WealthPorn Day Arrives

It’s WealthPorn Day today, also known as the day that Alpha magazine releases its annual list of the top-earning hedge fund managers. Of course, that also makes it a great day for politicians, including Hank Paulson, to call for greater regulation of the hedge-fund industry.

George Soros is at #2 on the list with income of $2.9 billion: I’m impressed that he’s even eligible, given that he doesn’t actually manage his Quantum Endowment fund. (Julian Robertson, who made a ten-figure sum himself, was excluded from the list on the grounds that he "doesn’t have outside investors", which makes me wonder why James Simons’s Medallion fund was included.)

I’m also mildly tickled by the fact that the chief critic of these paydays, in Jenny Anderson’s story about the list, is billionaire Pimco founder Bill Gross. Obviously some ways of making megabucks are more kosher than others.

Posted in hedge funds, pay | Comments Off on WealthPorn Day Arrives

The Latest Victim of the Credit Crunch: Libor

Carrick Mollenkamp has a worrying piece in the WSJ today about Libor in general, and the much-benchmarked three-month Libor fixing in particular.

Jitters have made many banks unwilling to extend loans to each other for more than one week. As a result, the rates they quote for loans of three months or more are often speculative, because there’s little to no actual lending for that time period, brokers say. "It amounts to an average best guess," says Don Smith, an economist at ICAP, the London broker of interbank loans and derivatives.

This is a genuine and big problem, and one can see how Yves Smith could slip gently into hyperbole in response:

I saw this when working briefly in Mexico in 1984. The local McKinsey office confirmed that there was no reliable data in the entire economy.

It’s not that bad, at all. For one thing, as the article points out, it’s not in banks’ best interest to underreport the rates they’re paying on interbank loans, since their own assets are largely tied to Libor. If you’re earning understated Libor plus 20bp, while in reality you’re paying understated Libor plus 30bp, then you’re in deep trouble.

But it is peculiar, to say the least, that unsecured debt is seemingly being marked at lower rates than secured debt:

The Federal Reserve recently auctioned off $50 billion in one-month loans to banks for an average annualized interest rate of 2.82% — 0.1 percentage point higher than the comparable Libor rate. Because banks put up securities as collateral for the Fed loans, they should get them for a lower rate than Libor, which is riskier because it involves no collateral.

There’s no easy solution to this problem, beyond looking only at the more reliable Libor fixings, such as the overnight and one-week rates. But with many loans tied to one-month and three-month Libor, that won’t help a great deal.

Update: The British Bankers’ Association now says it will ban anybody deliberately misquoting interbank rates.

Posted in banking, bonds and loans | Comments Off on The Latest Victim of the Credit Crunch: Libor

Why Bush Doesn’t Like Cap-and-Trade

You want an argument for why a cap-and-trade system makes more sense than a carbon tax if you want to reduce carbon emissions? Take a look at all the noise surrounding the Bush speech on the subject today. Bush’s goal, of stopping growth in US carbon emissions by 2025, is incredibly weak. If that goal were legislated by means of a cap-and-trade system, the open-market cost of emitting carbon would be very close to zero. And yet such a system won’t be proposed:

One person briefed on White House deliberations said a cap-and-trade program for electric utilities was dropped from the package yesterday, after the White House was flooded with complaints from industry officials and lobbyists.

What did the industry dislike? Simple: Once you’ve set up a cap-and-trade system with any cap at all, even the most unambitious, then at that point the cap can be changed. That is, of course, the key advantage of a cap-and-trade system: if it becomes obvious that emissions need to be reduced further, it’s relatively easy to do so. On the other hand, given the political difficulty of getting any kind of tax hike through Congress, a carbon tax is much harder to tweak or to raise.

And so Bush’s proposal is likely to be little more than yet another "strategy for a way forward" rather than anything substantive. That, too, is OK, in its way. If the Bush administration waffles and does nothing, then the door is wide open for the next president to implement a properly-thought-out cap-and-trade system, which is something all three remaining candidates support.

Posted in climate change | Comments Off on Why Bush Doesn’t Like Cap-and-Trade

Extra Credit, Tuesday Edition

John McCain’s gas-tax pander

A Recluse Lifts the Veil a Little: Sorkin gets an interview with Stephen Feinberg. Apparently he’s no stickler for fine carpeting.

Exxon Mobil investor says: stop wasting our time! The activist investor agitating against activist investors.

The Best Hedge Fund Manager of All-Time

Black Swans, Black Scholes and Black Holes

Posted in remainders | Comments Off on Extra Credit, Tuesday Edition

Blogonomics: Herb Greenberg Quits Blogging

The insightful Herb Greenberg is leaving journalism to start up "an independent equity research boutique". And all power to him: as Paul Kedrosky says, "he deserves the broadest possible playing field to display and, yes, benefit financially from his talents".

But if he wants the broadest possible playing field to display his talents, why is he giving up his blog?

In his comments section Greenberg says that the blog is "unlikely to continue, sorry to say," almost as though the decision wasn’t up to him. Of course it is: it’s his company, he can do what he likes. And a blog would be a magnificent shop window for his company’s wares.

I suspect that Greenberg is worried about cannibalization: why would potential clients subscribe to his research product if they can get substantially the same information free from his blog? But I do hope he’ll reconsider. Clients value personal access more than the research product, and a blog is the best conceivable marketing tool. Besides, the feedback you get on a blog is invaluable in honing and improving your opinions on just about anything. Or does Greenberg thinks he’s smarter than anybody on the internet?

Update: Greenberg responds in the comments, saying that he’s giving up blogging because he’s "worried that it will be a distraction to the business". I think he should go out for lunch with Fred Wilson.

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How to Respond to a Cease & Desist Letter

Kurt Denke, the president of Blue Jeans Cable, is the Andre Agassi of the audio/video cable industry: he has an absolutely devastating return of serve. You know in the movies where the bully picks a fight with the wrong guy? This is just like that.

If you’ve ever been on the receiving end of a cease-and-desist letter, as I have, of if you like seeing people stand up to IP bullies, or if you just love the craft of a lawyer’s letter done supremely well, go check out Denke’s response to the hapless lawyers at LaRiviere, Grubman & Payne who asked him to recall his cables.

