, quite clearly, that house prices can fall quite a lot in nominal terms over a period of many years. If it's happened before, it can happen again.

Posted by Felix at 15:57 EST | Comments (3)

Glitches

My computer went to sleep last night, and never woke up! It was working great when I went to bed, but this morning it was quite dead, and refused all attempts at coaxing it into waking up. I was meeting the fabulous Megan McArdle for a coffee on 57th Street anyway, so I took the opportunity to take the computer into the friendly cube-shaped computer hospital on 59th and 5th. They muttered darkly about a logic board, and took the computer away for surgery; with any luck, I should have it back by the weekend, but until then I have to get used to working again on my old desktop. No great hardship.

I'm mostly backed up; the main things I lost were all the tabs I had open in Firefox, ready to get turned into fabulous blog entries today; and one half-written new blog entry about mortgage equity withdrawal, which I haven't the heart to rewrite. If you're interested, go here: Calculated Risk has everything you need to know. The upshot is that using CR's numbers, 2007 GDP is likely to be about 0.8% lower than it would have been if mortgage equity withdrawal remained at 2006 levels.

Posted by Felix at 15:23 EST | Comments (4)

Dean Baker vs Chris Cagan

I have a lot of respect for the research of Christopher Cagan at First American CoreLogic. His latest paper, a 118-page study of the impact of ARM adjustment, was picked up by the Wall Street Journal, in a story which itself was picked up by Dean Baker:

The WSJ decided to highlight a 3-month old study to tell readers that everything is fine with the mortage market... the problem with the WSJ assessment is that it is based on the assumption that house prices do not fall. If prices fall by 10 percent, then Cagan projects that the default rate would be more than 70 percent higher and the losses to the financial system would more than double.
How plausible is it that house prices don't fall from their December 2006 level? Well, the National Association of Realtors data show that the median house prices has fallen 3.1 percent over the last year...
Does anyone think that house prices won't fall in 2007?

I'd point out that the study is dated March 19, it's not three months old. And the assumption that house prices do not fall is not an assumption that they do not fall in 2007: it's an assumption that they do not fall over the next six years. Which, frankly, is an eminently reasonable assumption. Median house prices are volatile in the short term, and might well go down in 2007. But the chances of a nominal fall in house prices over the next five years are, I think, de minimis.

Baker also ignores a lot of pretty good news in Cagan's report. First, he shows how limited the reset problem is:

The analysis anticipates a total of 1.1 million foreclosures with losses of about $112 billion, spread over six years or more. Our mortgage lending industry extends about $2 trillion of loans yearly, so these losses represent less than one percent of total lending. This will clearly not break the mortgage industry.

Even if prices fall by 10% and foreclosures reach 1.86 million – over six years, remember – we're still not talking major systemic impact.

What's more, the problem of negative equity seems to be getting better, not worse:

As of December 2006, 6.9 percent of the properties had negative equity, which is better than the 9.4 percent having negative equity (as of September 2005) found in the previous study published in February 2006. Although values have fallen in some markets during the intervening time, they have risen in other places, particularly on a year-to-year basis.

There's another interesting datapoint, too: in the last study, 29% of the mortgages originated in 2005 had negative equity. In this study, just 9% of the mortgages originated in 2005 had negative equity, and less than 18% of the mortgages originated in 2006 had negative equity. Why is that? It's because, contra Baker, prices did actually rise in 2006. If you look at the NAR report he's citing, the 3.2% drop is from January 2006 to January 2007. But the same report says that the median sales price in 2006 was actually 0.6% higher than the median sales price in 2005, and there was even a 0.8% rise between January 2006 and December 2006. As prices rise, both foreclosure rates and negative equity rates fall.

(For much more on the old study and negative equity, take a look at this old post of mine from February.)

There's much more in the study, which I would highly recommend to anybody who's seriously interested in the relationship between interest rates, adjustable-rate mortgages, and foreclosures. Here's Cagan's conclusion, which I think is decidedly solid:

In conclusion, this study shows that the time-honored truths of economics are true after all. Risky investments are in fact less secure than traditional investments, and should be valued as such. This sounds too obvious to mention, but it should be disregarded at one’s peril. For short periods of time, under special market conditions such as the surging prices of 2004 and 2005, the old adages stood away from the market in temporary abeyance; but as time went on the time-tested fundamentals of economics have reasserted themselves.
Another time-honored economic truth is that residential real estate is properly a matter for the long term. Traditionally, people purchase their homes to live in and enjoy for a period of several years or even for a lifetime. Strategies with a short time horizon, such as flipping, can produce great profits but also carry risks. People who undertake fixed rate loans that they are able to pay, and hold their homes for several years or more, can in most cases expect to do quite well.
It is legitimate to enter a home with adjustable-rate financing, but borrowers and lenders should consider what the payments are likely to be in a few years as well as initially. If the future payments can be sustained and not only the initial payments, and if significant negative amortization is avoided, buyers can use adjustable-rate loans with confidence. Those who purchase, borrow, lend and invest following basic and proven virtues are likely to be rewarded for their wisdom.

Posted by Felix at 0:44 EST | Comments (4)

LA question

I'm now back from LA. Everybody there loves it, and frankly they're welcome to it. The way that everybody needs to drive everywhere for everything is just not my style at all. But I do understand the attraction of LA, especially to Londoners who never get weather like that. One thing really puzzles me, however:

Why don't rich Los Angelenos have drivers?

The advantages of having a driver are obvious. You never need to worry about parking. You never need to worry about drinking and driving. You can get as engrossed in multimedia multitasking as you like – you can even watch dailies or shorts on your in-car entertainment system while stuck in traffic. And: you're automatically eligible for the carpool lane!

God knows there are loads of people in LA with more than enough money to hire a driver, but very few of them ever seem to do so. Any idea why that might be?

Posted by Felix at 23:21 EST | Comments (5)

Whither mortgages and housing?

Markets fell on Tuesday, on fears, we are told, about weakness in mortgages and housing; this prompted Brad Setser to ask me whether I'm still as sanguine as I used to be on such matters. I couldn't reply on Wednesday, since I went to Disneyland instead – I can highly recommend the Indiana Jones ride, if you find yourself there for whatever reason. While I was there, the market went back up again. As ever, my main conclusion from all this is that no one should ever draw any conclusions from one-day market moves.

All the same, I might as well get down here for the record what I think about mortgages and housing, because although I think that the bears have some enormous holes in their arguments, that doesn't necessarily make me bullish.

