Vernon Smith Leaves GMU; Bloggers Silent

Posted on July 23, 2007 by Felix

GMU’s economics department is, famously, full of bloggers. Its chairman Donald

Boudreaux blogs at Cafe Hayek

with colleague Russ Roberts; Robin Hanson

founded Overcoming Bias; Bryan

Caplan and Arnold Kling blog at EconLog;

Peter Boettke blogs at The

Austrian Economists; and, of course, Tyler Cowen and Alex

Tabarrok are bona fide stars of the blogosphere with their

hugely popular Marginal Revolution.

I’m sure there are more I don’t know about, too. All of these bloggers are famously

unrestrained.

GMU’s economics department is, famously, also home to 2002 Nobel laureate Vernon

Smith. (He’s 80 years old, and a Nobelist, so you’ll forgive him for

not having a blog of his own.) Smith more or less invented the hugely fecund

field of experimental economics, and is by far the most important economist

at GMU.

So when GMU grad student Brian Hollar broke

the news that Smith was leaving GMU and taking most of its experimental

economics faculty with him to Chapman University in California, it’s not surprising

that the blogosphere immediately started buzzing. Or rather, it is

surprising that the blogosphere didn’t start buzzing: so far, none

of the GMU economists has seen fit to mention this news at all. One might almost

think that a don’t-blog-this edict had gone out, either explicitly or implicitly.

But certainly the silence is puzzling.

Update: Midas Oracle has the letter

sent to GMU economics grad students.

Posted in economics | Comments Off on Vernon Smith Leaves GMU; Bloggers Silent

Harry Kat: Changing His Tune?

Posted on July 23, 2007 by Felix

Earlier this month, John Cassidy profiled

Harry Kat, hedge fund replictor. It certainly seemed that Kat’s

business was to replicate the returns that hedge funds generate, if not on a

month-to-month basis then certainly over the medium term.

Rather than trying to emulate a hedge fund’s monthly return—a

nearly impossible task—the researchers sought to match the fund’s

results over a period of several years, as well as the other statistical properties

of its performance that investors were likely to care about most: the volatility

of the returns, their correlation with the stock market, the likelihood of

suffering extreme losses.

In the spring of last year, Kat sent me an e-mail in which he expressed confidence

that he and Palaro would succeed. “It is possible to design mechanical

futures-trading strategies which generate returns with the same, and often

better, risk-return properties as hedge funds,” he said. “This

means investors can have hedge-fund returns but without the massive

fees and all the other drawbacks that come with the real thing.”…

Each night, after the markets have closed, FundCreator downloads financial

data from all over the world and determines what new trades each of its users

needs. When a user logs on in the morning, a red light flashes to indicate

that action is needed. “You just click on it every day, it tells you

what you need to do, you do it, and you get Quantum,” Kat said proudly.

“It’s simple.”

[Emphasis added.]

Now comes the WSJ’s Eleanor Laise, with a much more

skeptical take on hedge-fund replicators in general. Kat turns up at the

end:

Mr. Kat markets a competing approach to cloning that doesn’t aim to match

returns but instead tries to mimic typical hedge-fund characteristics, such

as low correlation to broader markets.

Doesn’t aim to match returns? I’d say that’s a pretty sharp change

of tune from Mr Kat. What on earth does it mean to "get Quantum" if

you don’t get Quantum’s returns?

Posted in hedge funds | Comments Off on Harry Kat: Changing His Tune?

Vonage: Bad for Shareholders, Good for Consumers

Posted on July 23, 2007 by Felix

I’ve been a Vonage subscriber for over four years, and have never had any problems

with them. I do know, however, that the company is losing money hand over fist,

and that its share price

is regularly hitting new all-time lows. Today it’s down about 5.5% to $2.61;

it’s worth remembering that Vonage went public only last year, at a price of

$15 per share.

One of the reasons for Vonage’s slump today is the mess that is the collapse

of SunRocket. I’ve consoled myself in the past that Vonage wouldn’t simply

go out of business overnight: someone, somewhere, would put a positive value

on its millions of subscribers, and would take over the company as a going concern.

But that certainly didn’t happen in the case of SunRocket. And the NYT quotes

John Nakahata, former chief of staff for the Federal Communications

Commission, as saying that I should be rather less passive:

“Ultimately, the consumer has to learn to factor in, how stable is

this entity I’m entrusting with my phone service?”

Clearly, Vonage is not a particularly stable company. What with patent fights

and stiff competition in a commoditized marketplace, it’s hard to see how the

company is going to stay afloat for long. And the last thing I want is to find

myself in a SunRocket-style situation where I lose my phone service overnight

and have to struggle to move my number elsewhere.

And even the prospect of a takeover is not particulary reassuring. If Vonage

is bought by some big telco, then there’s a good chance I’ll end up

on that big telco’s VOIP service, complete with the relatively high international

rates I’ve been successfully avoiding by using Vonage. On the other hand, there’s

no point in switching from Vonage to some other small VOIP company, because

all of them are pretty much in the same boat.

For the time being, then, I’m sticking with Vonage, and a lot of the reason

why is that none of the more financially secure players in the market seem to

offer anything like as good rates internationally. US consumers need Vonage

to continue to exist, just to provide some level of competition against the

triple-play packages which are becoming increasingly popular and which bury

highly profitable international rates in the small print. Vonage’s business

model might not be great for its shareholders, but it’s certainly good news

for consumers.

Posted in technology | 5 Comments

Transocean’s Unnecessary $15 Billion in Debt

Posted on July 23, 2007 by Felix

I love this Transocean-GlobalSantaFe deal.

For one thing, I love any deal which creates a $53 billion company by combining

two firms that almost no one has ever heard of. And for another thing, I love

the idea that even though Transocean (market cap: $32 billion) is clearly acquiring

GlobalSantaFe (market cap: $17 billion), the deal is still being described with

a straight face as a "merger of equals".

My favorite bit of all, however, is the way that the combined company is going

to have to raise $15 billion in order to finance this, er, all-stock deal. Even

as debt offerings are being pulled or downsized across the markets, these drillers

are borrowing money for no real purpose other than giving it straight to their

shareholders. Bloomberg

quotes Morgan Keegan’s Michael Drickamer:

Because the drillers were earning money faster than they could reinvest it

wisely, giving cash to shareholders through the deal makes sense, Drickamer

said.

But it’s not as simple as that. Here’s Reuters,

with a bit more detail:

"This is the type of transaction shareholders have been clamoring for,"

said Mark Urness, an analyst with Calyon Securities.

"They have managed to dividend-out a portion of their backlogs,"

Urness said.

The combined company would use its first two years of free cash flow to reduce

debt.

Essentially, the companies are borrowing $15 billion, giving it to their shareholders,

and will then spend the next two years paying that money back as fast as possible

out of cashflow. Apparently, this makes more sense than just taking the cashflow

and giving that to shareholders.

The era of leveraged deals is far from over, it would seem.

Posted in bonds and loans, M&A | Comments Off on Transocean’s Unnecessary $15 Billion in Debt

Unanswered Questions at Bear Stearns

Posted on July 23, 2007 by Felix

Does anybody really understand what happened at the two Bear Stearns hedge

funds which have now imploded? There are a lot of unanswered questions, and

Bear Stearns itself seems to be trying as hard as possible not to answer them.