It’s certain that Monster will take no further action against Blue Jeans. What I hope is that this correspondence will become famous enough that Monster – which is infamous for its bullying tactics – will have to cease and desist from sending such letters altogether, since a simple copy-and-paste should suffice, henceforth, to send them on their way.

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Why Wachovia Needs That $7 Billion

Yesterday, I asked why Wachovia needed another $7 billion in fresh equity, and suggested it might be because it overpaid for Golden West Financial and was considering writing down part of the $25.5 billion acquisition cost. There’s a big problem with that theory, however: goodwill is not included in capital-adequacy calculations, which means that even a large write-down wouldn’t harm Wachovia’s capital base.

Wachovia’s real problem with Golden West, it turns out, is not the headline acquisition cost, so much as the inherited Golden West loan portfolio, which includes a staggering $121 billion – no, that’s not a misprint – in "pick-a-pay" mortgages.

These loans behave just like you think they do: borrowers get to decide how much money they’re going to pay back each month. Predictably enough, that isn’t working out too well.

On Monday, Wachovia conceded total losses from Pick-A-Pay loans could eventually amount to a staggering 7% to 8% of the loans’ combined value, a range of $8.5 billion to $9.7 billion.

There’s your $7 billion right there.

What’s more, there’s good reason why the 8% figure might turn out to be conservative: Wachovia has already said that 41% of its pick-a-pay customers have made the minimum payment in each of the past 12 months. The loans are structured so that making the minimum payment makes no sense for someone who could afford to pay more, which means that a huge number of these borrowers are clearly in pretty dire straits already. If and when house prices continue to deteriorate in value, to a level well below the principal amount on the mortgage, Wachovia might end up having to write off an enormous chunk of these loans, and accept extremely low recovery values to boot.

Oh and one other thing: 60% of the pick-a-pay mortgages were written in bubblicious California. That $7 billion, far from being excessive, could end up being insufficient to cover the losses on these things.

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Blogonomics: Ad Network Valuations

Erick Schonfeld reports today that Federated Media, a network which sells ad space on a network of blogs, is raising $50 million at an eye-popping valuation of $200 million. That’s a hell of a lot of money: it’s nine times 2007 revenues, and earnings have only been positive since September, so it’s hard to even imagine what the valuation is as a multiple of earnings.

How can ad-selling networks like Federated Media be worth so much money, when they have precious little in the way of earnings and absolutely nothing in the way of actual content? It’s not obvious, but this certainly seems to be a good business right now: Federated Media rival Blogads was the driver behind Ken Layne taking over Wonkette from Gawker Media, while Glam Media, which is an ad-selling network at heart, is valued at $500 million.

Something here doesn’t compute. When an ad-sales team is selling inventory across hundreds of different sites, it will never be able to command the kind of CPMs that a small and dedicated site-specific sales person could generate. Now there is certainly no shortage of blogs with readership far too low to be able to afford a site-specific sales person at an annual salary well into six figures. But I’m told that Glam Media is approaching large blogs with offers of guaranteed revenue in the seven-figure range, at implied CPMs of well over $10 paying well over $10 per thousand pageviews. That’s probably more than Gawker makes, across its network of sites, even with its dedicated sales team.

Now Glam Media is something of a special case: it loves to boast of enormous pageview numbers, as though it were Glam Media itself and not its partners who were generating all that traffic. But Federated Media never pretends to be a website: Schonfeld quotes its publisher Chas Edwards as saying that its partners can and will walk away at any time if Federated doesn’t "deliver value".

Naturally, this puts a huge amount of leverage in the hands of the publishers, who have Federated Media and Glam Media and Blogads and even Google all competing to see who can sell the publisher’s inventory at the highest possible rate. In such a competitive space, it’s hard to see how margins could be high enough to justify the kind of multiples being seen in the latest Federated Media equity round.

What’s more, the Federated Media equity is being provided by venture capitalists, who are going to want an exit down the road. If they are happy buying in at a $200 million valuation, that means they see Federated Media potentially being worth well over $1 billion at some point in the next few years. I’m as much of a fan of BoingBoing and TechCrunch as the next guy, but they have every incentive to maximize their own take of their ad revenues. How can what’s left over ever be worth billions? And if it is, what does that imply about the valuations of the underlying blogs? Remember that Wonkette was just more or less given away: it just doesn’t make sense that the property itself is worth nothing while the right to siphon off some minority percentage of its ad revenue is worth millions.

Schonfeld says that the $50 million from the latest Federated Media round will be invested to "help existing media partners expand to new sites" – which implies that Federated Media will finally become more of an investor in blogs, rather than merely the company that blogs turn to when they want to outsource their ad sales. So maybe this is an investment in content after all. Certainly Federated Media is as well-placed as anybody to get in on the content-aggregation game. But its core business right now is ad sales, and that’s looking increasingly commoditized.

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How Holdbacks Brought Down Frontier Airlines

On Friday I got a bit confused about something called credit card holdbacks, and how they could be used to drive an airline into bankruptcy.

It turns out that it all goes back to something known as the Fair Credit Billing Act of 1978. The insurance you receive when you buy something on a credit card is not a perk the card companies offer out of the goodness of their own hearts; it’s the law. If you charge something on a credit card and it isn’t delivered as agreed, then the credit card has a legal obligation under the act to refund your money.

Now most of the time this isn’t a big deal for credit card companies: if I buy a pair of jeans with my credit card, I walk out of the shop with them, and there’s not much chance of a dispute. With airline tickets, however, I’m paying now for a service in the future, and if the airline ceases operations, the credit card company is on the hook for a large sum of money which it’s quite unlikely to be able to recover from the airline.

As a result of this, everybody with an ounce of sense books their airline tickets on a credit card: it’s free insurance. But that also means that the credit card companies have a huge liability to consumers if an airline stops flying. And in fact they did end up having to pay out a lot of money in the mid-80s, when a few post-deregulation startup airlines did just that.

So there was an impasse. Consumers would only pay for airline tickets with credit cards, but the credit card companies didn’t want to let anybody charge airline tickets. The way to break the impasse was the holdback. Credit card companies signed agreements with the airlines that they could hold collateral and retain a certain percentage of all ticket sales, in order to indemnify themselves in the event that those charges would have to be refunded.