I basically start with the observation that the run-up in housing prices in recent years has been seen all over the world: from Spain to South Africa, from Ireland to Australia. Not everywhere has participated: there's been a lot more price appreciation in Shanghai than there has been in Stuttgart. But there's clearly some kind of global force – let's call it "liquidity", for lack of a better term – which has been driving asset prices in general, and housing prices in particular, upwards. What's more, by the standards of many of these countries, the run-up in US home prices has been relatively modest.

Let's now take another look at the US. I don't deny for a minute that the number of defaults on subprime mortgages, especially subprime mortgages of the 2006 vintage, is eye-poppingly high, and rising. What's more, given the fact that originators have tightened up their underwriting standards substantially (and correctly), many mortgage holders are going to find it hard to refinance their adjustable-rate mortgages when they reset. This could drive default rates even higher, if the rates on those mortgages go up a lot. Home prices are still substantially above their 2004 levels, however, so the real problem is largely confined to mortgages originated in 2005 and 2006.

Now, it's easy to paint a picture whereby defaults on recent-vintage mortgages cause a more generalized tightening in credit markets along with a plunge in housing prices as supply goes up and demand goes down. I do accept that, in theory, this could happen. But before I believe the prognostications of those who say it will happen, I want to see some indication that their model of supply and demand and housing prices actually reflects reality. Specifically, I want to see whether it explains the rise in housing prices over the past few years.

The big mistake that I think a lot of the housing bears are making is that they're confusing correlation with causation. Yes, subprime credit has increased substantially in recent years. And yes, housing prices have gone up. But that doesn't mean that the former caused the latter. Indeed, there are a good reasons to believe that the increase in subprime credit did not cause the run-up in housing prices. For one thing, housing prices started rising before the increase in subprime credit. For another, much of the increase in subprime credit was concentrated in depressed areas such as Michigan and Ohio, which accounted for 15% of all US foreclosures in January. And it's precisely those areas which did not see a run-up in housing prices. Meanwhile, the market in New York City co-ops, for instance, has been booming (and shows few if any signs of slowing down) despite the fact that because those units are "non-conforming", it has always been incredibly difficult to get a subprime mortgage on them. Finally, the rise in subprime credit in the US was not matched by a rise in subprime credit in places like South Africa and China, which saw much greater price increases – so whatever forces drove housing prices up globally are probably sufficient in themselves to explain the increase in housing prices in the US.

Now, one of those forces is doubtless an increase in the availability of credit generally, if not subprime credit in particular. If housing prices rose on a tide of global liquidity, then they can fall if and when that tide starts going out. For the time being, however, there are no signs that is happening. Yes, there are problems in one localized sector of the US mortgage market. But credit markets globally are still as tight as they've ever been. And the US subprime market is simply not big enough to affect global credit markets in any substantial way.

At the margin, then, problems in the US subprime sector will surely have some effect on the US housing market – although, obviously, the effects will be greatest where the concentration of subprime loans is at its highest. But I still think that the big drivers of the US housing market in the recent present will continue to be the big drivers of the US housing market in the near future – which does give me some cause for optimism.

One thing is certain, however: foreclosures will continue to rise, which will be personally devastating to hundreds of thousands, if not millions, of homeowners. These personal tragedies will resonate on Capitol Hill, and the federal government might step in to help those individuals out – which might, in turn, help mitigate the economic effects of the foreclosures. What's more, all the talk of hundreds of billions of dollars being "lost" in foreclosures is a mite misleading: all that equity has already been lost by the time the foreclosure proceedings begin.

The big losers will be the holders of the equity tranches of MBSs and subprime-backed CDOs, as well as those subprime originators who find themselves holding a bunch of scratch-and-dent loans they thought they'd sold already. So it makes perfect sense that subprime mortgage originators are closing shop. But I'm not shedding too many tears for them: they made a lot of money in the boom years, and then they relaxed their underwriting standards far too much at the end of 2005 and the beginning of 2006. They deserve to bear the consequences.

As for the holders of MBS and CDO equity, we're talking very, very sophisticated investors and financial institutions here, who are almost without exception both willing and able to bear those losses. I see no systemic risks there.

Looking forwards, the number of subprime loans originated will go down, which means that issuance into the subprime MBS market will fall. That's fine. As the yields on those subprime MBSs rise and the underwriting standards on them tighten, there will be enough demand for them to meet supply. So I'm not particularly worried there, either.

The one big event risk, which hasn't happened yet, is a mass downgrade of MBSs carrying BBB and BBB– ratings, to junk status. If that happens, there will be forced selling of those MBSs by institutional investors who are not allowed to own speculative-grade debt, and spreads are likely to gap out substantially. Given how the markets managed to cope with the Ford and GM downgrades, however, I think they could probably cope with this as well. (Remember that Ford and GM bonds are unsecured, and therefore have much more room to fall.) What's more, at this point there's no indication that such a mass downgrade is going to happen.

Overall, then, I'm sanguine about the US mortgage and housing markets. There will be large losses, which will generally be sustained by entities well able to afford them. On an individual level, there will be some tragic losses of much-loved homes. But on a systemic level, I think there is relatively little to worry about.

Oh, and one last thing: there's an argument that US GDP growth has been reasonably healthy of late mainly because of the amounts of equity that consumers are taking out of their homes and spending in shops. If they stop doing that, goes the argument, then the US faces recession – and house prices never do well in a recession. Again, my response is simple: show me, plausibly, the degree to which home equity withdrawal boosted GDP growth in recent years. Then we'll have a good idea how much it could affect GDP growth on the downside.

Posted by Felix at 12:41 EST | Comments (9)

Help me change my mind on mortgages!

Brad Setser asks whether I've changed my mind about the mortgage market in the wake of today's data and the market's reaction to it. I haven't really looked at either yet, and tomorrow I'm going to be spending the day at Disneyland. So do please use the comments section here to give me all the datapoints I need. Then I'll answer his question on Thursday, probably.

Posted by Felix at 23:37 EST | Comments (7)

Can the amount of alpha keep up with the number of hedge funds chasing it?

Whither alpha? Alexander Campbell, in fine form, officiates at a debate between David Rowe and Barry Schachter. All of them, refreshingly, reject the idea that there's some limited supply of alpha, and that as the number of hedge funds and others chasing it increases, there will be less to go round for the average hedge fund manager.

