OpenTable, Closed Minds
I'm a huge fan of OpenTable, and I've always imagined that restaurants are, too. They don't need to spend hours on the phone telling people what's free and what's not, special instructions don't get garbled, and it's very easy to cross-reference the diner to previous visits. But apparently Raoul's didn't get the memo:
I can no longercontinue putting off talking about the back room. I'd prefer it didn't exist, since I love the rest of Raoul's. Actually, I'd prefer the maître d' didn't exist, either.
On my second visit, with tables empty everywhere in the front and middle rooms, he instructed the hostess to take us to the garden. I begged him: Please don't.
He looked down at us in the French style, and said, "You made your reservation online." Indeed, my friend had used OpenTable, listed on the restaurant's website. The maître d' informed us that OpenTable had assigned us to the back room, and that was that. As we were led away, no happier than prisoners in leg irons, he sneered, "Next time you should call."
Raoul's is an old-fashioned restaurant -- that's a large part of its charm. But if it doesn't want diners to use OpenTable, it shouldn't offer them the option.
I do occasionally wonder, though, what to do with my Dining Rewards Points. I somehow can't see myself redeeming them on the website, waiting up to six weeks for delivery, taking a Dining Cheque to a restaurant, and then using it to pay for (some of) my meal. It would be great if I could somehow donate them to charity -- help treat some non-profit workers to a very nice lunch every so often. But then I suppose more people would redeem them, and the business model might not work any more.
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Del.icio.usWhy Big Banks Should be Smaller
James Kwak wants to make US financial institutions smaller:
There are a few main things that made companies like AIG and Citigroup systematically important. One was interconnectedness: they did business with lots of counterparties. One was complexity: when push came to shove, the regulators were not able to assess the potential damage a failure could cause, and therefore erred on the side of bailing them out. But the big one was size, and this is why we call it Too Big To Fail. The companies in question were so big, and had so many liabilities, that they could cause a lot of damage if they suddenly defaulted on those liabilities...
Size can definitely go away, simply by setting a cap on the volume of assets any institution is allowed to hold (and doing something about off-balance sheet entities).
Kevin Drum is not convinced:
It still has the flavor of a solution that's clear, simple, and wrong. After all, Bear Stearns was a quarter the size of Citigroup, and it was considered too big to fail. So just what would the limit be on bank size? $500 billion in assets? $200 billion? Can a country the size of the United States even have nationwide banks with limits like that? And what happens the next time around, when all these smallish banks overleverage themselves and collapse en masse? Are we any better off than we are with a few big banks failing?
I'm with James on this one. Two things are worth noting about Bear Stearns: first, it might have been small by Citigroup standards, but its balance sheet was still enormous. And secondly, it wasn't considered too big to fail, it was considered too interconnected to fail, largely as a result of its role as a major CDS broker.
To get specific, I think that maybe $300 billion in assets would be a reasonable cap on bank size -- there's very little evidence that banks get any economies of scale beyond that in any case. If they want to be part of a global or even a national network that would be fine -- I'm sure such networks would spring up quite naturally, much as they have in the airline industry. After all, the United States managed to go 200 years without any nationwide banks, it's unclear why it desperately needs them now.
At the same time, the cap on the balance sheet of broker-dealers should be smaller still: the more interconnected you are, the lower the cap, to the point at which companies like the CME, which are far too interconnected to fail no matter how small their balance sheet, should be barred from issuing any liabilities at all.
As for what happens when lots of smallish banks overleverage themselves and collapse en masse, well, you get an S&L crisis. Which is fiscally painful, to be sure, but which can largely be avoided through good regulation and which more importantly doesn't have anything like the systemic implications of the current meltdown. So yes, we're better off with one of those than we would be with Citi and BofA both failing.
The problem is a practical one: how do we get there from here. There are no good and politically-feasible answers to that question. So in the real world, TBTF banks are here to stay. But that doesn't mean we have to like it.
Great Moments in Political Rhetoric: Hannan vs Brown
From the European parliament, of all places:
(Via MAI, although I'm late to this, it's been viewed almost 2 million times on YouTube already.)