The credit card companies in question aren’t the same companies who send you your bill; they’re not even Visa and Mastercard themselves. Instead, they’re what’s known as "acquiring banks", with names like First Data and First Tennessee, who process all the transactions for a single vendor.

The relationship between an airline and its acquiring bank is one of the three most important relationships that an airline has: the other two are with a global distribution system, for ticketing, and with a jet fuel supplier. When First Data suddenly announced to Frontier that it was increasing its holdback to 50%, Frontier was in a very tough situation. The action would decimate Frontier’s cashflow, since substantially all of its income came through the credit card channel. With cashflow already tight, Frontier couldn’t afford that. But no other acquiring bank was interested in taking on Frontier’s business. So Frontier took the only other option available to it: declaring bankruptcy, in the hope that a bankruptcy judge would stop First Data from implementing the higher holdbacks.

Are there holdbacks elsewhere in the credit-card world? Yes, in the travel industry, of course: cruise lines, package-holiday vendors, that sort of thing. And also on the internet: I pay for my goods from Amazon.com before I receive them, and if I never receive them then I can ask for a refund.

And what happens if the credit-card company does have to pay out? In that event, the money from the holdbacks is used to mitigate the cost of the payouts. Both the holdbacks and the payouts are shared between First Data and the banks who issued the credit cards. But until that happens, First Data is in charge of looking after the holdbacks.

The only thing I’m still a bit unclear on is the ownership of the holdback money. Is it kept in an escrow account in the name of the airline? Does the airline get all the interest on that account? Or is it money which First Data can use for its own internal purposes? If First Data went bankrupt, would Frontier be just another unsecured creditor, or would it be able to take full ownership of the escrow account? Given the risks to the consumer-credit market which seem to be looming at the moment, at some point it might be the acquiring banks going bust, and not just the airlines.

(Many thanks to Joe Brancatelli for his help with all this.)

Update: A former cash manager at a major airline clears up my last question: the money is (usually) the property of the airline, not of the credit card company.

I managed the credit card holdbacks which were in several hundred million dollars. The cash was not co-mingled with the Bank’s (Chase Paymentech in our case) and we kept all interest earned. I was able to even decide what types of securities to invest in (subject to certain limitations). These details vary from agreement to agreement and it is subject to negotiation at the onset of the processing agreement. The account had a control provision and Chase could take control in the event that our financial condition deteriorated.

Posted in bankruptcy | 1 Comment

When the Fed Gave Up on Bear Stearns

If you have a few minutes to spare, it’s worth reading the official background to the JP Morgan – Bear Stearns merger, as filed with the SEC. The bit which jumps out at me is that after throwing Bear a lifeline on the evening of Thursday March 13, the Fed abruptly let go of the rope one day later, and essentially said "you’d better be rescued by JP Morgan, or you’re going to die".

During the evening of March 13, 2008, Bear Stearns senior management met with its legal and financial advisors to review the events of the day, the sharp deterioration in its liquidity position, and options potentially available to Bear Stearns. Following this meeting, Mr. Schwartz contacted James Dimon, Chairman and Chief Executive Officer of JPMorgan Chase, to discuss Bear Stearns’ liquidity position and seek funding assistance or a business combination…

Ultimately, JPMorgan Chase agreed to provide to Bear Stearns a secured lending facility for an initial term of up to 28 days under which JPMorgan Chase would provide funding to Bear Stearns. JPMorgan Chase’s secured lending facility was supported by a non-recourse, back-to-back loan from the New York Fed through its discount window…

During the morning of Friday, March 14, 2008, the board of directors of Bear Stearns met to receive an update from senior management regarding its efforts to identify funding sources and to authorize entry into the proposed secured lending facility from JPMorgan Chase. Later that morning, Bear Stearns issued a press release announcing that it had obtained this secured lending facility and that it was discussing permanent financing and other alternatives with JPMorgan Chase…

On Friday evening, Bear Stearns and JPMorgan Chase were informed by the New York Fed that the New York Fed-backed secured lending facility that had been entered into earlier that day would not be available on Monday morning.

On Friday morning, then, Bear Stearns announced "a secured lending facility for an initial term of up to 28 days"; by Friday evening, they were told that lending facility had already expired and would not even last through Monday. Quite a volte-face by the Fed!

Why did the Fed change its mind so abruptly? It was clearly a successful attempt to force Bear Stearns into a deal with JP Morgan – and it equally clearly allowed JP Morgan to simply name the acquisition price ($2 per share), since Bear was no longer viable as a going concern.

Of course, there’s a huge story hidden in the passive voice in the official narrative. Bear "were informed by the New York Fed"? Well, that’s one way of putting it. Another way would be to say "Tim Geithner decided that he didn’t want to risk Bear Stearns dragging down the market for the next 28 days, so he cut off their air supply and forced them into a shotgun marriage with JP Morgan". But then again, that’s not the kind of language one normally finds in SEC filings.

(Via Equity Private)

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Spinning Deutsche’s Loan Sale

I’m having something of a Rashomon moment with respect to Deutsche Bank’s sale of leveraged loans.

Dana Cimilluca and Peter Lattman, in the WSJ, say that the mooted sale by Deutsche Bank "could bolster its own health as well as that of the global banking system". Their numbers: "prices just below 90 cents on the dollar," a total deal of "between $15 billion and $20 billion" although it could be closer to $8 billion, and even some profit opportunity:

Deutsche Bank also could earn some hefty income along the way, as it is offering to finance the buyout firms’ purchases with about three-times leverage — or $3 of debt for every of $1 of equity — and charging a healthy interest rate.

But then check out Vipal Monga in The Deal, who’s much more downbeat. He’s looking for "an average price of around 85% of par," and says that the deal size is likely to be "a shade less than $5 billion". And as for the financing, it’s much better for the buyers than for the seller:

The leverage is being offered at a rate under LIBOR plus 100 basis points, which allows the buyers to reasonably aim for an internal rate of return of more than 25%. The financing will have a term of seven years and offers margin holidays to the buyers, meaning they won’t have to face margin calls for some initial period if the debt’s market price falls.