Campbell's blog entry is a fine introduction to the debate. My view is that alpha comes from global imbalances – things like currency pegs which cause distortions in the market. Right now, there are more global imbalances than ever before, which implies to me that there should be more alpha than ever before.

Specifically, I think there's a big delta in the financial markets right now. (I think delta is the right word...) You have the hedge funds and private equity types at one end, who are all about making money and generating alpha. And then you have the world's governments at the other end, who are all about accumulating reserves and who really don't seem to mind very much if they underperform the market. So long as this state of affairs continues, both can be very happy.

(One extreme example of this is Russia, where the government sold off its patrimony at fire-sale prices to ultracapitalist investors. Lots of alpha for the investors there – and the Russian people are the losers.)

More generally, there seems to be more money chasing low-risk fixed-income investments now than at any point in history – this is why private equity is making so much money by issuing vast amounts of cheap debt. There are lots of investors who want risk-free debt, and lots of hedge funds, investment banks, and the like who can make money off the fact that issuing debt can generate higher returns for equity investors.

So count me in with the people who think there's likely to be more than enough alpha to go round for the foreseeable future. That said, of course, there will always be a lot of hedge fund managers who think they're better than they actually are, and who end up just giving money away to the managers who really generate alpha.

Posted by Felix at 15:23 EST | Comments (1)

Simple bond mathematics

Dean Baker doesn't seem to quite understand how the inverse relation between price and yield works in practice:

Back in the summer of 2003, the interest rate on the 10-year treasury bond bottomed out at 3.05 percent. Today, it stands at around 4.6 percent. This means that the bonds China held back then have lost approximately one-third of their value. (The price of the bond is inversely proportional to the yield. The actual calculation of the bond price is a bit more complicated, since it does matter when they reach maturity.) If the yield on 10-year treasury bonds rises back to its avearge rate for the decade of the 90s (6.8 percent), then the value of the bonds would drop by another 30 percent.

Let's go to the SmartMoney bond calculator, and look at the price of a 10-year, 5% bond. (Feel free to use any other maturities or coupon rates: the results won't be all that different.)

If the yield is 3.05%, the price is 116.6.
If the yield is 4.6%, the price is 103.5. That's a drop of 11.2%, which is nowhere near "approximately one-third".
If the yield is 6.8%, the price is 87.2. That's a drop of a further 15.7%, which is nowhere near "30 percent".

But of course those drops overstate reality quite a lot. Because between summer 2003 and now, there have been 7 coupon payments, totalling 17.5 cents. So if you bought that bond at 116.6 in 2003, it might be worth only 103.5 today, but you will have received 17.5 cents in coupon payments along the way – which, added to the value of the bond, brings you to 121, or a 3.7% net gain.

Of course, there are lots of extra variables involved, including the fact that a bond's maturity goes down over time. But I really don't think it's possible for a US Treasury bond to lose two-thirds of its value, as Baker implies that it can – especially if you take coupon payments into account.

Posted by Felix at 14:35 EST | Comments (2)

Felix's high-powered bedfellows

I was quoted in an article by Alen Mattich of Dow Jones this morning. I certainly can't complain about the company I'm keeping:

Some like James Grant of the respected industry newsletter, Grant's Interest Rate Observer, have been warning about the wider implications to the credit markets of rising default rates. Collateralized debt obligations, made up of repackaged mortgages and sliced into various grades of creditworthiness, are likely to see defaults higher up the credit scale than investors suspect, according to Grant.
Not everyone is convinced.
Felix Salmon, an economics blogger, points out that you need to separate out the companies making subprime mortgages from the mortgages themselves. While equity in a number of subprime originators has collapsed, it doesn't follow that debt structured from these pooled mortgages will implode, he says.
That's the way the Federal Reserve seems to see things. Subprime doesn't represent a systemic risk to the financial sector. The problem will stay localized.

So there you have it. Me and the Fed, we're like this.

Posted by Felix at 13:31 EST | Comments (2)

Does Robert Parker's ego know no bounds?

I'm reading Elin McCoy's book The Emperor of Wine, on Robert Parker. Here's a chunk of page 153, as grabbed from Amazon:

I like that "Parker interpreted". Remember that this is the 1990s we're talking about here: How much of an ego does a man need to interpret a "sly introduction" as a winemaker essentially pimping out his own daughter for a higher score?

Posted by Felix at 12:54 EST | Comments (1)

The Frankfurter Allgemeine's overwhelming beauty

What's the most boring newspaper in the world? There are many, I'm sure, but I know a lot of people who would put the Frankfurter Allgemeine at the top of the list. Well, the Society for News Design has some news for you: it's just announced that the Sunday version of the Frankfurter Allgemeine has won its award for the best-designed newspaper of the year.

From classically formed fonts to page-dominating visuals, the Frankfurter Allgemeine exudes beauty, overwhelming beauty. This is a masterfully designed, visually intelligent publication. Turning the pages of this paper – with its great expanses of white – is like walking through a gallery that's filled with sophisticated photography, sensuous illustrations, and damn-near-perfect typography. There are surprises and special treats, too. Like graphic novel treatments and illustrations on the TV page. Clearly aimed for an educated audience, this paper is filled with nuance. It doesn't shout – it illuminates.

Wow!

My only question: Is the Frankfurter Allgemeine Sonntagszeitung a completely different paper from the daily version, like the Times and the Sunday Times in England? Or is it just a Sunday version of the same paper?

(Via)

Posted by Felix at 12:18 EST | Comments (1)

LA Times shows how to write sensibly about the housing market

I'm in California this week, which is why posting is rather light: the beach is rather more attractive than squabbling over mortgage-backed bonds. But of course California is the poster child for the housing market boom and bust, and so one can't get away from it entirely – and the LA Times leads this morning with a story headlined "As sub-prime lender implodes, housing shudders". It also has another story, headlined "Home woes don't hurt most bonds".

It's rare that I go out of my way to praise newspaper articles which have essentially no new information in them, but in this case both articles are clear, fair, and informative. The lead article explains that New Century Financial, which is based here in Orange County, "skidded closer to bankruptcy Monday, stoking fears that the mortgage industry's woes could further damage a sluggish housing market." It went on to explain that with refinancing options being taken away from them, many subprime borrowers are defaulting and could end up in foreclosure. With less demand from subprime buyers and more supply from foreclosures, the housing market is certain to be adversely affected to some degree. But the story also has a quote from Pimco's Scott Simon, saying that the MBS market – which is by no means the same thing – "should be just fine".