One Easy CDS Fix
I've had my share of disagreements with Arnold Kling on the subject of credit default swaps in the past, but he has a good idea today:
Regulators and accountants could require firms that are net sellers of credit default swaps to translate those positions into bond holdings and put these synthetic bonds on their balance sheets. My guess is that had such a policy been in place in 2000, the CDS market would not have taken off.
My guess is that Kling's guess is wrong: there were actually very few net sellers of CDS, and in any case for most of this decade the stock market seemed to think that ever-expanding financial balance sheets were a good thing, not a bad thing. But yes, definitely: if you're a net seller of protection, then the notional amount of credit that you're exposed to should be considered an asset on your balance sheet, just as it would be if you owned that credit in bond form.
It is conceivable that the the monolines -- which were by far the largest publicly-listed net sellers of protection -- might have thought twice about continuing their escapades in the CDS market if there would have been such an enormous effect on their balance sheet. Doing so would have brought them more into line with the buyers of synthetic CDOs, who were the other large net sellers of protection, and who invested up front all the money that they could possibly lose.
Kling's other point is that it's hard to buy long-dated derivatives on the big exchanges in Chicago: if you want something with a maturity of three years or longer, you need to buy it in the OTC markets. That's true, but he's wrong that "it is quite difficult to take a position of any size" in long-dated options: those OTC markets are huge, and in many cases substantially larger than the exchange-traded markets. And they seem to work pretty well, in the absence of massive players like AIG taking large net positions (on the order of hundreds of billions of dollars) in the market.
Why is the NYT Breaking the Web?
Websites get old, and need to be redesigned occasionally. That we understand. But the first rule of designing a website is that you make sure you can redesign it without breaking all the incoming links. And the first rule of redesigning a website is don't break all the incoming links.
The Obama administration broke that rule on January 20, when all links to whitehouse.gov broke at the stroke of noon. And now the New York Times has broken that rule as well, with all links to iht.com now redirecting to a marketing stunt for what the NYT is rebranding as its "global edition".
So for instance if you're reading my blog entry from May 2007 linking to an IHT op-ed by Ngozi Okonjo-Iweala, you won't be able to follow that link and read the op-ed. What's more, that op-ed doesn't exist on nytimes.com, in any form. The NYT essentially did its best to erase it from the internet, for no good reason.
How did the NYT manage to perpetrate something so utterly boneheaded? And does this mean that those of us who care a lot about our links not dying should start linking instead to organizations which are less idiotic, like the Guardian and the BBC? I hope that the NYT rectifies this error sharpish. Because it's losing a lot of webby goodwill by the hour.
Extra Credit, Sunday Edition
My Manhattan Project: The first-person story of Mike Osinski, whose software fuelled the mortgage-securitization boom.
TR thoughts on ticket re-sellers / scalping: Trent Reznor of Nine Inch Nails explains the economics of concert tickets.
Huffington Post launches journalism venture: Arianna and her friends are putting $1.75 million into investigative reporting. It's unclear whether the operation expects any revenues, or if it does where they're going to come from.
Hedge Fund Regulation Doesn't Matter: An Artificial Operational Due Diligence Floor: It's important that hedge-fund regulation not give investors a false sense of security. Its main purpose is to look out for systemic risk, not ponzis.
More Evidence of Volcker Being Marginalized
South Park - Stan Marsh takes us through the mortgage crisis: Very well done.
How the CDS Market is Going to Improve
A Credit Trader has a great post on what he calls "risky annuity risk", an artifact of the CDS market which will go away when all credit default swaps start trading on a fixed coupon. If you like to geek out with the arcana of the CDS market, you'll love this.
Let's say you're a CDS trader who buys $50 million of 5-year default protection on General Motors at 100bp. That means you pay 100bp per year -- $500,000 -- in return for getting a big payout should GM default at any point in the next five years. Six months later, GM is looking much riskier, is trading at 300bp. You decide to take your profits, so you sell $50 million of 4.5-year default protection at 300bp. You're now receiving $1.5 million a year, and paying out $500,000 a year, for a net profit of $1 million a year over the next four and a half years. Which adds up to $4.5 million. Well done! You book your $4.5 million profit, and celebrate with some fine Champagne.