There’s no cut-and-dried way of telling who’s closer to the truth on this one, but Monga seems to have more detail and more color. But one can at least look at the terms being offered to the private equity shops and ask whether a double-digit spread over Libor really constitutes "a healthy interest rate" from Deutsche’s point of view. My feeling is that it doesn’t, not when Deutsche is selling the leveraged loans at distressed levels.

Let’s use the WSJ’s numbers: if the deal is $15 billion at say 89 cents on the dollar, that would mean write-downs of $1.65 billion. A spread of 100bp on three quarters of $15 billion, meanwhile, means income of about $112 million a year – or 6.8% of the putative write-down. Which doesn’t seem particularly healthy to me.

Posted in banking, bonds and loans | Comments Off on Spinning Deutsche’s Loan Sale

Private Equity Debt Buybacks: A Second Bite at the Cherry?

Here’s one for Dear John Thain or anybody else wondering about what happens when a private-equity shop buys the debt of its own portfolio companies. Let’s say that the portfolio company in question goes bankrupt, and is taken over by its creditors – who are an arm of the very same private equity company who owned it in the first place. Management stays in place, and the fees remitted back to the private-equity company remain. But at the limited-partner level there’s a world of difference: the first set of equity investors is wiped out, while the second set of debt investors ends up with all the equity upside.

At the general-partner level, you can see how this might be attractive. With valuations falling through the floor, the chances of getting back to breakeven on the equity are slim, and that 20% performance fee is a chimera. But as soon as the debt is converted to equity, it’s entirely possible that the debt-fund limited partnership will make profits, and that the general partners will be able to skim off their 20%. It’s a bit like those companies which reprice their CEO’s options when the stock price falls: the people in charge get a second bite at the cherry.

Do I think this is going to happen? No, not really. But is there any reason why it can’t?

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Extra Credit, Monday Edition

HELOC Nonsense: Tanta on how HELOCs work in the real world.

The Muffie Benson-Perella Show: Fox Business invites a fictional character onto their 5pm show.

Spiers, Cox Get New Titles For Same Jobs: A first, I’m pretty sure: a reasonably high-level debate about the finer points of inflation statistics, in the comments section of a post on Gawker.

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Iceland: Victimized by its Tiny Currency

Jim Surowiecki has a good piece on Iceland this week. "When we look at Iceland’s predicament," he says, "we should say that there but for the grace of China go we."

It’s a good point. If Iceland risks becoming the Bear Stearns of the North Atlantic, then America is the Citigroup: too big to fail.

I do differ with Surowiecki on one thing, though. He says that the troubles currently besetting Iceland are a direct consequence of the subprime crisis and the ongoing credit crunch. In a narrow sense, that’s true, but looking at the bigger picture Iceland has always had a very fragile economy. And the main reason is its insistence on having an independent, free-floating currency.

Iceland is the smallest economy in the world to have a floating currency. And floating currencies are dangerous to have: they’re by definition at the mercy of international currency speculators, with their trillions of dollars in daily flows. Iceland, in particular, has seen the value of its currency set not by any real fundamentals so much as by the mechanics of the notorious carry trade, where hedge funds borrow money in Swiss francs or yen, and invest it in high-yielding currencies like the Icelandic króna or the Brazilian real.

In strong years, this is good for Iceland: it means that Icelandic companies, including its banks, can snap up northern European retailers and financial institutions at attractive prices. But when the carry trade is unwound – and it always unwinds with a snap, never gradually – then Iceland is forced to implement extremely unpleasant pro-cyclical monetary policies to avert financial disaster.

Did Iceland borrow too much from abroad, as Surowiecki asserts? Yes. But if it had adopted the euro before doing so, it wouldn’t have its current problems. Of course, Iceland isn’t even in the EU, let alone close to becoming a formal member of the eurozone. But as Willem Buiter reminds us, you don’t need to be in the EU to adopt the euro. Maybe this present crisis might force Iceland’s population to start thinking the unthinkable.

Posted in economics, euro, foreign exchange | Comments Off on Iceland: Victimized by its Tiny Currency

Blogonomics: Selling Wonkette

Wonkette has been sold, to its managing editor, Ken Layne. In the memo, Nick Denton explains that Gawker Media just wasn’t very good at selling political ads. "Political advertisers are a strange breed; they don’t come

through the same agencies our sales people deal with," he writes, explaining that the New Wonkette "will become part of the Blogads network of political sites,

which includes Daily Kos".

This doesn’t mean that Wonkette is being sold to Blogads, just that Blogads will sell the advertising on the site. Makes sense. But then up pops Ken Layne in his own comments section to explain that Wonkette has done just that in the past:

Our new advertising partner is the same company that plastered this site with political ads back in the day.

So here’s the question: if it’s just a matter of Blogads being better at politically-oriented ad sales than Gawker Media’s ad team, why not outsource ad sales to Blogads as happened in the past? Blogads ends up selling the advertising on Wonkette either way, but this way Denton loses 100% of the equity in the site as well, and gets very little in return: Peter Kafka says "he’s more or less giving the sites away".

I’m sure that Wonkette is losing money right now; it may or may not become profitable with Blogads as an ad partner. In this election year, don’t you think that Denton would want to find out before selling for a negligible sum?

Assuming that Denton’s being smart, however – which is normally a reasonably safe assumption to make – this news is definitely a bad datapoint for anybody with dreams of becoming rich through blogging. Wonkette had 5.9 million pageviews and 1.5 million unique visitors in March: on the basis of the back-of-the-envelope calculations which have become increasingly commonplace in the blogosphere, it should have been worth an eight-figure sum. Instead, it seems to be worth almost nothing.

In order to make Wonkette profitable, Layne is likely to bring in a new equity partner, who will inject cash into the business (something Denton’s often reluctant to do) and raise the site’s visibility in Washington. If it works, there might be some serious money to be made. But if it doesn’t, then the new owners will essentially be throwing bad money after good, trying to invest in a political website with only seven months left until the election’s over and in the face of a looming advertising recession.