Naturally, the combination of large financial losses and extreme opacity is

almost certain to result in lots

of litigation. But even those of us without any direct financial interest

in the Bear funds have many reasons to want to understand exactly how the whole

fiasco happened.

The biggest question in my mind is how investors in the two different funds

could end up losing pretty much exactly the same amount of money. The first

fund was more conservative, and it got a $1.6 billion bailout from Bear Stearns

– and yet nearly all of the money of its investors has disappeared. Meanwhile,

the second fund was more highly levered, and got no bailout at all – and

yet it seems that all of its borrowers have been repaid in full, and that its

investors might actually get a tiny amount of their money back.

Steve Waldman has lots

more questions, especially regarding the manner in which creditors were

repaid.

As an investor in one of the funds, I’d want to know how much debt was extinguished

for each of the assets surrendered, that is, what sort of valuations were

implicit in the workout, and how they were arrived at. If the assets were

not in fact auctioned, perhaps creditors paid less in terms of debt forgiven

than the assets were in fact worth. Perhaps Bear’s interest in putting an

embarrassing incident behind it without causing turmoil in a fragile market

led it to drive less-than-a-hard bargain with creditors, who were after all

in an exploitably poor bargaining position. Were fund managers gentlemanly

among Wall Street colleagues, or fierce on behalf of their investors? I’d

want to know.

Chief among the askers of such questions would seem to be Barclays, which has

lost

as much as $400 million of its own and its clients’ money. All of Barclays’

loans to the funds have been repaid; the losses are on investments in the funds.

But because Barclays was a big lender to the funds, it had the ability to limit

the investments those funds were making. And there seems to be a good chance

that Bear Stearns ended up, essentially, breaking loan covenants:

Barclays imposed certain investment restrictions on Bear. The restrictions

ranged from limiting the number of noninvestment grade holdings that the fund

could buy, to curbing the fund’s exposure to collateralized debt obligations,

securities backed by pools of mortgage loans, and asset-backed securities.

But according to people familiar with the situation, some of those restrictions

were breached by the Bear fund.

If this is true, then Bear Stearns could yet be on the hook for some big legal

liabilities – especially since all the funds’ other investors are likely

to start suing Bear as well.

Posted in hedge funds | Comments Off on Unanswered Questions at Bear Stearns

When Governments Buy Companies

Posted on July 23, 2007 by Felix

The UK is one of the least protectionist countries in the world, when it comes

to foreign companies buying domestic assets. A French utility wants to buy a

UK water company or railroad? No problem. A Mexican cement company wants to

buy a UK competitor? Come right in. But now, the foreign investors with their

eye on the UK are not private, but public. And that’s making people nervous.

The

Observer wrote, in a leader yesterday:

Last week Sainsbury’s looked ready to succumb to takeover by the investment

arm of the Qatar government. Last year, ferry operator P&O was taken over

by the government of Dubai. Gazprom, the Russian state gas monopoly and a

tool of Kremlin foreign policy, is reportedly planning to bid for Centrica,

owners of British Gas. That would follow its purchase of Pennine Natural Gas

last year.

The Chinese government has set up a $300 billion fund to buy Western companies,

with British assets top of the list. There are sound reasons to keep Britain’s

economy attractive to foreign investment, but embracing liberal global markets

should not be a cover for nationalisation under foreign flags.

The editorial set off an interesting debate chez Tim

Worstall, who reckons, basically, that money is fungible and that it therefore

doesn’t matter who’s doing the buying. But clearly a line has to be drawn somewhere.

Matthew

Turner notes:

Tim himself draws the line at defence contracters (presumably not the US

or other allies though) and North Korea (for anything). Issues of national

security led some commenters to say they wouldn’t want Russia to be in charge

of our energy generation. Hands-off governments could become hands-on ones

if it comes to a decision between shutting a factory in the UK and one in

their home country.

My view is that national security matters, and that Russian ownership of UK

gas assets comes very close to posing a national-security problem, given Russia’s

demonstrated willingness to use its gas assets to political ends. On the other

hand, a lot of foreign takeovers do not pose any kind of national-security problem

at all. “How on earth can it be in Britain’s interest to allow Sainsbury’s

to become the nationalized property of a Gulf state?’’ asks

Unite’s Brian Revell – to which the answer is that if Qatar pays more

money than anybody else is willing to offer for the UK supermarket, then Sainsbury’s

present shareholders can use that money to generate better domestic returns

elsewhere.

Similarly, in the US, the proposed acquisition of foreign-owned ports by Dubai

was not a major security threat, overheated

Senatorial rhetoric notwithstanding, and the same thing can be said of the

proposed acquisition of Unocal by China’s CNOOC, especially considering the

fact that the overwhelming majority of Unocal’s assets are overseas to begin

with.

Which brings us to the news

that Barclays is getting a major cash injection from the governments of China

and Singapore. This is only natural, and nothing to be concerned about. Singapore

has been investing its enormous foreign reserves globally for decades, and China

can’t be expected to invest its own trillion dollars of reserves in nothing

but Treasury bonds. China and Singapore are part of the global financial system,

and it makes perfect sense that they’d like a minority stake in a global bank.

In fact, it makes much more sense than China’s stake in Blackstone.

Generally, then, I have little sympathy with those who complain of "nationalisation

under foreign flags". If finance can knit the world together more tightly,

then so much the better. There will always be exceptions, of course. But they

are fewer than most people might think.

Update: Chris

Dillow weighs in, forcefully.

Posted in economics | Comments Off on When Governments Buy Companies

Using the iPhone Abroad

Posted on July 22, 2007 by Felix

I’ve been doing a bit of homework, and I think I now know most of what there

is to know about using the iPhone abroad. In a word: Beware.

If you’re not careful, you could end up running up a truly enormous bill. Here

are all the details.

The first thing to know is that the iPhone doesn’t work abroad at all unless

and until you phone up AT&T and ask them to allow international roaming.

Before they allow it, they’ll check your credit. It’s very easy to run up a

four-digit phone bill without realizing it, so they want to make sure you’ll

be good for it.

Once international roaming is activated, you have two choices for your phone

calls. The first choice is that you pay AT&T $5.99 per month for something

they call World Traveler, which means that all calls you make abroad are very

expensive. They start at 99 cents per minute, in most of western Europe, and

cost $1.99 a minute in Argentina and $2.29 a minute in Egypt. The second choice

is that you don’t pay the $5.99 a month, in which case calls 30 cents

per minute more in those countries. If you go somewhere not covered by the World

Traveler plan, like Iceland or Lithuania, there’s no discount: you’ll pay the

same rate ($1.29 a minute or $3.49 a minute, respectively) whether you’ve got

the plan or not. The full list of rates is here.

As well as the World Traveler plan, there are also special dedicated plans

for Canada and Mexico. AT&T Mexico costs $4.99 a month and lets you roam

for 59 cents a minute – as opposed to 99 cents a minute normally. AT&T

Canada costs $3.99 a month and also lets you roam for 59 cents a minute, as

opposed to 79 cents a minute normally. What’s more, if you travel to Toronto

or anywhere in something known as the "Golden Horseshoe" at the west

end of Lake Ontario, you can roam on the Rogers network for free.