The bond-market article explains that subprime MBSs might be performing very badly at the moment, but that there's no sign of a more generalized flight to quality, nor any risk of a more generalized credit crunch.

So bravo to the LA Times, and its journalists David Streitfeld, E. Scott Reckard, and Tom Petruno. I've seen more than enough overheated scaremongering in recent months to know that writing sensible articles like these is harder than it looks.

Posted by Felix at 11:17 EST | Comments (0)

Is there a looming crisis in the mortgage market?

The world is full of people desperate to know what Gretchen Morgenson thinks about the market in mortgage-backed securities, or MBSs. The problem is that her column last week on the subject is hidden behind the Times Select firewall. So we can all be very grateful that she has now rewritten it, at even greater length, and republished it under a "News Analysis" slug. (No firewall!) The headline? "Crisis Looms in Market for Mortgages".

Or, you know, we can ignore it, on the grounds that Morgenson adduces no evidence whatsoever that any crisis is looming at all. For one thing, she doesn't seem to understand the difference between two entirely different types of investment: equity in subprime mortgage originators, on the one hand, and debt backed by pools of subprime mortgages, on the other. It's certainly true that originating subprime mortgages does not seem to have been a very good business to invest in over the past year or so. But Morgenson never connects the dots and explains why that means that the market in subprime MBSs is likely to implode.

Morgenson also talks at great length about the enormity of the market in MBSs, but never stops to point out that the vast majority of that market is in bonds issued by Fannie Mae and Freddie Mac, and that no one has any worries whatsoever about those securities crashing.

Here's a bit of typical overheated prose:

Wall Street firms and entrepreneurs made fortunes issuing questionable securities, in this case pools of home loans taken out by risky borrowers... Regulators stood by as the mania churned, fed by lax standards and anything-goes lending.

But here is Morgenson's own graph, showing the practical effects of that churning mania: MBS issuance more than $1 trillion lower in 2006 than it was three years earlier. It's very hard to look at this graph and see any evidence of a bubble: rather, it seems that private-sector MBS issuance has been rising only to make up for a large drop in issuance from Fannie and Freddie.

Morgenson's most substantive problem is that there's a ticking bomb in the MBS market, in the form of investors failing to mark their securities to market. First she says they don't, then she says they do, and then she says they don't – let's see if you can make more sense of it than I can.

Owners of mortgage securities that have been pooled, for example, do not have to reflect the prevailing market prices of those securities each day, as stockholders do. Only when a security is downgraded by a rating agency do investors have to mark their holdings to the market value. As a result, traders say, many investors are reporting the values of their holdings at inflated prices...
Years ago, mortgage-backed securities appealed to a buy-and-hold crowd, who kept the securities on their books until the loans were paid off. “You used to think of mortgages as slow moving,” said Glenn T. Costello, managing director of structured finance residential mortgage at Fitch Ratings. “Now it has become much more of a trading market, with a mark-to-market bent.”...
Interestingly, accounting conventions in mortgage securities require an investor to mark his holdings to market only when they get downgraded. So investors may be assigning higher values to their positions than they would receive if they had to go into the market and find a buyer. That delays the reckoning, some analysts say.

Of course, Morgenson is missing two crucial points here. The first is that here simply isn't a market in most MBSs tranches – that's why so much of the recent activity has concentrated on MBS indices rather than the underlying securities. The liquid, mark-to-market activity that Costello is talking about is entirely in Fannie and Freddie bonds, not in individual tranches of securitized subprime mortgages. You can't mark subprime MBS tranches to market daily for the very good reason that most such tranches simply don't trade on a daily basis.

And the second point is that if you actually look at the prices for those subprime MBS tranches when they do trade, guess what? They haven't actually fallen much in price at all. If investors were marking to market, it really wouldn't make much difference. As Josh Rosner told me, the problem is not that existing MBSs are likely to default or drop in price. A default is much like a prepayment, from an investor's point of view, so investors only really care about default rates when they start approaching prepayment rates. And they're nowhere near those levels.

Anyway, here's my favorite bit from Morgenson's article. Before you read it, ask yourself what a scary loan-to-value ratio for subprime mortgages would be. 125%? 100%? 95%?

The rapid rise in the amount borrowed against a property’s value shows how willing lenders were to stretch. In 2000, according to Banc of America Securities, the average loan to a subprime lender was 48 percent of the value of the underlying property. By 2006, that figure reached 82 percent.

There you go: 82%, in the year universally considered to be the laxest year in the history of subprime mortgages. Now do you understand why investors aren't particularly worried about default?

Invidiously, Morgenson even hints darkly at nefarious conflicts of interest at the ratings agencies, saying that they might be soft-pedalling downgrades to save their own hides. I don't think they are. Mortgage pools are designed to be able to withstand a temporary drop in house prices or rise in default rates. I look at the tiny number of MBS downgrades and take comfort in it. I'm perfectly happy to concede that subprime mortgage originators who were active this time last year are going to be in a lot of trouble now. But I'm nowhere near convinced that there's any real problem in the market for the securities based on the mortgages they originated.

Posted by Felix at 11:33 EST | Comments (15)

Rent vs buy redux: Is buying a useful commitment device?

One of the things l love the most about having a blog is the way in which I often bring up a subject and then get a stream of commenters – many of whom know much more on the subject than I do – really move the topic forwards.

A prime example is my post from Friday on rent vs buy calculations, itself prompted by a previous comments stream. My back-of-the-envelope calculations only looked at the position after one year, but a number of commenters have looked out much further than that, and one even did a Monte Carlo simulation! What's more, my commenters didn't just pull numbers out of thin air, as I did, but gave me some very useful real-world datapoints.

Nicholas Weaver put a spreadsheet online for one property in California, assuming rent stays constant starts at $1325 a month and rises by 3% a year, and using a real-world purchase price of $400,000. Upshot? Renting was a lot cheaper. Now, he says, his rent is $1675, for a house worth more than $600,000.

And RichB, in England, came up with an even more elaborate spreadsheet for a UK place listed at £795,000 which is renting for £2750 per month. (Remember that the UK abolished mortgage-interest tax relief, with no appreciable effect on housing prices.) He assumed upkeep costs of 0.5% of the purchase price (about £330 per month), and rent rising at 3% per year. Again, renting was a lot cheaper than buying: if you held the house for 10 years and prices rose by 6% per year annualized that whole time, you'd still be £115,000 worse off by buying.