In any case, it’s obvious from this sale that even sites with over 5 million pageviews a month don’t simply make money automatically. Back when Denton launched the site in 2004, with original editor Ana Marie Cox, content was very cheap and competition was minimal. Ana’s now a highly-paid star writer for a major national newsweekly, and editorial budgets across Gawker Media have been rising inexorably as blogs take their place as just another media outlet which compete for talent alongside newspapers, magazines, television, and radio. The Wonkette masthead now runs to three editors, a video producer, and three interns, on top of whatever staffing is necessary on the business and technology side of things.

Or, to put it another way: a few years ago, no one was making much money on blogs, but no one was losing much money on blogs either. Today, both outcomes are possible.

Update: Peter Kafka also mentioned that "an earnout clause could eventually give Denton a few more bucks if the sites do well". I somehow doubt, however, that Wonkette is going to end up remitting to Gawker Media anything approaching a seven-figure sum. Denton’s ROI on Wonkette might conceivably end up being positive. But I very much doubt it will ever be anything to write home about.

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Recession: What can the President do?

Paul Krugman and Jesse Eisinger both have new columns out today, and they’re remarkably similar, dealing as they do with what, if anything, the next president is going to be able to do about the economic malaise facing the USA.

Jesse is in full-on ultrabear mode:

From the moment the next president takes office, one issue will overwhelm all others: the American financial crisis…

The threat now is to the foundation of our economic structure. Faith in the financial system is crumbling. Because of the scope of the problem, dealing with its aftermath will dominate the next president’s entire agenda.

Other concerns will still draw attention. But they will come in second. Health-care reform? Not going to happen anytime soon. Immigration overhaul? Pay no attention. Global warming? Iraq? By necessity, these issues will recede from view (though they will obviously remain problems).

The next president will take office during what may well come to be known as the Great Recession, the worst financial crisis of the post-World War II era…

The next president may well be dealing with markets in a continued free fall and a Fed that’s out of ammo and suffering serious damage to its reputation.

Jesse concludes that something really big is needed: a "New New Deal" which can socialize the risk which has increasingly been borne by working families in recent years. And Krugman provides some details of what such a New New Deal might look like:

Reinvigorated regulation could help restore confidence to the financial system. A return to pro-labor policies could help raise real wages. Pro-competitive policies — which are not the same thing as giving powerful businesses whatever they want — could help America regain its leadership in information technology. In other words, there’s a lot that could be done to perk up our sagging confidence.

All the same, both columns are stronger on problems than they are on solutions, and my feeling is that even the president of the United States of America doesn’t have enough power to turn a real Great Recession around. The financial crisis might yet work itself out, or it might continue to get seriously worse. Either way, I’m far from convinced that the US government is going to be able to do much about it.

Posted in economics, Politics | Comments Off on Recession: What can the President do?

The Problem With Private Equity Buying Leveraged Loans

Remember how those private-equity companies are buying back a bunch of their own debt at 90 cents on the dollar? Well, if it’s literally their own debt, rather than simply a bunch of leveraged loans in general, then Equity Private notes there might be a problem:

The equity holders in these companies that have taken the loans have to be ‘at risk’ with respect to the debt holders, and the debt holders have to act like debt holders and demand regular payments and enforce defaults or the IRS will characterize the capital as an equity investment and bounce the deductions on the debt payments that these companies have been filing.

In other words, there’s a reason why shareholders and bondholders are generally two different sets of people: the IRS frowns on companies making interest payments to themselves and then taking a tax deduction for doing so. Still, I’m sure that Leon Black et al are smart enough to work out how to get around this without being accused of forming a you-scratch-my-back-I’ll-scratch-yours cartel.

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Bidding Sotheby’s Down

Robert Frank is worried about the accounts receivable at Sotheby’s, which more than doubled to $835 million in 2007. This means that the "clients of Sotheby’s appear to be falling behind on their bills," he says – which could be bad news for the auction house.

What’s fascinating to me is the contrast between Sotheby’s share price, which has been declining pretty steadily for the past year or so, and its revenues, which keep on hitting new record highs.

Frank includes a pro forma paragraph to that effect, but he’s clearly not convinced:

Bill Sheridan, Sotheby’s chief financial officer, said the accounts receivables and guarantees aren’t a problem. Receivables rose largely because the firm’s sales increased, he said. Its consolidated sales — a combination of auction, private and dealer sales — rose 51% in 2007, while auction sales were up 44%.

Certainly the bears have been on the winning side of the argument since Sotheby’s stock spiked up to $57 in October. The company is now trading at less than half that level, with its stock just over $24, and so far there’s been no sign that the fall is over. But all of that is worries about the future, since the present is looking spectacular. An operating margin of over 30%, a return on equity of almost 50%, and diluted earnings of $3.25 per share in 2007, which puts the stock on a trailing p/e of less than 7.5.

It’s also worth noting that Sotheby’s hardly stands to lose $835 million if its buyers don’t pay: as the middleman, in that event it doesn’t pay the seller, and Sotheby’s loses only its commission.

Still, as Frank explains, there’s a lot of room for worry. We don’t know when exactly the contemporary art bubble is going to burst, but we can be pretty sure that it will, at some point. And when that happens, Sotheby’s is going to be left holding a vast number of guarantees on unsellable paintings. It all feels a bit like Citigroup, a year ago: the music is playing, the company is dancing, and no one likes to think about what’s going to happen when the music stops.

Frank is also worried that Sotheby’s is giving collectors three or four months to pay for their art – something which is cause for concern, to be sure, but which is also understandable in the context of financial markets which are more illiquid than at any time in living memory.

All the same, the number of rich collectors is not going to start falling any time soon, and many of them are salivating at the prospect that an economic downturn might force on-their-uppers old-money types to divest themselves of an heirloom or three. There’s more to the auction business than just contemporary art, and the rest of the market doesn’t look nearly as bubblicious.

I also wonder whether art collectors are shorting Sotheby’s shares as a hedge against the art market collapsing. It’s impossible to buy contemporary art at auction these days without worrying that you’re overpaying, and there’s no easy way to insure against your art falling in value. If shorting Sotheby’s is the best way of doing that, then maybe the company’s not in quite as much trouble as the depressed stock price might indicate.

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Buffett Caves

Well, that didn’t take long. A week ago the WSJ reported that Federal prosecutors were requesting the resignation of General Re CEO Joe Brandon; today it happened, despite Brandon’s having the strong support of his boss, Warren Buffett.