Can you sign up for World Traveler before you leave and then cancel it when

you return? Sorta. There’s no annual contract, or anything locking you in. But

international calls can take a long time to show up on your bill, and you only

get billed at the lower rate if you have World Traveler when they show up. The

date that you made the call is irrelevant. So expect to be signed up for the

plan for two or possibly even three billing cycles, if you want to be sure of

catching all the calls you made.

All calls made while roaming are billed at the same flat rate, whether they’re

incoming or outgoing, and no matter where they’re made to. If you’re roaming

in Iceland, for instance, you can call the Maldives for $1.29 a minute, but

if you’re in the Maldives, it costs $4.99 a minute to call Iceland – just

as it costs $4.99 a minute to receive a phone call, no matter where

in the world the caller is calling from.

For that reason, a service like JaJah doesn’t

help when you’re travelling internationally, even if you have wifi access. JaJah

is based on the idea that received calls cost less than outgoing calls, but

that’s not the case with international roaming. If you’re calling the US, that

costs the same as someone in the US calling you.

What about voicemail? The iPhone’s visual voicemail system is a godsend for

international travellers, since it vastly reduces the number of minutes used

checking your voicemail. Those minutes are, of course, billed at the international

roaming rate. And if you have your phone on when someone calls, and the call

goes through to voicemail, then that call gets billed at the international roaming

rate as well.

Then there’s text messaging. With text messaging, or SMS, it makes a difference

whether you’re sending or receiving. Receiving a text message while abroad is

not a problem: it comes out of your monthly allowance. Sending a text message

while abroad, however, costs 50 cents per messsage. Which is a real bargain

compared to the cost of a phone call or – as we will see – the cost

of sending an email if you’re not in a wifi zone.

By now, of course, most international travelers are well aware of the cost

of phone calls. But the iPhone adds a whole new layer of costs on top, because

it’s designed to be used in conjunction with an unlimited data plan. The problem

is that data is only unlimited within the USA. When you’re abroad, it’s very,

very expensive. To be precise, it’s $0.0195 per kilobyte, or $19.97 per megabyte.

To view the Portfolio.com home page, at that rate, costs $18.49.

Alternatively, of course, it costs nothing – if you’re using the iPhone’s

wifi functionality. If you join a wifi network, all your data usage is free

(at most, it costs whatever the price is to join that network). Surf the web

to your heart’s content, check your emails, use Google Maps, view YouTube videos

– none of it costs a penny. But remember to navigate back to the home

screen of the iPhone when you’re done. When you next turn the phone on, if you’re

not in a wifi zone, you really don’t want your phone to start automatically

downloading your 50 most recent emails, or giving you driving instructions from

Paris to Dakar. That’s fun if you have wifi, but it’s very, very expensive if

you don’t. (Also worth knowing: once the iPhone starts downloading your most

recent emails, that operation cannot be cancelled.)

The really sad news here is with respect to Google Maps. The Google Maps functionality

on the iPhone is absolutely gorgeous, and extremely useful when you’re travelling

in a strange place. But the problem is that it’s constantly drawing and redrawing

those maps and satellite images, downloading data all the while. If you find

yourself lost in some strange village and need directions to your hotel, Google

Maps will do that for you, no problem. But unless that strange village happens

to have a wifi network you can hop on to, they will almost certainly be the

most expensive directions you ever get.

There is an international data plan you can sign up for, but it’s not particularly

attractive. It gives you 20MB of data per month for a monthly fee of $24.99.

If you go over that rate, depending on what country you’re in, you pay $0.005

per kb.

There are two reasons why this isn’t very attractive. For one thing, 20MB of

data isn’t very much, especially if you’re using Google Maps or spending any

time browsing the web – the kinds of activities where you could easily

get through your montly quota in one day. (And don’t even think about

watching videos on YouTube.) And when you go over the 20MB limit, $0.005/kb

isn’t very cheap: downloading the Portfolio.com homepage, at that rate, still

costs $4.74.

The other big problem with the $24.99/month plan is that it’s an annual contract.

You can’t sign up for it before you go travelling and then cancel it upon your

return: if you try, you’ll be whacked with a $175 early cancellation fee.

So what’s the best way of taking an iPhone abroad? If you’re really scared

about running up data bills – and you should be – then one way of

ensuring that can’t happen is to phone up AT&T just before you leave, on

800-335-4685, and ask them to disable your data plan. Then phone them again

on your return, and get them to turn it back on. You can still use the phone

to surf the web and check your emails when you’re in a wifi zone, but you won’t

get a massive bill for doing the same thing over the cellular network.

The other thing you can do is switch your phone to airplane mode most of the

time. That turns off everything: both voice and wifi. When you’re in a wifi

zone, or when you want to make a phone call, come out of airplane mode and do

whatever you need to do, then turn airplane mode back on again.

This solution has the advantage or disadvantage, depending on how you look

at it, of barring incoming phone calls. You might miss something important,

but you won’t be woken up in the middle of the night by a telemarketer and have

to pay over a buck a minute for the privilege. And every time you turn your

phone on, to make a call or to surf on a wifi network, the iPhone will check

to see if you have any voicemails from people who’ve tried to reach you. You

can then check the voicemails you want to check, miss the voicemails you want

to miss, and only pay for airtime once. If you keep your phone on at all times,

in contrast, then you need to pay twice for every voicemail you listen to: once

when it’s left, and once when it’s retrieved.

Your best friend, then, when you’re travelling, is the Settings page. At the

top of the page are the two most important settings: Airplane mode, which we’ve

already covered, and Wi-Fi. If you want to use Wi-Fi, it’s a good idea to select

and join a network first, before you start checking email or web pages. That

way there’s no gap during which AT&T can start charging you their exorbitant

data rates.

Remember that the iPhone is a version 1.0 device. It has a lot of glitches,

and international roaming is a big one. Everything simple and effortless about

the iPhone – the seamless switching between wifi and cellular data –

becomes a massive and potentially extremely expensive problem when the phone

leaves US shores. Once the iPhone becomes available in the rest of the world,

I have some faith that international data rates might come down a bit, or that,

alternatively, it will be possible to buy a local pay-as-you-go SIM card to

use in foreign countries when you’re travelling. For the time being, however,

I’d highly recommend not using your iPhone abroad like you use it domestically

– not unless money is no object. If anybody wants to calculate the cost

of watching Dick in a Box

while roaming internationally at $0.0195 per kilobyte, I’d be fascinated to

find out.

Update: Boing

Boing has the tale of the man who roamed in England and Ireland for two

weeks, and ran up a $3,000 bill.

Posted in technology | Comments Off on Using the iPhone Abroad

Give Your Money Away

Posted on July 22, 2007 by Felix

Most econobloggers, myself included, find it hard enough to drink from the

firehose of current information. (My RSS reader currently has 7,148 unread items.)

But Mark Thoma, econoblogger extraordinaire, not only seems

to manage to keep up on current news and debates, but also manages to find

utter gems like this one, an essay by Joan Robinson from

1936. Go read it. Among many other things, it more or less explains the existence

of 90% of the Wall Street Joural’s editorial page long before that ignoble institution

existed in its present form. What’s more, the lucidity of the prose puts essentially

all of today’s professional economists to shame. The basic gist is that the

rich use economics – or, more to the point, economists – to delude

themselves that they shouldn’t give their money away.