But. Buying is what economists like to call a "commitment device" – one of those situations where you can make yourself better off by reducing the number of options available to you. RichB, for instance, makes this crucial assumption:

The difference between the monthly mortgage payment and monthly rent, as well as all up front costs, are assumed to be invested at 5.5% (with a 40% tax rate).

This strikes me as both reasonable, in terms of the rent vs buy calculation, and also, at the same time, utterly unrealistic. People stretch themselves and bend over backwards and perform all manner of other metaphorical financial calisthenics to make their mortgage payments every month so that they can continue to live in their home. People buy homes at the outer edge of the affordability envelope because they value all that space and light and convenience in terms of commuting, and so on and so forth. No one will have the same kind of real and emotional attachment to a monthly plan involving paying a certain amount of money into a savings plan yielding 5.5% per annum. In other words, the difference between rent payments and mortgage payments, if the mortgage payments are higher, is not likely to get invested: it's likely to get spent.

So maybe there's a good reason why people buy houses even when it would be mathematically cheaper for them to rent: it's a forced savings device. All that money they save and scrounge up for the down-payment; all that extra money they find every month for a mortgage payment which they wouldn't bother doing if they were renting – it all goes towards building up equity in a very valuable home. Theoretically, they could do the same amount of savings with money rather than with property, but in practice very few people ever do. To take RichB's example, after 10 years someone who bought the house would have hundreds of thousands of pounds of equity in his house. While someone renting the house would have memories of great holidays and meals at restaurants, and would have a spiffier wardrobe, but would have much less total net worth.

Posted by Felix at 10:26 EST | Comments (11)

Why playing the lottery can be a rational thing to do

Benedict Carey finds a 2000 paper by Lloyd Cohen, which is well worth rediscovering. From the abstract:

The central purpose of this paper is to show that lottery play is not economically irrational and uninformed. The paper presents a theory of lottery tickets not as misguided inputs into wealth production as some critics believe but as valuable inputs in creating a sense of open-ended possibility, specifically the possibility of escaping one's current life by acquiring great wealth.

Cohen has some interesting ideas surrounding the idea that lotteries are a regressive tax:

The regressivity or progressivity of the tax implicit in the monopoly rents collected by the state turns on the question of whether it is the universe of lottery players who pay the tax or just the winners. Imagine that $10,000,000 is wagered at $10 a person from 1,000,000 people and a single winner is paid $4,000,000 and the state keeps $6,000,000 as a tax/rent. Who has paid this $6,000,000, the 1,000,000 purchasers or the one winner?

It's certainly true that people who play the lottery are almost certain to lose money. But Cohen's insight is that playing the lottery is not therefore automatically irrational. People like me love to calculate the expected gain or loss from buying a lottery ticket: back in 2005 I wrote a little post on the subject at MemeFirst. A commenter then came along:

Personally, I can afford a dollar (or equivalent) every now and then to keep the dream of international playboyery alive.

In other words, as Carey puts it:

Like a throwaway lifestyle magazine, lottery tickets engage transforming fantasies: a wine cellar, a pool, a vision of tropical blues and white sand.

People don't invest the money they spend on lottery tickets. They spend it, and get those transforming fantasies in return. Cohen even manages to put this in economic terms:

In all things economic, there is a diminishing marginal something. In the case of “ belief in possibilities,” the most initially steeply diminishing marginal utility is that of probability. That is, one requires some real finite probability to support a belief in the possibility of escape, and while the more the better, the falloff in gain from additional probability is precipitous. On the other hand what is indispensable is a scenario that could conceivably be realized that satisfies the conditions of the hoped for fundamental transformation of one’s life.

Cohen even manages to use his theory to explain not only why one would expect the poor to play the lottery more than the rich, but also why one would expect the middle-aged to play the lottery more than the young, and so on. It's all rather appealing – as a work of theory.

Does Cohen's argument stand up against the kind of people who would abolish lotteries? It's certainly true that those people rarely stop to spend much time considering the real benefit that lottery-players obtain from merely buying tickets even if they don't win the lottery. Economists, who like to assume that individuals are economically rational (more or less), will move quickly to the conclusion that playing the lottery can therefore be a rational thing to do. Such a conclusion has the pleasant side effect of avoiding the opposite conclusion, which is that poor people are stupid and should be protected from themselves.

On the other hand, the money which poor people lose spend on playing the lottery is large enough to really make a difference to the communities in which that money is lost spent. Maybe the solution is for local lotteries to be set up, with the help of insurance companies who will insure against a tiny chance of an enormous payout. Lotteries have historically been organised on a statewide or nationwide basis because they payouts have historically had to come directly from ticket sales. But it's very easy to envisage a lottery with an enormous jackpot ($100 million, say) which never generates anywhere near that amount of money in revenues. If such a lottery spent all its profits in the neighborhoods where the lottery tickets were bought, lotteries would be more defensible.

Posted by Felix at 16:13 EST | Comments (9)

Rent vs buy calculations

There's an interesting debate going on in the comments section of yesterday's housing post about the relative costs of buying and renting a house.

David Sucher is in Seattle:

We have had a great discrepancy between buying & renting since the early 1970s i.e. it has always been far more expensive to buy than to rent and very few (like show me one and I'll buy it) residential properties 'cash-flow' at a 20% down purchase. But people do buy when they can afford it. As markets are not likely to be wrong over such a long period of time, my conclusion is that the psychological value of owning is simply worth the extra $$$ and responsibility.

And Nicholas Weaver responds:

In terms of raw cash flow, buying costs more than renting under ALL conditions I've looked at. Even in a "sane" market, on a cash-flow basis, buying is expensive.
But notice that for "cheaper then renting", I only consider lost-money (interest, tax, HOA) as 'cost' for buying, the rest of that huge mortgage payment you should see again, evenutally, so I don't consider that a cost.

Well, maybe not all conditions. In fact, I've been doing some back-of-the-envelope sums and have come to the conclusion that buying is likely to be cheaper than renting. Take the example of someone who can buy their house with cash, and who doesn't consider themselves a particularly astute or successful investor. Let's say that the house costs $1 million, that renting it would cost $5,000 per month, and that property taxes and other costs of ownership are $500 per month. Let's also say that the interest rate on cash deposits is 5%.