I don’t think this is a huge blow to General Re or to Berkshire Hathaway: Tad Montross, the former president and now CEO of General Re, knows the business intimately, while Berkshire’s reinsurance superstar, Ajit Jain, remains solidly in place. Still, it does seem that Buffett caved. I’d’ve done the same, though: especially when you’re trying to set up a new municipal reinsurer, you don’t want to antagonize any arm of the federal government.

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Neutra Houses for Sale

Arts blogger extraordinaire Tyler Green has a piece in the May issue of Portfolio on Richard Neutra’s Kaufmann House, which is being sold by Christie’s with an estimate of $15 million to $25 million; I blogged the house myself, back in November, and said that if architecture really were collectible in the same way as art, then we wouldn’t see it being sold at auction.

Tyler provides another datapoint proving that collectible architecture simply isn’t treated with the respect afforded collectible art:

The Kaufmann House isn’t the only Neutra on the market. His 1959 Singleton House, in L.A., is listed for just under $20 million. The current owner, hair-care baron Vidal Sassoon, bought it three years ago for $6 million and dramatically remodeled it. “It’s not so Neutra anymore,” Doe says. “What was the master bedroom is now a sunken bar. That’s a little extreme.”

Some photos of the Singleton House can be seen here. The thing which worries me most about the listing is the bit where it says "2 potential extra building pads on site". One has some hope that anybody shelling out $20 million for a Neutra house would build with the utmost respect around it. But then again, this is LA that we’re talking about.

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Ngozi Okonjo-Iweala is Brilliant

It’s the Brilliant issue of Portfolio this month, and under "Game Changers" one finds a lot of big-deal CEOs: Rupert Murdoch, Jamie Dimon, Lloyd Blankfein, Ratan Tata. And right there next to them is Ngozi Okonjo-Iweala. I went down to Washington to talk to her for the magazine, and she had a lot to say about her new gig at the World Bank.

Okonjo-Iweala is something of a force of nature, and interviewing her is quite an experience: you basically walk in and hope that your first question is a good one, because she’ll talk non-stop until she has to go to her next meeting. In any case, this is what she told me when I asked her what she was passionate about in her new job as a managing director of the World Bank.

I think that one of the reasons I agreed to rejoin the bank was I thought that Bob Zoellick, when he talked to me about it, brought a sense of passion, mission, and clarity about what he wanted to do in the Bank that was very appealing. Basically it was the idea that this is an institution in which new ways of doing business, new instruments, new approaches to helping people in developing countries improve their living standards and reduce poverty. This was very appealing. And this mix of approaches would include not just your standard aid, but looking very much at using all the powers and instruments of the World Bank Group, including the IFC and MIGA, to try and deliver for people in developing countries.

Then he set out a vision to which I subscribe, which has to do with focusing on six strategic themes, designed again to focus on helping poor people but also middle-income countries within the World Bank Group to share with the poorer countries. It has a theme of focus on the poorest countries; focus on fragile states, states that are in conflict or post conflict, trying to help them; focus on middle-income countries because he feels that the bank still has business in those countries: we have the staff and the talent that could be appealing to help these countries move further along on the development path. A focus on Arab states and how you help them integrate into the world economy; a focus on global public goods – with all the talk about climate change issues now, and how does the World Bank use its human and financial resources to help developing countries adapt to the changing climate, and go beyond even adaptation to be very proactive in terms of their contribution to making the climate change agenda a positive one for the whole world. That was very appealing to me. And finally on the knowledge and learning: the idea that the World Bank is a repository of knowledge, and how do we better share this knowledge among ourselves and with our clients, and transmit the knowledge from one part of the globe to another. That’s why we are the World Bank.

So along these six themes, I thought this speaks to me. And particularly speaks to me because my brief at the bank is to have oversight of three important regions of the world. The Africa region obviously, which is very exciting; South Asia, which has the characteristic of having some of the largest numbers of the world’s poor, in India, but also a combination of middle-income characteristics. India has some very poor regions or provinces that compare with the poorest developing countries, but at the same time it has another part of India that is moving along as if it’s clearly an emerging market but also a developed country. They have made the world’s smallest car, that is affordable to low-income countries all over the world; they are behind industries ranging from steel to car manufacturing to textiles, even to hotels and tourism. They are branching out, these companies from India, and becoming global. And trying to buy up big companies – I think they’re trying to buy Jaguar now. So here’s a country that has that unique exciting mix of both middle-income characteristics with poor characteristics, in a state like Bihar, or Rajasthan. And then there’s Bangladesh and Pakistan.

I’m also responsible for Europe and Central Asia. You have again a very interesting mix of countries who are joining the EU and are part of the developed world, so to speak. And then you’ve got poor countries in Europe like Albania, you’ve got countries in conflict like Kosovo and Bosnia, you’ve got the Stans: Tajikistan, Kyrgyzstan, Uzbekistan, and countries like Kazakhstan which have a mixture of characteristics: they are poorer countries, some of them are resource-rich, which provides very exciting challenges. From my own experience in Nigeria: how do you manage these resources in a way which can benefit the population? Some of the things we managed to do there are very relevant to that experience.

So here’s a large portfolio of regions and countries that is very rich. And at the same time I’m also responsible for the bank’s human resources function. I have oversight on that, which means that I get to try and change the way that we manage our human resources, our skills mix, to make these strategic themes work. To me it’s a good combination of trying to make the vision a reality.

I want to go further into the excitement of working on these countries with this very exciting mix. There are issues I’m very passionate about. How do you remove the constraints to growth in these countries? How do you work with them to bring in the kind of development that can really reach down to the poorer people in the population? And if you look across both the poor and middle-income countries, you see there’s one common theme that they all come back with, and that is a focus on infrastructure. And infrastructure of two types: physical infrastructure is becoming a constraint, in many of these countries, to development. And that makes you think: how can we help them with infrastructure in a way that also helps integrate regions or sub-regions? In Africa you have landlocked countries that have no access, and you can work on infrastructure which links them with other countries and gives them access to the sea for their exports: roads, railways, ports.

