Paying Down the Mortgage vs Investing in the Market

Posted on May 21, 2007 by Felix

On Saturday, I was quite

rude about a man named Richard Campbell, who wants to take out a 90% mortgage

on a house he could buy outright for cash. That’s silly: he has no reason to

believe that his investment prowess is such that his return on investment will

be higher than the interest rate on his mortgage.

Today, however, Bloomberg’s John

Wasik digs up an old piece

of research from the Federal Reserve Bank of Chicago which says that occasionally

it does make sense to invest your money and carry a larger mortgage

balance. Was I wrong?

In a word, no. The Chicago Fed report, by Gene Amromin, Jennifer

Huang, and Clemens Sialm, looks at the situation where

an individual already has a mortgage, and has the choice between paying down

principal, on the one hand, or contributing to a tax-deferred retirement account,

on the other. Sometimes, it turns out, the tax benefits of the IRA or 401(k)

more than make up for the fact that its returns can’t be expected to be higher

than the mortgage interest rate. But that’s not the situation in which Mr Campbell

finds himself: one assumes that, being a rich man, he’s already maxed out all

of his tax-free investment opportunities.

The Chicago Fed report does leave one question lingering in a tantalizing manner:

if it makes sense to contribute to an IRA rather than pay down one’s mortgage,

does that mean it also makes sense to take out a home-equity line if necessary,

in order to maximize one’s IRA contributions? The answer would seem to be yes.

What Wasik doesn’t make clear is when he starts to depart from the Chicago

Fed report and moves on to his own opinions. Here, I think he’s wrong.

As an investment, your home offers you no cash dividends or diversification,

especially if you have little in the way of stocks or bonds. Investing in

a mutual fund that packages mortgage securities, real estate, U.S. Treasuries

or Treasury inflation-protected securities reduces your dependence on the

housing market, which is in decline in much of the U.S.

I don’t see it. Let’s say that a homeowner has a $300,000 house with $150,000

left on the mortgage, which carries an interest rate of 6%. And let’s say she

has a choice between (a) paying down the mortgage by $10,000; or (b) investing

the $10,000 in a mutual fund. Fast-forward one year, and the value of the house

has dropped by 5%, while the value of the mutual fund has gone up by 5%.

In the first scenario, the homeowner paid 6% interest on a $140,000 mortgage,

for an outlay of $8,400. With the house now worth $285,000, her home equity

is $145,000. Final net position: +$136,600.

In the second scenario, the homeowner paid 6% interest on a $150,000 mortgage,

for an outlay of $9,000. Her home equity is $135,000. And her investments are

worth $10,500. Final net position: +$136,500.

In other words, even when your investments go up and your house goes down,

you’re still no better off making the investments. Or, to put it another

way, if you borrow against your house and invest the proceeds in the market,

that doesn’t reduce your exposure to the housing market.

Posted in housing, personal finance | Comments Off on Paying Down the Mortgage vs Investing in the Market

Why do the Chinese Want a Blackstone Stake?

Posted on May 21, 2007 by Felix

We are long since used to the sight of US companies falling over each other

to compete for the privilege of being able to invest in China. Part of this

is because they see large returns down the road, but another important part

is because they feel that having Chinese investments will bring them closer

to the all-important Chinese government.

It turns out that they were going about this entirely in the wrong way. Rather

than invest in state-owned Chinese banks, Goldman Sachs should have been persuading

the state-owned Chinese banks to invest in it!

Steve Schwarzman is the man who we can credit both for having this insight

and for having the geopolitical clout to be able to act on it: he’s selling

the Chinese a $3

billion stake in Blackstone, at a tiny 4.5% discount to the IPO

price. The Chinese are now literally invested in Blackstone’s ability to

do deals in China, which must make Schwarzman very happy indeed.

But what’s in this deal for the Chinese? As Naked

Capitalism notes, the Blackstone IPO is very controversial, and there’s

a great deal of regulatory risk surrounding the deal structure.

One can only assume that if the Chinese are taking large stakes in individual

companies like Blackstone, they’ve been investing in US equities more broadly

for some time. If they’ve reached the limit of their comfort level with public

equity, it might make sense to have some kind of exposure to private equity.

But even then, one would expect the Chinese to be investors in a Blackstone

fund, rather than investors in Blackstone itself. And in any case I’m far from

convinced that China has a big stake in the US public equity markets. It seems

that there’s something else going on here, but if there is, then Schwarzman

isn’t telling.

Posted in china, stocks | Comments Off on Why do the Chinese Want a Blackstone Stake?

Adventures in Personal Finance, Part 2: The Rich Couple

Posted on May 19, 2007 by Felix

Sometimes the middle classes have a hell of a lot more financial horse-sense

than the rich, even if the financial press doesn’t like to spin it that way.

Exhibit B: Richard Campbell, asking

a question of MarketWatch’s Lew Sichelman.