Do you buy the home or rent it? If you buy it, after one year you are down $6,000 in taxes and other expenses, so the cost of buying is $6,000. If you rent it, after one year you are up $50,000 in interest on your $1 million, and down $60,000 in rent, so the cost of renting is $10,000. Then come taxes. If you rent, your rent payments aren't tax deductible, but your interest income is taxable. So if you pay 30% tax on that $50,000 interest income, that puts you another $15,000 in the hole. Meanwhile, if you own, those property taxes are tax deductible. Buying just became significantly more attractive still. Then, of course, you're better off still if the value of your house appreciates over the course of the year.

How does a mortgage affect these calculations? Let's say that you have $200,000 for a down payment, and the rest of the purchase price comes from a 6% mortgage. Now, if you buy, you're still down $6,000 in property taxes, but you also need to pay 6% interest on an $800,000 mortgage, which is another $48,000. Total cost of buying: $54,000, all of which is tax-deductible. If you rent, you pay $60,000 in rent, while earning $10,000 in taxable interest income. Total cost of renting: $50,000, plus another $3,000 in taxes. You're still better off buying, certainly if there's any kind of nominal house-price appreciation going on.

Of course, if you tweak the numbers, you get different results. Crucially, if you can invest your money and get a higher return than prevailing mortgage rates, then it becomes much less attractive to buy. But no one would lend money to homeowners if it was that easy to get a higher return elsewhere.

In my example, how much would that house have to cost before it became cheaper to rent? Let's say the house was $1.2 million, and we still had that 20% down payment. Cost of buying is $63,600, tax-deductible; cost of renting is $52,000 after taxes, which is over $74,000 before taxes at a 30% tax rate. How about $1.5 million? Cost of buying is $78,000, tax-deductible; cost of renting is $49,500 after taxes, which is about $71,000 before taxes. Finally, it's cheaper to rent than to buy – assuming, of course, that house prices have zero nominal appreciation.

I'm not intimately connected with the housing market, but my gut feeling is that it's not easy to find $1.5 million houses renting for $5,000 per month. Then again, depending on what state you're in, the property taxes on a $1.5 million house might well be vastly greater than $500 per month, and I'm unclear on the extent to which property taxes get passed through into higher rents.

Still, this is all highly theoretical; I'd love to see some real-world calculations.

Posted by Felix at 13:30 EST | Comments (15)

How much of Harvard's black population is descended from slaves?

Aditi Balakrishna, in the Harvard Crimson, looks at the reasons why recent immigrants are overrepresented among black Harvard students:

“In practical terms, immigrants, no matter what color they are, are a highly selective group of people,” [said Camille Z Charles, who wrote the study on which the article is based].
“At some level, there will always be an immigrant-native difference because you only get the most motivated, best prepared, cream-of-the-crop set of immigrants,” since their families have had to leave their native countries and start anew in the United States, she said.

Greg Mankiw, however, picks up the story and puts a very different spin on it:

It has been widely noted that Senator Barack Obama, while black, is not a descendant of slaves. Instead, his father was a recent immigrant from Kenya. An article in today's Harvard Crimson suggests Obama (Columbia undergrad, Harvard Law School) is representative of a common story.

It's true that most African-Americans are descendants of slaves. But it's not true that black immigrants are not descendants of slaves, as Mankiw implies. Many black immigrants come from the Caribbean, and Caribbean blacks are just as much descended from slaves as American blacks are. A good proportion of African immigrants are descended from slaves, too. Where else might black immigrants come from? If the UK, then they're probably descended from slaves, since they're likely of Caribbean heritage. You get the picture. It might well be the case that Obama is not a descendant of slaves – in fact, he's a descendant of slave-owners. But you can't extrapolate from his case to all the other black immigrants at Harvard.

Posted by Felix at 12:40 EST | Comments (3)

Private equity is the new banking, if the Rothschilds are any indication

Two interesting stories today: a big profile of Nathan Rothschild in the NYT, saying that his buy-side activities might make him the richeset Rothschild ever:

In five short years, the man in line to be the fifth Baron Rothschild is close to becoming a billionaire through a web of private equity investments in Ukraine, Eastern Europe and most significant, his partnership stake in Atticus Capital, the fast-growing $14 billion hedge fund.

Meanwhile, Nathan's father is making similar bets:

Lord Rothschild, the veteran City figure who is part of the banking dynasty, has agreed to back Darwin Private Equity, a new £250m private equity group founded this year by a trio of youngprofessionals from CVCCapital and Permira.
RIT Capital Partners, the publicly traded investment trust that is 17 per cent- owned by Lord Rothschild, will take a "significant minority" stake as well as making a £50m cornerstone investment in its maiden fund of up to £250m.

And, notes the FT, the other branch of the (English) Rothschilds is also heavily involved in private equity: Sir Evelyn de Rothschild and his wife own private equity shop EL Rothschild.

Meanwhile, NM Rothschild, the bank, has a new rival, known as JNR, which is owned by the 35-year-old Nathan Rothschild, and, according to the NYT, "run by a small crew of investment bankers". But JNR isn't an advisory shop like NMR; rather, it looks very much like a gussied-up investment firm. Why make millions on fees when you can make billions in investments?

Posted by Felix at 11:45 EST | Comments (0)

Barnes on England vs France

Julian Barnes on That Sweet Enemy, a book about Anglo-French relations over the centuries:

Although public opposition to the Iraq war in Britain is high, it would take a lot more fair-mindedness than most British (or Americans) are capable of for them to utter, instead of "Blair [or Bush] was wrong," the simple words "Chirac was right."

The Anglophone reader is made forcibly aware that, even at the basic level, each supposed fact and understanding about our conjoined cross-Channel history has an equal and opposite counter-fact and counter-understanding. Did the British hold the key German attack on the Somme in the spring of 1918, and then make the thrust that ended the war? Or did they collapse in shameful panic and have to be rescued by French reinforcements? Was Dunkirk an example of British heroism which, by prolonging the struggle, gave France hope and eventually liberation? Or was it a further demonstration of the traditional British willingness to fight to the last Frenchman and then decamp, leaving their ally to its fate?

It's a great review, well worth reading. And the final word – well, I shan't ruin it for you, but here's the setup:

For all the high military and diplomatic dramas described by the Tombses, the one I would have most enjoyed witnessing occurred during an official visit to Britain by General de Gaulle. The regular assassination attempts on the French President meant that he always traveled with a bag of his own blood, in case a sudden transfusion was required. When he arrived at Harold Macmillan's house in Sussex, his entourage handed the blood to Macmillan's cook, and instructed her to put it in her fridge...