But then GM defaults. This is not good for you. Yes, you're perfectly hedged when it comes to default risk: the amount you owe to the person who bought protection at 300bp is exactly the same as the amount that the person who sold you protection at 100bp owes you. Assuming no counterparty risk, you're flat, and there's no problem there. The problem is that your $1 million-a-year income stream has suddenly gone dry. The CDS have all been wound up: you're not paying $500,000 a year any more, and you're not receiving $1.5 million a year any more, either. And your $4.5 million profit has disappeared.
This is what ACT calls "essentially unhedgeable jump-to-default risk" -- you bet on a credit souring, the credit sours, you make lots of money, but then you hope desperately that the credit doesn't sour all the way to a credit event, because then you lose most of the money you thought you'd made.
The solution to this problem is to set the coupon on all CDSs at, say, 100bp. In that case, the first deal is exactly the same: you're the protection on $50 million notional of GM debt at a spread of 100bp, and you pay out your $500,000 per year. But when you come to close out the deal, instead of selling protection at 300bp, you sell protection at the same fixed spread of 100bp. Since GM credit default swaps are trading at a spread of 300bp, however, you're essentially selling the exact same contract that you entered into six months previously -- you're selling the privilege of being able to pay just $500,000 a year in return for that big payout if GM goes bust. How much is that privilege worth? $4.5 million.
The CDS has become a tradeable instrument, which goes up in price when spreads widen, and which goes down in price when spreads narrow. The buyer of protection always pays the seller $100,000 a year for every $10 million nominal amount, and the seller of protection pays the buyer an up-front sum if the spread is below 100bp. Conversely, if the spread is above 100bp, then the buyer of protection pays the seller an up-front sum.
By moving to this system, CDS traders manage to get rid of that pesky jump-to-default risky annuity risk, and can cash in their gains as soon as they close out their positions. Liquidity in the CDS market should improve, bid-offer spreads should narrow, and volumes should rise. Of course, that's exactly what all those people who want to move to exchange-traded CDSs want, right?
Update: Alea, in the comments, corrects my misconceptions about how the new system will work: apparently the annual premium will be a thing of the past, and the whole premium will be payable upfront. Which means that the buyer of protection always pays an up-front sum, no matter what the spread.
Update 2: Wait, no, that's not it, either, the buyer of protection still pays an annual premium, and then there's an upfront payment as well. Isn't that what I said the first time? Look, here you go, Markit explains it all in great detail. Look at pages 15-16.
Bonuses are Large Because They're Unpredictable
Mike at Rortybomb explains that the whole reason why Wall Street bonuses are so big is that there's a non-zero chance that they won't be paid:
I've heard it from several people that the argument for the bonus is "we deserve our bonus because we don't really get paid a big salary and expect to live on our large bonus." I retort "Well it is so large because you need to be compensated for the employer counterparty risk; you run the risk your employer will be gone, and the next one, be it a new bank or the USA, won't want to honor it."
There are other risks, too, with the end-of-year bonus system: maybe your employer will fire you just before you're due your bonus. Or maybe they'll simply decide that you don't deserve one this year, or that you deserve only a very small one.
The point is that there's so much uncertainty built in to the bonus system that the expected bonus has to be enormous in order to make up for it. Suppose I give you a choice between a base salary of $75,000 a year and an expected bonus of $1 million, or a base salary of $350,000 a year. If you're anything like me, you'd take the smaller amount with the higher predictability.
Now in the case of guaranteed bonuses, the calculus does change somewhat -- in that case, you might well opt for the $1 million. But the guarantee doesn't mean that you're certain to get that seven-figure payday; it just means that the degree of uncertainty has fallen substantially. And as Mike points out, you're still very much running the risk that your entire company goes bust, or that its new owners decide to abrogate those guarantees.
Not getting your bonus is a bit like those bad beats in poker. There's no point railing against them, they're bound to happen some of the time, and indeed if they never happened then the game wouldn't be structured that way in the first place. So accept it and move on with equanimity. Otherwise you just come across like a petulant child.