Coincidentally, Barry Ritholtz reprints

a Tom Toles cartoon wherein the WSJ editorial page runs a story

headlined "Rich Insufficiently Rich, Study Proves". After 71 of the

most momentous years in human history, nothing has changed.

If you want another reason to give away your wealth, try being rich on a cruise

ship in a storm. The biggest and most expensive cabins tend to be the highest

up, where the movement and the seasickness is the greatest. And along similar

lines, Yves Smith has found

a Popular Mechanics survey which shows that on airplanes, first-class

seats are by far the most dangerous to sit in. If you’re in a plane crash

and sitting at the back of the plane, your chances of survival are 69%. At the

front of the plane, they’re 49%.

But what if you want your wealth in order to buy Chris Dillow’s new

book?

Well, it turns out that you shouldn’t

buy it after all.

So, what are you waiting for? If you need a good destination for your cash,

you could do a lot worse than to start here.

Posted in economics, remainders | Comments Off on Give Your Money Away

Blackstone and Orbitz Tumble

Posted on July 20, 2007 by Felix

Whose bright idea was it to take Orbitz public under the ticker symbol OWW?

That’s certainly the sound that Blackstone chief Steve Schwarzman

is making today: not only is his own

stock trading at a mere $26 per share – down $5 from its offer price

– but the stock of Orbitz is down, too. Blackstone took the travel company

public today at $15 per share, but it’s already trading a good 50 cents below

that level. Even Blackstone didn’t drop below its offering price on its first

day of trading.

It’s easy to see why neither business looks particularly attractive right now,

despite their multibillion-dollar valuations. The primary fuel driving Blackstone’s

stellar returns – cheap junk-rated debt – is becoming very scarce.

And Orbitz is losing money in the highly competitive world of online travel

reservations, where price is king.

In any event, I think that travellers are learning that Orbitz never undercuts

the fares available at the airlines’ own sites. Perhaps people use the site

to find the best fares – but then they buy them directly from the airlines,

avoiding the Orbitz booking fee. That’s what I do, not because of the booking

fee, so much as because I’ve noticed much better service and much more flexibility

from airlines when I’ve bought the ticket from them directly than when I’ve

bought the ticket through Orbitz. To take one example, Orbitz tickets on Virgin

Atlantic are generally non-upgradeable, while the same ticket bought for the

same price from the airline can be upgraded easily.

Orbitz is hoping that it will make profits from hotels and car reservations,

which should give it profits even if the airline-tickets business is never particularly

lucrative. I’ll believe it when I see it. But maybe Blackstone is being smart

here, for getting out of at least some of the business while it can.

Posted in stocks | Comments Off on Blackstone and Orbitz Tumble

New ABX Mortgage Index Still Looks Ugly

Posted on July 20, 2007 by Felix

Nancy Leinfuss was mostly

right. The much-followed ABX index of subprime mortgage bonds rolled over

yesterday, and Leinfuss wrote on Wednesday that the new series, known as 07-2,

would barely outperform the old series, known as 07-1.

At the end of the first day’s trading, here’s how the prices

look:

  06-1 06-2 07-1 07-2
AAA 99.29 97.79 96.44 99.33
AA 97.85 93.43 90.94 97.00
A 90.21 77.43 70.42 81.94
BBB 80.67 56.28 48.03 56.61
BBB- 71.75 50.00 44.86 50.33

As I understand it, these prices are calibrated so that they are comparable,

even though the coupons on the different series do vary dramatically. (The BBB

series in 06-1 had a coupon of just 154bp, for instance, which is now 500bp

in the 07-2 series.)

Behind each series, once you get past the layers of credit derivatives and

securitizations, are mortgages written in the previous six months. The 07-2

series, then, is based on subprime mortgages written in the first half of 2007,

while the 06-2 series is based on subprime mortgages written in the first half

of 2006.

By 2007, of course, everybody knew about the unexpected spike in subprime default

rates, and underwriting standards, we were told, had tightened up significantly.

So how come the prices on the 07-2 tranche are significantly lower than the

prices on the 06-1 tranche, which is based on 2005 subprime loans written before

underwriting standards tightened up? It turns out that maybe the changes in

underwriting practice weren’t quite as widespread as we had been led to believe:

The new index’s average FICO score, a gauge of borrower credit risk is 625,

the analyst said, similar to the two previous series. The weighted average

combined loan-to-value (CLTV) is slightly higher than prior indexes, as is

the percentage of loans in the pools with CLTV greater than 80. He added that,

while the new series will have fewer second-lien loans and the smallest amount

of interest-only loans, it will have the largest percentage of 40-year loans.

Which raises the obvious question: what about the subprime loans which are

being written now? Are lenders still extending cheap credit to homeowners

who can’t afford to make their mortgage payments? How will the 08-1 series look,

in six months’ time?

Posted in bonds and loans, housing | Comments Off on New ABX Mortgage Index Still Looks Ugly

Low Rates: Dead or Alive?

Posted on July 20, 2007 by Felix

It’s the duel of the newsweekly pundits! Is God dead, or is God alive? (And

by God, of course, I mean the era of low interest rates.) Put Justin

Fox clearly in the atheist

camp:

Something with far more impact on most Americans’ lives than a stock-market

correction has already happened.

That something is the close of a remarkable era of easy money. Cheap credit

helped fuel the stock bubble at the end of the past millennium and almost

entirely fueled the real estate boom of the first years of this millennium.

It kept us spending through the tough years that followed the stock market’s

collapse, and it allowed the Bush Administration to finance big budget deficits

without strain. Easy money also helped enable the rise of private equity as

a major economic force.

Now, though, it’s history.

Meanwhile, BusinessWeek’s Michael Mandel is still preaching

the gospel, armed with the power of the Market Bunny of Doom. (You’re just

going to have to click through to understand what I’m talking about there.)

"It’s still a low-rate world," says Mandel, with the 10-year Treasury

at 5.02%, just 29 basis points above its level when he wrote a cover

story headlined "It’s a Low, Low, Low-Rate World: Why money may stay

cheap longer than you think".

Can it be that both esteemed columnists are right? That God, a bit like Schrödinger’s

cat, can be both alive and dead at the same time? I think so.

The thing to realize is that even though rates are low, credit

is getting tighter. It’s a replay, in much milder form, of the flight to quality

we saw in 1998. Private equity shops are finding

it harder to raise cheap debt, because that debt was not priced in accordance

with its underlying credit risk for the past couple of years. But if you look

at risk-free interest rates, they show no signs of going up very much. In fact,

they might even go down if risk-averse investors start rotating out of structured

credit and into more traditional safe havens. Asset-backed triple-As might not

be junk, as Floyd Norris’s headline

today would have you believe, but they’re certainly not as safe as Treasuries.

Posted in bonds and loans | Comments Off on Low Rates: Dead or Alive?

Congestion Pricing is Important

Posted on July 20, 2007 by Felix

Yesterday, the New York congestion

pricing deal was big news. A long

list of notables lined up to praise it, and the NYT’s City Room blog published

over 1,450

words of detail on it. Today, it seems to be an afterthought, at least as

far as the NYT is concerned. The paper’s headline is "New

York Deal Tightens Limits on Election Cash", and even the subheds,

in the paper, make no mention of congestion pricing, which is finally mentioned,

en passant, seven paragraphs into the story:

The compromise also tied together other issues, in classic Albany style.