More and more the bank is doing regional integration projects in infrastructure. In the energy sector, in the roads sector: in energy we supported the West African gas pipeline that takes gas from Nigeria all the way through the west coast, going up to Ghana, Côte d’Ivoire, and even trying to stretch to Senegal now. That’s a very positive type of development to support. And we’re looking at various other sub-regional projects that can link countries together. In aviation, in energy, in roads, even in water. We supported the Leostho Highlands water project that takes water from Lesotho to South Africa. In Mozambique we’ve supported several projects that provide energy for the sub-region. So these are some of the things linking these countries in Africa. In South Asia you can look at the same thing: there are already links between Nepal and India that are long-standing, there’s potential to do projects that link the small landlocked countries with the bigger countries and give them a chance.

So those kind of things are quite exciting because they have lots of potential. At the same time there’s also the chance to look at the human development skills building. Many of these countries are hampered by lack of skills, be it in Africa, in Central Asia, or South Asia. And the need for helping countries grow skills that can take them forward in a globalizing world is very very important. You see how India has these two economies. They’ve leapfrogged, with the IT skills and the knowledge skills: they’ve become the center of outsourcing in the world, and the center of ICT development. And all the people that they trained, 50 years ago, are now out here running Microsoft, running IBM, all the hardware and software companies, and they’re sending knowledge and investment back to India. So if you develop your skills at an early stage, it can pay off years and years later. We’re trying some of those same ideas to help Africa, we’re going to see what more we can do to still help India: India still needs skills. And the other countries. So the human development angle is very attractive.

And then you talk about global public goods. I’m very passionate about the issue of being able to work with countries on the issue of climate change. Again if you look at African countries: how do you help them develop? It’s a great adaptation to climate change issues without letting it stop their development. How do you do agriculture, which is very important on the continent, even in South Asia and parts of Central Asia, where agriculture is huge, in terms of cotton, wheat, corn, and so on — how do you do this whilst helping farmers adapt to climate change? Those are some of the things that are interesting.

Now we’ve got floods that are unprecedented in many of these countries: not that they didn’t used to occur, but the frequency is getting higher. You’ve got droughts that come, again with higher frequency. So countries are going through some degree of stress. So what do you do to capture and conserve water, when there are these floods, so that when the droughts come, you can deal with it, through irrigation systems, through allowing people to tap into the water that you’ve already captured. Right now there are many countries where they don’t have these systems. You have the floods, and then the water is gone and drained away after a lot of damage. And that’s followed by a period of drought in which people have no access. So what do you do to help these countries to simply have some water management techniques which can help with adaptation.

What about forestry, and conserving forests? The World Bank has played a very important role in the conference in Bali. In also trying to get people to focus on the issue of deforestation in developing countries, and how do you work with developing countries and remunerate them for keeping the forest? Because they’re good carbon capture. But if the world wants this to happen, wants countries to maintain their forests and not cut them down, then you also have to think of incentives to do that. And these are issues where the Bank is uniquely placed to help.

There’s also the whole area of clean energy. There’s certainly technologies: you know that India is industrializing, so is China, and even some of the poorer countries, they will be industrializing and having their own manufacturing capability. They require a lot of energy to do that. Everybody’s aware that China’s building a new coal-fired plant every few days, and a key issue with all this is that the technologies exist now which enable them to make these plants into clean energy plants. But we need to support them. The developed world needs to help bring resources to invest. The World Bank needs to use both its expertise and its resources to help these countries to adapt.

The bank is going to develop several clean energy funds, running into several billions, to support developing countries to do this. And there are many developed country governments that are very supportive: the US, Japan, the UK are supportive of these clean energy funds. So things like that are quite exciting for me, because the fact is we will have resources to help these developing countries adapt in a way that supports their development. It’s not "manage for climate change or develop". It’s both. You can do both. And we have the capacity to do it.

And finally we mustn’t forget that we have been working with countries on another set of global public goods: managing diseases like HIV/Aids, malaria, turberculosis. And the Bank has done quite a good job: I can get figures of how much we’ve put into these areas. We are one of the biggest institutions supporting this. Diseases know no boundaries. So it’s a global public – maybe it’s a global public bad. And the Bank works on these global public bads, to make sure that they turn into goods.

And finally on the private sector side. I just want to mention that the Bank is deploying many instruments. In the IFC and MIGA portions of the Bank, there are so many things we are doing to support small and medium enterprises. In many countries. You know I started a fund before coming here, I co-founded a fund to support investment in African women entrepeneurs. So imagine how exciting it is for me that here, I’m at this institution where you can multiply that kind of action. The IFC now reaches millions and millions of small entrepeneurs through its actions. It suppports microfinance banks in various countries. It’s even starting funds that can invest in small and medium enterprises. You can leverage the bank’s instruments, financial and human, in order to really deliver for developing countries. And if I can help push that in those regions I’m responsible for, I feel that’s why I’m back.

At which point Okonjo-Iweala had to run to a meeting with Bob Zoellick. You can see why he appointed her one of his key lieutenants.

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Why Wachovia Needs Another $7 Billion

Why does Wachovia need another $7 billion of equity capital, on top of the $8.3 billion it raised earlier this year? It’s not like its capital ratios are particularly gruesome: as of March 31, its Tier 1 capital ratio was 7.5%, slightly higher than a year ago, and its total capital ratio was 12.1%, up from 11.4% a year ago. And that’s despite the fact that its loan loss provisions have risen from 0.80% to 1.37% of total loans.

Yes, Wachovia is losing money, but it’s hardly losing $7 billion: its unexpected quarterly loss was $393 million. And yet it’s raising new capital at somewhere in the region of $23.50 per share, which is very expensive, given that book value is $36.40.

Most likely this capital infusion is an attempt to prepare for an enormous write-down related to the $25.5 billion acquisition of mortgage lender Golden West Financial in May 2006. If Golden West’s business is worth only say $5 billion today, then at some point Wachovia’s going to have to take an enormous one-time loss, and it doesn’t have the capital to be able to do that right now.

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Ben Stein Watch: April 13, 2008

Ben Stein has a lot of money invested in the stock market, and tends to think of the stock market as a proxy for financial markets as a whole. So last summer, when the credit crunch first hit, he was sanguine about it because stocks didn’t fall. Now, when it’s clear that financial markets generally are in a lot of trouble, he still thinks it’s all about stocks.