Posted by Felix at 10:53 EST | Comments (0)

How convincing is Roubini's argument that the housing recession will only get worse?

Nouriel Roubini today blogs his new paper which argues that the US housing recession is far from bottoming out. In truth, however, the paper is really just a longer-than-usual blog: it generally asserts at least as much as it argues, and is written more colloquially than formally. Not that there's anything wrong with that.

There are basically two parts to the paper, which attempts to try to work out how much longer the current housing recession will continue. The first takes a basically chartist approach, looking at previous housing recessions and assuming that the present one will be similar. The second takes more of a supply-and-demand approach.

The problem is that a chartist approach is never particularly convincing, and certainly not in this case, where the charts themselves seem to disprove any attempt to demonstrate that the housing market has remotely predictable cycles. And the supply-and-demand approach has two big problems: it doesn't explain housing-market movements in the past, and it basically assumes its own conclusions.

It's also worth noting that nowhere in the paper does Roubini talk about housing prices, as opposed to housing construction. His definition of a housing recession is nowhere made explicit, but seems to be based on housing starts, and is certainly not based on house prices. So even if he's right about the future of the housing recession, that doesn't necessarily mean that prices will go down.

A few specifics, for those who care. First, his main chart:

A large amount of Roubini's analysis comes from looking at this chart and performing all manner of inductive feats on it. He looks at the size of the drops between arrows, the amount of time elapsed between them, and so forth, and then makes predictions as to the position of the next up arrow based on those old datapoints.

This last housing recession lasted 12 months so far. The average duration of the previous seven housing recessions was 32 months. Housing starts are down (as of January 2007) 38 percent from the January 2006 peak, but only 16 percent from their moving average peak. In past housing recessions starts bottomed, on average, after a 51 percent drop form the peak, and after a 37 percent drop from the moving-average peak. Thus, the past housing recession episodes tell us that housing starts could fall another 13 percent from their actual peak (or another 21 percent from their moving average peak) and that it could take another 21 months to reach that bottom.

Is all this of any use to anybody? If you'd tried that technique with the last housing recession, which lasted 84 months by Roubini's calculation, you'd have been well off base: the average of the previous six housing recessions was just 23.5 months. And you'd have been even more off base if you'd tried to predict the length of the last housing upturn, based on the length of previous housing upturns.

It does seem to me that Roubini is looking at an extremely noisy series and trying desperately to find patterns in that noise which simply don't exist. I mean, just look at that chart. Does it really strike you as the kind of thing from which any useful prediction can be extracted? A nice pretty sine wave it is not.

Nevertheless, Roubini is so bought in to the concept of housing-market cycles that he writes things like this, without any empirical support:

Inventories are as important as excess inventories are crucial drivers of demand and supply cycles.

To be fair, I have no idea how one would even start trying to demonstrate that a given series was a "crucial driver" of any economic "cycle". But whenever one reads a sentence like that, it's worth remembering that it comes entirely from the world of economic theory, as opposed to the world of empirical fact.

After all the cycle-based stuff, it's refreshing to get some real supply figures in the second half of the paper. After all, economic luddite though I am, I will concede that prices tend to go up when demand exceeds supply, and that they tend to go down when supply exceeds demand.

The problem is that although Roubini has supply figures dating back to 1968, he doesn't really have any kind of data series at all on the demand side. So all of his calculations are based on demand increasing steadily with population growth: he makes no allowances, for instance, for shrinking family size. And although he's happy projecting both supply and demand forward until 2010, he never stops to ask whether his model can explain the developments we've already seen in the housing market. After all, if the housing market hasn't been following his rules of supply and demand for the past few decades, then there's no particular reason it should start now. And all those crazy spikes in the housing-starts chart don't look to me as though they were perfectly predictable reactions to changes in supply and demand. Or, to put it another way, the changes in supply and – especially – demand which caused those crazy spikes are hardly the kind of changes which Roubini is modelling in this paper.

It also seems to me that all of Roubini's models assume what he's purporting to conclude: that various data series, such as the stock of housing inventories, will revert to mean over the next four years. Again, this is chartism, and I see no reason at all to consider that assumption a reasonable one. And while Roubini's predictions for supply in the housing market seem perfectly reasonable to me, I'm not at all convinced about his predictions with respect to demand. With prices stagnant and rents rising, it's making increasing amounts of economic sense to buy rather than rent – and even to buy for rental income. Add to that the effects of mortgage-interest tax deductibility, and the effects of a weakening dollar on demand from overseas, and I think it's quite easy to paint a scenario with rising, rather than falling, demand.

I should say that it's entirely possible that Roubini is right, and that both housing starts and housing prices are going to fall substantially over the next couple of years. I certainly don't have any privileged information on the subject. But he doesn't either. And I'm no more convinced that the sky is falling now than I was before I read his paper.

Posted by Felix at 19:20 EST | Comments (10)

Are "brain drain" effects real?

Greg Mankiw worries about the effect of a brain drain on the Indian economy, were the US to open its doors to skilled workers:

If skilled software engineers leave India for Silicon Valley, the unskilled workers left behind in India could well be worse off. Allowing more skilled workers into the United States might exacerbate global inequality, even if it enhances global efficiency.

I'm not convinced. "Brain drain" effects always seem to me to be more anecdotal than empirically proven. And if I recall correctly, one of the countries in the world which was most worried about a brain drain was Ireland. How did that work out?

Posted by Felix at 18:19 EST | Comments (1)

How derivatives could have saved the mortgage market

What went wrong with the subprime mortgage market? In a nutshell, a lot of the problem was that it wasn't as sophisticated, in terms of derivatives, as the rest of the bond market.

Let me explain. Investors demanded vast amounts of subprime mortgages in the form of MBSs, and Wall Street did everything it could to meet that demand. Unfortunately, Wall Street met the demand by happily securitizing anything and everything sent to it by originators using ever-laxer underwriting standards. Think of it as the mother of all reverse inquiries: CDOs and other investors essentially went to the originators and told them they would love it if they could originate vastly more in the way of subprime MBSs than they ever had in the past. And so the originators did just that – by writing mortgages which turn out, in restrospect, to have been very bad ideas for the homebuyers, for the originators, and for the investors.