It would set up a commission to study Mayor Michael R. Bloomberg’s plan

for “congestion pricing” and alternatives that are intended to

ease New York City traffic, but it put off action on any measure until March.

After announcing the deal, Governor Spitzer also indicated that he was inclined

to grant lawmakers a long-sought pay raise as a reward for, as he put it,

going “a very long way toward enacting the reform agenda that I laid

out.”

Yes, they really put scare quotes around "congestion pricing", as

if burying the story wasn’t enough.

The plan reappears at the very end of the article, if anybody ever gets that

far:

The agreement would also establish a 17-member commission to come up with

a final plan to reduce traffic congestion in Manhattan, subject to approval

by the City Council and the Legislature, by next March.

Though the compromise on reducing congestion appeared very similar to a plan

that the mayor criticized earlier this week, Mr. Bloomberg, in a statement

on Thursday, called the plan “a victory.” But the final measure

is fairly modest. Among other provisions, it would require that any program

expire in 2012, effectively turning any plan for “congestion pricing”

into a kind of pilot program

Still, the mayor said he would seek as much as $500 million from the federal

Department of Transportation to pay for the plan. The department has announced

it would make $1.2 billion available to cities that undertake traffic reduction

programs.

This is just weird. The expiry date is no big deal, since the legislature can

repeal congestion pricing at any time anyway. And of course the scheme

would be a pilot program: it’s the first of its kind. (It always had an expiry

date, from day one.) That makes it more important, not less. On one

of the most important developments to affect its readers’ daily lives in the

foreseeable future, the New York Times has been comprehensively beaten by not

only the WSJ, which has a long

article looking at the experience in London, but also by the New

York Post.

Both supporters and opponents of congestion pricing deserve better coverage

than this – so we can certainly be thankful that the likes of Streetsblog

are there to fill the gaps.

Among the opponents of the deal one should count commenter tinbox, who wrote

in response to yesterday’s post on the subject that all manner of nasty things

might happen in the wake of the plan’s introduction. Congestion prices might

rise, as they have in London; the scheme might be privatized; New Jersey motorists

might be upset. All of which seem like good things to me. And in any case the

congestion charge for NJ motorists is going to be all of $2, since the $6 tunnel

toll is deductible from the proposed charge.

I hesitate to draw too much of a causal relationship, but the highest office

rents in the world for the past few years have been in London’s Mayfair, right

in the congestion-pricing zone, and they’ve been rising stratospherically. The

congestion charge there has made London a much more pleasant city to live and

work, and it’s helped to solidify London’s status as a global financial center.

New York City – and New Yorkers – can and should be allowed to compete

on a level playing field, without unhelpful interference from Albany.

Posted in cities | Comments Off on Congestion Pricing is Important

Repugnant Markets

Posted on July 20, 2007 by Felix

Blogger Tim Harford got blogger

Virginia

Postrel, blogger Robin

Hanson, and a few non-bloggers such as the Bishop of Swindon to all talk

to him for a fascinating BBC radio documentary

on repugnant markets. Go read the transcript:

it’s great stuff. Among the topics covered: paying for someone’s kidney; the

right of dwarves to be paid to be tossed; life insurance; and prediction markets.

My favorite bit is where the Bishop of Swindon, Lee Rayfield – who’s

also a PhD in transplantation immunology – says that paying for kidneys

creates a "dehumanised society," while donating one altruistically

doesn’t. But Postrel, who famously donated a kidney herself, is far from sure

about that:

HARFORD: For people such as Bishop Rayfield, the essential difference between

a market and a kidney exchange is that the exchange preserves an altruistic

motive. But is it really true that the gift relationship is better than a

straightforward commercial transaction? Sometimes gifts can produce far more

onerous obligations than price-tags…

POSTREL: Knowing my particular friend, she would have really liked to do an

arm’s length transaction with a stranger where she paid somebody she

didn’t know because there can be a great deal of emotional entanglement

when there is a gift. It happens to be that I’m not the kind of person

to think that she owes me anything, but especially in families there are all

kinds of psychodramas that go on with requiring this to be a gift.

It’s effectively impossible to donate a kidney anonymously, and in today’s

society the best way of assuaging the psychodramas associated with saving someone’s

life is to turn the whole thing into a commercial transaction. I wonder what

Lee Rayfield would think if I donated a kidney in return for a large donation

to a charity of my choice?

Posted in economics | Comments Off on Repugnant Markets

New York Congestion Pricing: It’s Alive!

Posted on July 19, 2007 by Felix

Aaron Naparstek of Streetsblog has details

of the congestion-pricing deal which was struck in Albany today, and I have

to say it’s a good one. Somehow, the dysfunctional New York system has managed

to pull something strongly resembly a victory from the jaws of defeat.

This is much more than an agreement on a panel to study city traffic, as the

NYT’s Danny Hakim would have

it. Rather, New York City gets to propose exactly the same thing to the

new panel that it proposed to the US Department of Transportation on June 22.

The panel can fiddle with the proposal as much as it likes, but – and

here’s the clever bit – once all the fiddling is over, the average reduction

in vehicle miles travelled must remain.

If everything goes according to plan, that stipulation will ensure that New

York City gets at least $250 million in federal funds to help subsidize this

groundbreaking and necessary idea. And once those funds are in place, the congestion

scheme will swing into action. After looking it over, I have to say I’m optimistic.

I don’t know why it had to take so long and be so acrimonious, but all’s well

that ends well, and I’m sorry for all the

rude things I wrote about New York State’s politicians.

Actually, let me keep that apology on ice for the time being. If the bills

get passed, and the federal funding kicks in, and everything goes as smoothly

as can be hoped, and traffic in midtown starts to fall – if all

that happens, then I’ll take back what I said. But just because something ought

to happen in New York never means that it will happen. For the time being, file

me under "cautiously optimistic".

Posted in cities | Comments Off on New York Congestion Pricing: It’s Alive!

Dell: Immune From Delisting

Posted on July 19, 2007 by Felix

Well, I was wrong. A couple of weeks ago, when the Nasdaq gave Dell an extension

rather than forcing the computer company to delist, I

said that if Dell hadn’t filed the required reports by July 16, it would

"simply get another extension". What was I thinking? Of course it

didn’t. Instead, the Nasdaq board has simply decided that Dell shares can

continue to trade on their exchange indefinitely, despite the fact that

it hasn’t filed its past four quarterly reports, or its annual report.

You might consider this to be self-interested spinelessness on the part of

the Nasdaq – after all, what’s the point of reporting rules, if you waive

them the minute they’re broken? You might also consider this to be a case for

the SEC to look into, since the SEC does nominally regulate the Nasdaq –

a point made by a commenter on my earlier post. That comment was followed up

by one from The Panelist’s David

Neubert:

Nasdaq would have a hard time dealing with the reduction in revenue from

losing the 20 million shares a day volume from Dell. As a for profit public

company why would NASDAQ actually care about the public trust? They aren’t

a regulator anymore. Oh, I’m sorry they do have some regulatory responsibility.

. . . (can you say henhouse or fox?)

It seems that there’s a double standard at Nasdaq (and, I suspect, at the NYSE

as well). If a company is relatively small – small enough that its volume

doesn’t contribute significantly to the exchange’s bottom line – then

the exchange will be tough. On the other hand, if the company in question has

a large float of shares outstanding, it has de facto impunity when

it comes to listing requirements and the like.