"The markets are in a genuine credit crisis, on a scale rarely seen," says Stein in this week’s column – and then goes straight on to say that one of the reasons for this credit crisis is "the ending of the uptick rule in short sales." Er, no, Ben. A credit crisis affects credit. The uptick rule in short sales affected only stocks, insofar as it affected anything at all.

Joe Wiesenthal is quite right when he writes that "grousing about shorts is truly the last refuge of a scoundrel". The fact is that the uptick rule, or the lack thereof, didn’t even harm the stock market, let alone the credit markets. But Ben loves pointing fingers, and his second-favorite target is short sellers.

His favorite target, of course, is investment bankers. Our current Treasury secretary happens to be an investment banker by trade, and so Stein loves to attack him. Of course, being attacked by Ben Stein is a bit like being harangued no discernible reason by a demented vagrant: an impartial observer might feel sorry for the attacker, but none of the blows ever land. Stein accuses Paulson of "diverting attention" from the credit crisis by announcing long-term plans for revamping the regulatory structure overseeing US financial institutions. Has your attention been diverted? Mine hasn’t, or not by Paulson, in any event, and I’ve seen no indication in the financial press that coverage of the credit crisis has diminished since Paulson unveiled his plan.

But Paulson has mooted merging the CFTC with the SEC, and Ben’s not happy about that, calling it "an attack on basic legal protections of investors". Which isn’t true in any case, but also shows up Stein’s utter inability to consider "investors" to be anything other than just "stock market investors".

Stein also can’t conceive of a world in which some people suffer losses without other people (invariably investment bankers) finding themselves with enormous gains. "The false god of deregulation allows unscrupulous people to loot the system," he says, convinced that a cabal of cackling capitalists is somewhere cheering the present crisis, making billions of dollars every time another bank implodes.

The really funny bit is where Stein contrasts the winners and the losers. On the winning side you have "Wall Street", while on the losing side you have "the people who were wiped out in Bear Stearns stock", as though such people were widows in Omaha rather than the very investment bankers who Stein thinks are gaming the system so that they always win.

Still, Stein’s come a long way from his don’t-worry-be-happy days of a few months ago: he’s now putting out a call for "brave Coast Guard heroes," and ends his column by saying that "I don’t feel so good about the future." Can one hope that he knows the NYT is finally going to get around to firing him?

Incidentally, does anybody have a clue what Stein might be talking about when he says that "Paulson’s proposals divert the nation from such urgently needed measures as real solvency guarantees for the banks"? Is a "real solvency guarantee" the acceptable way of saying "bank bailout" in much the same way as "intelligent design" is simply a confusing way of saying "creationism"?

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Frontier Airlines, The Latest Credit Card Victim

I’m well aware that there’s no such thing as a free lunch. But some things come close, at least to the untrained eye, and one of them is the insurance that you get whenever you buy something on a credit card. It doesn’t matter if you bought a toaster or an airline ticket: if the machine doesn’t work or the airline suddenly ain’t flying for some reason, then you’re likely much better off if you bought with plastic rather than paying in cash.

Well, it turns out that the insurance isn’t free after all, and it’s not (just) a way for the credit-card companies to get you to use your card more. They also get to withhold money from vendors, and even push them into bankruptcy as a result. Here’s Sean Menke, the CEO of Frontier Airlines:

"Our principal credit card processor, very recently and unexpectedly informed us that, beginning on April 11, it intended to start withholding significant proceeds received from the sale of Frontier tickets. This change in established practices would have represented a material change to our cash forecasts and business plan. Unchecked, it would have put severe restraints on Frontier’s liquidity and would have made it impossible for us to continue normal operations."

Yep, never mind jet fuel, it’s credit card withholding which did for Frontier. JP Morgan analyst Jamie Baker explains what’s going on to Ann Keeton:

Typically, credit card processors turn over revenue to airlines in a couple of days, Baker said. But they can sign agreements with financially weak airlines, such as Frontier, to hold back a percentage of revenue from the time a ticket is purchased until the passenger takes the flight.

That percentage, it turns out, can be very high. The NYT again:

In its court petition, Frontier said that First Data had notified the airline that it was increasing the amount of collateral it required to $130 million from $54.5 million and that it would retain 50 percent of the airline’s bank card sales.

In other words, Frontier’s credit-card cashflow was being slashed in half, on top of a requirement to post an extra $75 million in collateral. You can see how a demand like that could force Frontier to declare bankruptcy.

I’m assuming, here, that the withholding is connected somehow to the insurance, and that First Data would have been liable to repay those fares if Frontier cancelled its flights. Is that indeed the case? Is there something online which explains how this all works?

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Annals of Stupid Philanthropy, BB&T Edition

What is it with ill-advised million-dollar charitable donations by banks? First of course there was Citigroup giving $1 million to the 92nd Street Y so that Jack Grubman’s twin girls could get into the preschool there. And now, well, I’ll let Matthew Keenan tell it:

The charitable arm of BB&T Corp., a banking company, pledged $1 million to the University of North Carolina Charlotte in 2005 and obtained an agreement that Ayn Rand’s novel "Atlas Shrugged" would become required reading for students. Marshall University in Huntington, West Virginia, and Johnson C. Smith University in Charlotte, North Carolina, say they also took grants and agreed to teach Rand.

As Daniel Davies says, “OMG CORPORATE TAKEOVER oF educations BAD MMKAY!” Actually, go read his whole post, there’s some cool substantive stuff in there as well. I just can’t see how this makes any sense from a corporate point of view. Normally a bank makes charitable donations partly in order to portray itself as warm and fuzzy; this just makes it look evil.

And I might as well slip it in here ‘cos I’ve already put up my linkblog for the day: John Rennie has a fantastic takedown over at Scientific American of Ben Stein’s execrable Expelled movie. (There is some kind of Propaganda Wars connection, but I won’t belabor the point.) Go read it: Rennie goes into a lot of detail about the atrocious intellectual dishonesty displayed by Stein in the movie. The piece should be required reading for anyone at the NYT who thinks that Stein deserves to keep his perch there.

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