How could all this have been avoided? Quite simply, in theory: Wall Street could simply have started issuing synthetic MBSs. Total subprime originations would not have risen nearly as much, underwriting standards could have remained relatively strict, and the investors would be much happier today. There would also have been less of a housing bubble, as individuals would have found it much harder to buy houses they couldn't afford.

But financial technology never really got as far as synthetic MBSs. And so we find ourselves in the situation we're in today.

Posted by Felix at 18:08 EST | Comments (3)

Is Federated Media worth $300 million?

Blog ad-sales network Federated Media is not for sale, says its founder John Battelle, although he does concede that "any startup has its price". And what would that price be? According to a MergerMarket interview with Federated COO Jason Weisberger picked up by TechCrunch, 8 to 10 times gross revenue, which in turn is likely to be $30 million in 2007. Let's say $270 million.

Weisberger also throws out the figure of 25 times Ebitda; if that was also $290 million, then that would put Federated's Ebitda in 2007 at about $11.5 million.

These are big numbers for a company which owns no IP of its own and essentially just sells ads for other people. On the other hand, Federated does seem to be doing very well, and now employs well over 30 full-time staffers, it would seem.

The sums actually add up. Federated takes 40% of revenues: if it pulls in $30 million in 2007, that would be $12 million. Let's say payroll and other overhead is $3 million: that still leaves Ebitda of $9 million. Plus, it's growing fast: it had 365 million monthly pageviews in January, up from 200 million in September.

Let's conservatively say that FM averages 450 million pageviews a month in 2007: that's 5.4 billion pageviews for the year. And let's say they manage to charge $10 CPM to their high-end advertisers. Revenue of $30 million for the year would imply 3 billion impressions, or less than one impression per pageview, on average. That's definitely doable. Even at $5 CPM they need to sell only 1.1 impressions per pageview, which I'm sure is much, much lower than their total inventory. And it's worth noting that their rack rates for BoingBoing, say, to pick a blog pretty much at random, range from $7 all the way up to $20, while GigaOm's rates are as high as $35.

So could Federated Media really be worth $300 million? There certainly seems to be no shortage of blogs out there which could be brought under the Federated Media umbrella, and I'm quite sure that advertisers aren't going to stop their migration from TV and print to the web any time soon. It's not unrealistic to see Federated Media serving 20 billion pageviews per year, 2 impressions per pageview, at $10 CPM, which would add up to total revenue of $400 million, of which FM would keep $160 million. Profits could approach $100 million per year at that point, which would make a $300 million purchase price seem eminently reasonable.

Of course, just because it could get there doesn't mean it will get there. Any of FM's authors can leave at any time for a richer deal from a rival network – although there's no sign that any of them are particularly discontented at the moment. If I were serious about monetizing felixsalmon.com, I'd first try to get my traffic numbers up a bit and then I think I'd try to sell myself to FM. Let's say I started at 5,000 pageviews per day, 2 impressions per pageview, $10 CPM – that would work out at $26,000 per year in total, of which I would receive $15,600. Not megabucks, by any stretch of the imagination, but this is the Long Tail of internet content, and FM would seem to be very well placed to sell it. And there are thousands of baby blogs like mine out there. FM can make minibucks off a lot of them, and then be in there from day one when, inevitably, a few of them really take off. And there are economies of scale for authors in the network, too: while I doubt all that many advertisers would want to advertise on felixsalmon.com specifically, they might well be interested if I was bundled in with, say, Marginal Revolution. (Which is actually with BlogAds at the moment.)

And although FM doesn't have any real IP of its own, that also means that it doesn't need to create compelling content, either – something which is becoming increasingly expensive, these days, in terms of staffing costs and getting websites successfully off the ground. Many try, few succeed.

Nick Denton reckons that FM is going to be bought by AOL, which would make quite a lot of sense: AOL's ad-sales team is strong, but FM has blog-specific expertise which would help sell Engadget and the other AOL blogs. What's more, buying FM would mean that AOL could bundle Engadget with all manner of other similar blogs . And it would also mean that rather than simply shuttering blogs which don't get a million pageviews per month, it could spin them off to their authors, who could make a decent living under the FM umbrella. 100,000 pageviews per month could mean income for the author of $300,000 per year.

So how much would AOL be willing to spend for FM? On that front, I have no idea. But I reckon Battelle would want at least nine figures.

Posted by Felix at 14:50 EST | Comments (0)

Adventures in real-estate terminology

If you got the hard-copy version of the New York Times Magazine last weekend, you almost certainly skipped past the advertising sections at the end: an eight-pager on El Salvador from our old friends Summit Communications, followed by a "Best of the West" real estate section from something called Andrew Kay Concepts but which was also, peculiarly, copyrighted by the New York Times.

In any case, I'm not sure how I noticed this, but clearly the world of "luxury apartments" is far, far too déclassé for the people being targeted to buy into the Waldorf=Astoria Residences Las Vegas. (Oh yes they did.) The blurb actually calls them – wait for it – vertical estate residences.

What does that even mean? I thought it meant they were triplexes, or at least duplexes, but looking at the floorplans, apparently not. The only vertical thing about them is that they're stacked on top of each other.

In any case, if you've got something over $3.2 million to spend on a Las Vegas apartment, go take a look and tell me what a vertical estate residence looks like in reality – or at least in a showroom. The mind boggles.

Posted by Felix at 12:33 EST | Comments (1)

What are the implications of Nick Stern's utility function?

Now here's a provocative paper, from the ever-astute Charles Kenny. In all the talk about Nick Stern's discount rates, he points out, there has been relatively little ink spilled on the fact that Stern uses a declining marginal rate of utility. But seeing as how he does, says Kenny, there are lots of other consequences we should be thinking about if we are to start thinking that way. For one thing, if what we want to do is maximize global utility, we should immediately and fully liberalize the global labor market. And for another thing, since it's a lot cheaper to increase the utility of the poor than it is to increase the utility of the rich, we should be funneling hundreds of billions of dollars a year at the world's poorest.

In fact, the numbers involved are not impossible by any means:

Raising the incomes of the poorest ten percent of the world’s population to the second poorest ten percent’s level (from $291/year to $577) takes $172bn. Raising the two lowest deciles to the income of the third ($829) takes $474 billion.

That's right: you could effectively double the income of the poorest 10% of the world's population, taking them out of the extreme poverty of living on less than $1 per day, for less than the annual c