Posted in stocks | Comments Off on Dell: Immune From Delisting

Green Dimes: The VC-Backed For-Profit Philanthropy

Posted on July 19, 2007 by Felix

There’s a lot of controversy surrounding the concept of for-profit philanthropies.

Personally, I think the idea is pretty good, although I do understand that at

the margin, there will always be a trade-off between doing the maximum amount

of good and making the maximum amount of money. Which is why some people got

very upset when it was revealed

that Mexican microlender Banco Compartamos had made hundreds of millions of

dollars for its investors.

I do still believe that a happy medium can be found, however. In some cases

the more good that gets done, the more attractive the business is to its customers,

and the more profitable it becomes – everybody wins. That, I’m sure, is

the thinking behind Green Dimes, which

has just raised

more than $20 million of venture capital from Tudor Investment Corporation

and others.

The idea behind Green Dimes is that individuals sign up for a dime a day, and

in return the company will reduce the amount of junk mail they receive by more

than 75%. That in itself is good for the planet, but Green Dimes also plants

one tree per member per month – more than a quater of a million trees

so far.

I daresay that something like Green Dimes might be sustainable on a non-profit

basis, but Green Dimes is ambitious: it wants to grow fast, it wants to expand

internationally, and it doesn’t want to just use its own cashflow or waste vast

amounts of time filling out grant applications and begging donors to write relatively

small checks. Much better, in many respects to go for-profit, get lots of money

up front. More people sign up, more trees get planted, and the founders get

to make lots of money to boot.

Everybody wins, in theory. I just hope it works out that way in practice.

Posted in climate change | Comments Off on Green Dimes: The VC-Backed For-Profit Philanthropy

The Economics of Tour De France Breakaways

Posted on July 19, 2007 by Felix

Andrew Leonard finds

a great piece of microeconomic analysis in

the sports pages, of all places, from the NYT’s Edward Wyatt:

It should not be surprising then, that the racers’ strategies and their

sponsors’ goals may coincide. While every sponsor wants to see one of

its riders cross the finish line first, there can only be one winner of each

stage. But there is another, relatively simple way for a sponsor to get hours

of television time: the breakaway…

Most often, a breakaway can look like an exercise in futility — a few

cyclists riding alone for hours, only to be caught by the pack within a mile

or two of the finish. Even when the group makes it alone to the end of the

stage, the charge to the finish inevitably brings disappointment for all but

one of the riders — disappointment that would appear to outweigh the

effort.

Not for the sponsors, however.

“It’s just a great advertising board,” said Bradley Wiggins,

a British rider who went on a solo breakaway of 118 miles in the sixth stage.

Wiggins’s effort was particularly appreciated at the offices of his

team’s sponsor, Cofidis, a French company that provides consumer loans.

And there you were, thinking breakaways were just an attempt to win the stage.

How naive. Leonard is not so unhappy, however.

This news is at once enlightening and disconcerting. I’m not sure I wanted

to know the crass motivations underlying the valiant breakaway. Instead of

"win a stage for the Gipper," it’s "stay in front a few hours

before you lose for the Discovery Channel!" Woo hoo!

But upon reflection, I am satisfied by this even deeper truth about

existence. The motivations that drive us are invariably more complex than

a surface glance reveals: every stab for glory provides for cover for less

glittery incentives.

What’s interesting to me is the viewership figures: apparently half of France’s

television audience is tuned in to the Tour. I guess the absence of stars and

the ubiquity of doping scandals has done nothing to dampen the sport’s popularity

in its spiritual home.

Posted in economics | Comments Off on The Economics of Tour De France Breakaways

China Moves Out of Treasuries to Support the Mortgage Market

Posted on July 19, 2007 by Felix

Floyd Norris notes that China "was a net seller of Treasury securities

in May" and says that it "unloaded about $6.6 billion" of them,

across the yield curve. He

asks: "Could the newfound hesitance to buy more Treasuries be a reaction

to increasing protectionist sentiment in this country?"

No.

For one thing, China isn’t actually selling anything. The first thing anybody

writing about Chinese foreign-currency reserves should do is go and see what

Brad Setser is

saying. For one thing, Brad clarifies that China "allowed its total

holdings to fall by not reinvesting maturing bonds and bills," rather than

actually selling anything. But more to the point, Brad is very suspicious

about the whole data release. "With Russia and China I know not to trust

the TIC data," he says. "I fully expect to see a large upward revision

in Russian and Chinese US holdings when the next survey data is released."

What’s more, Norris wonders why the Chinese government might be buying fewer

Treasuries and more Agency bonds. Might it be because that’s exactly what

the Bush Administration is asking it to do? Bloomberg’s Josephine

Lau reports:

The Bush administration is urging China’s central bank to buy more government-backed

mortgage bonds in an effort to sustain financing for U.S. home loans.

U.S. Department of Housing and Urban Development Secretary Alphonso Jackson

is in Beijing to persuade the Chinese central bank to buy more securities

from Ginnie Mae, a corporation under HUD that guarantees $417 billion in federally

insured, fixed-rate mortgages.

I was kinda joking when I proposed

that China might come in to support the CDO market. But it seems that the Bush

administration is very serious about it getting the country to support the market

in mortgage-backed securities.

Posted in bonds and loans | Comments Off on China Moves Out of Treasuries to Support the Mortgage Market

iPhone Questions for Kevin Maney

Posted on July 19, 2007 by Felix

Does Kevin Maney

take requests? I do hope so, because Walt Mossberg’s mailbox

column this morning uncharacteristically raises more questions than it answers.

(Update: Never mind. I’ve answered

all these questions, and more, myself.)

Until Apple initiates iPhone service with foreign carriers, which is expected

to be a gradual process that will begin in Europe, iPhone owners traveling

abroad will be forced to roam on AT&T and to pay through the nose for

data as well as voice calls made over cellular-phone networks…

For email and the Web, the best bet for iPhone owners is to avoid using cellular

networks and employ the phone’s Wi-Fi capability, which can cost nothing

extra. Try to find a free or reasonably priced Wi-Fi hot spot in which to

check email and do Web browsing. You may even be able to make cheap voice

calls this way using Internet-based calling services like JaJah

(mobile.jajah.com) which, in my domestic tests, worked properly via the iPhone’s

Web browser.

"Pay through the nose" is right. It’s almost impossible to find international

data rates on the AT&T website, although if you look hard enough you’ll

find a special international data plan

for people who want to pay an extra $25 per month. I tried asking the support

people, and they told me that without that plan, international data costs $.0195

per kb, or $19.97 per megabyte. Obviously, in that case, I won’t be doing any

web browsing when I’m travelling internationally, unless I’m on wifi. But if

the wifi stops working for some reason, it would cost me $18.49 just to download

the Portfolio.com home page, once.

What’s also scary is that the iPhone automatically starts downloading data

every time you click on the Safari or Mail buttons at the bottom of the screen

– buttons which are right next to the Phone and iPod buttons. Once you

click on the Mail button, in fact, the iPhone automatically downloads your 50

most recent emails, and there’s no way of stopping it. Which can get very expensive

very quickly.