Ben Stein Watch: March 29, 2009
Ben Stein counts Jim Cramer as a friend. And millions of people watched the showdown between Jon Stewart and Jim Cramer on The Daily Show. But judging by his column this week, Cramer's friend Mr Stein wasn't one of them:
As you may know, Mr. Cramer appeared earlier this month on "The Daily Show," where Mr. Stewart yelled and cursed at him.
No, Ben, Jon Stewart does not yell at his guests. Cramer is the yeller, not Stewart. And in fact there was surprisingly little cursing, by Daily Show standards, on either side.
This was a substantive exchange -- yet Stein still insists on characterizing Stewart as "a comedy guy from Comedy Central". And he also seems to think that Stewart's only criticism of Cramer is that Cramer's predictions were wrong. And so he launches into a long explanation of how "we as humans cannot tell the future"; in fact, in the space of four paragraphs, Stein manages to use the word "human" or "humans" no fewer than six times (and "mortals" once), each time making the same point about fallibility.
Defensive much? Well, yes:
I would be remiss if I did not add that I have succumbed to this temptation to speak as if I could tell what the future holds...
The most that economic seers can do is apply broad, generally acceptable principles to current situations and try to go from there. When I stray far from that, I hope that thoughtful readers will call me to account.
Ben, you're a Hollywood hack, not an "economic seer". But in any case, if you're genuinely interested in people calling you to account, feel free to browse through the archives here. You're welcome.
And of course you don't disappoint in this column when it comes to hackery:
Just two years ago, how many people would have confidently predicted that we would elect our first African-American president in 2008? Who would have imagined that Citigroup would trade for a time under $1 or that General Electric would trade for a time under $6 or that Bear Stearns and Lehman Brothers would virtually vanish, or that a graduating class of law students would be unable to get jobs or that high-end M.B.A.'s would be unemployable?
And who would have guessed that we would have a fall of more than 50 percent in the broad stock indexes or that oil would triple in price and then fall by more than $100 a barrel? Some people might have seen parts of this pattern, but all of it? Again, life is far too complex to be predicted with any consistency.
Let me see: you're pointing out that no one predicted, two years ago, that Obama would be elected president and where Citigroup would trade and where GE would trade, and that Bear would vanish and that Lehman would vanish and that law students would find job hunting difficult and that MBAs would too and that stocks would fall more than 50% and that oil would go up a lot and that oil would then go down a lot. And you conclude that since no one managed to get all of that right, then hey, that just shows that life is terribly complex.
If all of these things had a 50% chance of happening, the chances of them all happening would be less than one in a thousand. Stein might as well have thrown in a few real outliers too: who on earth would have predicted that Natasha Richardson would die after a skiing accident? No one's asking for all predictions to be right. They're just asking that people like Ben Stein quit with the brainless boosterism and pay attention to reality once in a while.
Alternatively, Ben, you could simply quit with the punditry: all those TV appearances and books and newspaper columns which are predicated on the idea that you do know what's what. It's much easier to simply keep quiet than it is to be wrong the whole time. And then you won't have me or anybody else calling you to account any more.
Who's Gaining from the AIG Unwinds?
Tyler Durden has a scary post up, connecting banks' profitability in January and February to the fact that those were the months when AIG Financial Products was unwinding an enormous number of its contracts en masse. These trades, initiated by AIGFP, were allegedly enormously profitable for the biggest banks in the CDS market:
The size of these unwinds were enormous, the quotes I have heard were "we have never done as big or as profitable trades - ever"...
I can only guess/extrapolate what sort of PnL this put into the major global banks... I think for the big correlation players this could have easily been US$1-2bn per bank in this period."
If this is true, then (a) the banks still aren't anywhere near sustainable profitability, and (b) those AIG retention bonuses -- paid on the grounds that only the people who got AIG into this mess could get it out -- are even more egregiously untenable than we had suspected.
The whole point of having the government take over AIG was that it wouldn't need to enter into panicked unwinds. If it went ahead and did that anyway, the levels of competence and oversight at AIG are even lower than most of us had thought. Which is quite an achievement.
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