So some questions for Kevin:

  1. Is there some way of turning off the phone functions of the iPhone but keeping

    the wifi active, when I’m using the email or web browser, to make sure that

    I don’t run up enormous data bills by mistake? I have a feeling that if you

    remove the SIM card, you turn off wifi functionality as well.

  2. Alternatively, is there some way of turning off the data service when I’m

    travelling, so AT&T won’t even let me run up those bills in the first

    place?

  3. How will JaJah help me make cheap voice calls when I’m travelling in a wifi-equipped

    area? As I understand it, JaJah is a ringback service, where you type in the

    number you want to call and then you pick up your phone when it starts ringing.

    But international roaming rates are the same whether you’re making a call

    or receiving one – which means that just placing the call directly costs

    the same as receiving a call from JaJah, no?

I’m sure the answers to these questions will be of great interest to everybody

with an iPhone who intends to leave the US at any point.

Update: After speaking to a friendly woman named

Cassandra at AT&T’s international help line (800 335-4685 from within the

US, 916 843-4685 from outside the US), I think the answers to (1) and

(2) are no and yes, respectively. You can’t turn off the phone functions, but

you can phone up AT&T before you leave on your trip, and ask them

to turn off the data functions. The first person I talked to told me that would

stop the wifi from working too, but I don’t believe him.

I did, however, learn one distressing thing: the $25-a-month international

data plan has a one-year minimum contract with a $175 early-cancellation fee.

In other words, it’s useless for all but the most frequent of international

travellers, and you can’t simply activate it before you go on holiday and then

turn it off upon your return.

So now I’m trying to work out whether I should turn off all the data functions

when I’m travelling, in order to prevent an inadvertently astronomical data

bill. The thing is, it’s precisely when you’re travelling that the excellent

Google Maps functionality on the iPhone really comes into its own. Does anybody

have a feel for how many kilobytes of data are downloaded during a typical Google

Maps session?

Posted in technology | Comments Off on iPhone Questions for Kevin Maney

Shari It Didn’t Work Out

Posted on July 19, 2007 by Felix

It’s not easy, being the daughter of a media mogul and working for your dad.

Elisabeth Murdoch left News Corp to start her own company,

Shine. Today we learn

that Shari Redstone is leaving Viacom. Who’s next? Christie

Hefner?

All three are highly-accomplished businesswomen who are equally blessed and

cursed by the shadow of their fathers. Murdoch seems to have blossomed outside

the family shop, while Hefner has done so within it. Maybe Redstone will steer

a middle course if she takes over her father’s National Amusements theater chain

and runs it as an independent entity.

Posted in defenestrations, Media | Comments Off on Shari It Didn’t Work Out

The Blogs vs Dennis Kneale

Posted on July 18, 2007 by Felix

Forbes managing editor Dennis Kneale isn’t having a good time

of it in the blogosphere today. First Barry Ritholtz takes

a whack:

When a scribbler who does not manage money for a living begins to pound his

chest about calls he made — economic calls that have so far proven to be

incorrect — we are seeing a warning sign.

Then Lance Knobel piles

on:

What I do find ludicrous… are the many comments that the reason why Murdoch

wants Dow Jones is to improve his credibility. That was the line taken by

Dennis Kneale, managing editor of Forbes, on the excellent Marketplace radio

program yesterday.

I happen to agree with both Barry and Lance, here. The stock market can do

many things, but a 1400-point run-up in the Dow is most certainly not an incontrovertible

sign that the underlying economy is particularly healthy. Meanwhile, I’ve made

Lance’s argument myself. Clearly I’m not cut out to be a pundit, if what

the media wants is people with opinions like those of Kneale.

Posted in Media | Comments Off on The Blogs vs Dennis Kneale

Chart of the Day: Fixed vs Variable Subprime Default Rates

Posted on July 18, 2007 by Felix

Alea today finds the most astonishing

chart, which I simply have to reproduce:

The crazy thing here is the massive discrepancy, over the past two years, between

default rates on variable subprime mortgages, on the one hand, and default rates

on fixed-rate subprime mortgages, on the other. And I have to say that I’m at

a loss for how to explain it.

I know what it’s not: it’s not ARM resets. Those are only just beginning to

kick in now, while the gap between variable and fixed subprime default rates

started gapping out as early as the end of 2005. (When the only resetting ARMs

were the ones written in 2003.)

And it’s not lax underwriting standards, either. Yes, underwriting standards

did become too loose. But they were applied to subprime borrowers,

not to subprime products. A lender wouldn’t use much tougher underwriting

standards when writing a fixed-rate loan compared to when writing a variable-rate

loans.

OK, maybe I’m overegging the pudding a little here: I’m sure that both ARM

resets and lax underwriting standards played some role in generating

that huge spread between variable and fixed subprime default rates. But I suspect

there’s something else going on here as well.

My best guess is that subprime borrowers split into two camps. On the one hand,

there are the Noble Few, who took advantage of excess liquidity to get their

feet onto the bottom rung of the property ladder. These are people who wanted

very much to buy a house – not as an investment, so much as to own their

own home. They locked in fixed rates, comfortable that they would be able to

make their mortgage payments for the next 15 or 30 years: however long it took

to buy the house outright.

But the Noble Few were outnumbered by the Reckless Many, who had dollar signs

dancing in front of their eyes and would read daily in the newspaper of the

fortunes being made in the property market by people who followed the time-worn

advice to "buy the biggest house you can afford". Maybe they were

would-be flippers, who never intended to own their home for longer than the

period of the initial teaser rate. Or they were people who wanted or needed

cash, for a family emergency or just for a flat-screen TV, and they wanted to

borrow that money at the lowest possible rate. Or they were suckers who were

taken advantage of by unscrupulous mortgage brokers. Or they were simply financially

naive, and determined that the cheapest mortgage they could get must be the

best mortgage they could get.

In all these situations, the borrower chose the mortgage with the lowest monthly

payments – and the mortgage with the lowest monthly payments was always

a variable-rate mortgage.

To put it another way, what we’re seeing in this chart is the entry of a whole

new borrower class into the subprime market. Until recently, people taking out

a subprime mortgage were much like people taking out a prime mortgage (but with

less money and worse credit) – they were people whose primary motivation

was to buy and own a house.

At some point, however, home-equity withdrawals and speculative purchases and

dodgy mortgage originators all conspired to change the profile of the average

subprime borrower – especially the sort of subprime borrower

who chose a variable-rate mortgage. Which is one of the reasons why all the

models which had worked in the past suddenly broke, despite no huge spike in

interest rates.

The financial markets knew how people behave after taking out a mortgage. They

just didn’t realize that in the specific case of variable-rate subprime mortgages,

they were dealing with a completely different set of people.

Okay, that’s overegged as well. That might be some of it, but even that can’t

explain all of it. But just take another look at that heavy black line showing

fixed-rate subprime default rates. They’ve never been lower. And that’s

something you’d never guess from reading the papers.

Posted in housing | Comments Off on Chart of the Day: Fixed vs Variable Subprime Default Rates

Why the Subprime Mess Doesn’t Require a Fed Rate Cut

Posted on July 18, 2007 by Felix

Brad DeLong has

capitulated. "I have been an optimist about the subprime market,"

he says. "Now I am not so sure. It no longer looks like things are as contained

as I had thought… if I were on the FOMC I would start voting to cut interest

rates."

It’s not clear to me what datapoint(s) converted DeLong from optimist to pessimist.

I hope it wasn’t the blog

entry he quotes headlined "$10 Billion Hedge Fund Now WORTHLESS",

because that’s just wrong. If a $1 billion fund controls $10 billion of assets

which then decline in value to $9 billion, the whole $1 billion is wiped out

– but that’s only $1 billion of losses, not $10 billion of losses. There’s

still $9 billion of assets left over.

It’s also interesting that DeLong has turned pessimistic even as the stock

market is shrugging off the whole shebang and making new highs, and the non-RMBS

parts of the credit markets seem to be quite deliberately and pretty quietly

moving to a more sustainable and sensible footing. In other words, LBO debt

and CLOs and the like are now being priced where they ought to be priced, rather

than at the ridiculous levels we saw in the recent past. Call it a controlled

deflation of the credit bubble, which might well prevent a catastrophic bubble-burst.

In such a situation, what would a rate cut achieve? It might be counterproductive,

and reflate the credit bubble which is only now (finally, thankfully) subsiding.

What’s more, it wouldn’t give subprime borrowers any more access to houses than

they have already, since the limiting factor there is not interest rates but

underwriting standards. Nothing that Brad worries about in terms of increased

supply and decreased demand for housing would really change, especially considering

the fact that the housing market, more than any other, is based on long-term

rates in the 15-30 year range, which have shown no inclination whatsoever to

react to changes at the overnight end of the curve.

I do think that regulators might want to have a close look at the foreclosure

process if and when it starts affecting many more people than it ever has in

the past. But cutting interest rates to help out overindebted homeowners is

not going to help.

Posted in fiscal and monetary policy, housing | Comments Off on Why the Subprime Mess Doesn’t Require a Fed Rate Cut

Blowing Bubbles

Posted on July 18, 2007 by Felix

Robert Shiller is something of a self-proclaimed expert on

bubbles, having literally written the

book on them. Then again, he does seem to have a tendency to declare a bubble

in just about any market trading significantly above its historical valuation.

His latest

insight is that whenever you hear the term "awash in liquidity,"

that’s a very good signal that there’s a bubble somewhere nearby.

Meanwhile, David Leonhardt is also on bubble

patrol today: apparently when people concentrate on nominal asset prices

rather than real asset prices, that "helps create the conditions for a

bubble".

Of the two, Shiller makes slightly more sense. When there’s lots of money floating

around, it’s easier to spend it, as anybody who’s experienced a significant

rise in their checking-account balance will attest. Whether that means we’re

in the middle of a bubble, however, I’m not sure.

Leonhardt’s argument, on the other hand, I find very hard to understand. Yes,

if you look at asset prices in nominal rather than real terms, they will seem

to be rising more impressively. And the people who are wowed by Dow 14,000 are

in fact looking at an asset which isn’t nearly as high in real terms as it might

seem in nominal terms. But surely what this means is that markets aren’t

as frothy as they might at first seem.

Both Shiller and Leonhardt conclude the same thing: that stocks are expensive.

Which is a bit weird, considering that, relative to everything else, they certainly

seem as though they’re actually

rather cheap.

There has certainly been much more financial-asset inflation in recent years

than there has been consumer-price inflation. I’m just not convinced that means

we’re in a bubble.

My suspicion is that right now there’s not enough demand for capital to match

the supply of it. Companies don’t really need to raise either equity

or debt, which means that most equity and debt issuance is the result of financial

engineering, and doesn’t really reflect the areas of the economy which need

the most investment. So a lot of money is essentially chasing its own tail,

rather than being extracted from the financial system and injected into the

real economy. Is that a bubble?

Posted in economics, stocks | Comments Off on Blowing Bubbles

Staying Sanguine About the Bear Stearns Losses

Posted on July 18, 2007 by Felix

DealBook

today sets up a mini cage match between me and Janet Tavakoli:

Mr. Salmon said Bear’s final tally is much better than Wall Street

had expected, but others would disagree. “How did you go from reporting

very high returns to suddenly now saying the collateral is worth nothing?”

Janet Tavakoli, president of Tavakoli Structured Finance, asked The New York

Times in an article

published Wednesday.

(Update: Tavakoli says in the comments that she was

misquoted by Gretchen Morgenson, and that in fact she agrees with me.)

The fact is that these are leveraged funds, and the collateral in them is very

much not worth nothing. In fact, the collateral in them is worth so

much that all the lenders to the funds, including Bear Stearns itself, might

well get paid back in full.

The key thing to realize here is that the assets of the funds were much larger

than the total amount of money put into the fund by investors. The investors

took the equity tranche, if you will: the difference between two large numbers.

On the one hand there was the fund’s assets, which were largely comprised of

CDO investments, and on the other hand there was the fund’s liabilities, which

were largely comprised of repo lines with prime brokerages.

The high returns of the fund were essentially the fruit of a leveraged carry

trade. The funds borrowed money from their prime brokers at a lower interest

rate than the coupons on the CDO tranches they invested in. The difference between

the two was profit. But if the market value of those CDO tranches fell, then

the assets of the fund could drop perilously close to its liabilities –

which is exactly what happened.

What if by "the collateral" Tavakoli meant not the net assets of

the fund, but rather the collateral in the CDOs which the funds bought? Again,

it’s not worth nothing: the more levered of the two Bear Stearns funds invested

mainly in AA-rated securities, and so far no AA-rated paper has even come close

to being wiped out, as opposed to merely falling in value.

But the real answer to Tavakoli’s question does not come down to nitpicking

about what she means by "collateral". Rather, it’s a simple question

of how hedge funds value illiquid assets. And the fact is that for most of these

funds’ lives, the value of their CDO tranches didn’t really change. These weren’t

buy-low, sell-high hedge funds which were looking for capital gains from investing

in undervalued securities. Rather, they were leveraged coupon-clipping hedge

funds which made substantially all of their returns in the cashflows from their

bonds.

Given that the CDOs weren’t trading on the market, one can understand why any

fall in the value of those CDOs might have been missed by the fund manager,

Ralph Cioffi. After all, it took the best part of a month for Bear Stearns to

finally put a value on those investments once it was forced to do so by margin

calls.

In other words, the high returns reported by the hedge funds only told half

the story. They showed how much money the funds’ investments were making –

but they didn’t show the degree to which the value of those investments was

falling. When Bear finally got around to calculating that value, it turned out

that the investors in the funds ended up with nothing. Which is bad news for

those investors, and also bad news for Bear Stearns, which is revealed to have

rather less rigorous risk controls than it would have us think. It also, most

likely, presages similar revelations at other fixed-income hedge funds, many

of which also took leveraged bets on high-rated CDO tranches.

At the same time, of course, other hedge fund managers, such as John Paulson,

seem to be making money hand over fist. Some hedge funds will always blow up –

it’s in the very nature of hedge funds for that to happen occasionally, no matter

what Veryan Allen might

think. But the big worry in the market right now is not that hedge funds which

got it wrong will blow up. That’s just part of how markets work. The worry is

that a series of hedge-fund implosions will spill over into prime brokerages and

thence into credit markets more generally. And if the brokers who lent money to

the Bear funds are getting all their money back in full, then the danger of that

happening is greatly reduced.

Posted in bonds and loans, hedge funds | Comments Off on Staying Sanguine About the Bear Stearns Losses