Mr Campbell is in contract to buy a vacation home. "Both I and my wife

work white-collar managerial jobs in New York, so we have more than enough to

buy the place outright," he says. They just don’t want to do that: in fact,

what they want is to take out a 90% mortgage. The problem is, a 90% mortgage

costs more than an 80% mortgage. Life’s so unfair, sometimes. Mr Campbell and

his wife have more than enough money: shouldn’t they be able to get a 90% mortgage

at the same interest rate as an 80% mortgage?

"Your remarks make perfect sense," replies Mr Sichelman, "but

nobody ever said this is a perfect world."

In fact, Mr Campbell’s remarks make very little sense.

For one thing, Mr Campbell and his wife are managers, they’re not professional

investors. Stocks are near their all-time highs, there’s a bubble in the credit

market, and house prices are falling. Yet they’re seemingly convinced that they

can get a higher return on their money than the 8% or whatever it is that they’re

going to pay on their mortgage. In other words, they think they’re smarter than

the bank who’s lending to them. "Ha!" they seem to be saying, "You

poor saps are willing to lend to us at 8%, but we are smarter than you, and

will take that money and invest it and make double-digit returns!"

In fact, Mr and Mrs Campbell are not smarter than the bank who’s lending to

them, and there’s a very good chance that their investments will return less

than the amount of interest they’re paying on their mortgage. In which case

they would have been better off simply buying their vacation home for cash.

Secondly, Mr Campbell seems convinced that People Like Him simply don’t default:

Isn’t it odd that in our advanced world of actuarial analysis, no one breaks

down those numbers to find that those low-down-payment defaulters also have

lousy credit, don’t have a job, are younger than 25 or whatever.

It’s not the low down-payment which causes default, he’s saying, it’s lousy

credit or young borrowers or other things which distinguish him from the great

unwashed. Actually, the things which cause default are the kind of things which

really do happen to the likes of Mr and Mrs Campbell: layoffs, unexpected medical

bills, death, divorce, lawsuits. Our rich friends are not nearly the perfect

credit risk they think they are.

What’s more, Mr Campbell is exactly the self-regarding type who is likely to

simply walk away from his vacation home if he finds himself in financial difficulties,

leaving his lender holding the bag. After all, if he puts little if any money

down, then it’s easy come, easy go. If the home goes up in value he’s made lots

of money; if it goes down in value, he can stick it to the bank. (A Wall Street

type once advised

me to do exactly that.)

Finally, Mr Campbell has an obvious solution to his problem staring him in

the face, and can’t see it. He wants to put just 10% down, not 20%, but he doesn’t

want to pay the interest rate on a 90% mortgage. Fine. All he needs to do is

put 20% down, get an 80% mortgage, and get half of the 20% downpayment by borrowing

it from his broker. Given the size of his assets, his broker will be more than

happy to loan him the money, especially if he uses his stock portfolio as collateral.

Who’s better with their money, then? The debt-swamped

middle classes, or the second-home-owning rich? Clearly, I think, the former.

(Via)

Posted in housing, personal finance | Comments Off on Adventures in Personal Finance, Part 2: The Rich Couple

Adventures in Personal Finance, Part 1: The Middle-Class Family

Posted on May 19, 2007 by Felix

Sometimes the middle classes have a hell of a lot more financial horse-sense

than the rich, even if the financial press doesn’t like to spin it that way.

Exhibit A: John

Leland, in the New York Times, in a story headlined "Couple Learn the

High Price of Easy Credit". There’s an accompanying graph showing how the

average family spends more than it earns, and Leland has found himself the average

family:

[Christine] Moellering, and her husband, Mark, 39, earn average salaries

for their age (together about $66,000 a year), live in an average-priced home

and have an average cost of living.

Ms Moellering, and her husband, Mark, also have two young children (the daughter

goes to ballet lessons) and the ridonkulous bathtub featured in this

photo, as well as a 42-inch television. We set ourselves up for a contemporary

morality play, where people learn the hard way what happens when you spend beyond

your means.

But in fact a careful reading of the article shows that the Moellerings are

actually doing pretty well, financially speaking. The bathtub looks extravagant,

but we don’t know how much it cost; the television cost only $800; and the ballet

lessons are essentially paid for by the state of Michigan.

It’s true that supporting a family of four on $66,000 a year, especially with

the occasional splurge, is not easy, and these chaps have managed to rack up

$22,228 in credit-card bills on top of $161,574 in debt secured on their home.

But a lot of that credit-card debt, it turns out, is hangover from their wedding,

and, importantly, it’s coming down, not going up.

The Moellerings’ total annual debt-service payments are $17,500, give or take

– which is about 22% of their total income, including the $1200 per month

they receive from the State Department of Human Services. And that $17,500 includes

substantially all of their housing costs, which means that even once you throw

in credit-card interest, they’re still better off now than they would be if

they were paying $1,500 a month in rent. (This is where I reveal myself to be

a New Yorker, one of that peculiar breed of Americans who thinks that $1,500

a month in rent is dirt cheap.)

In fact, if you scroll down past all the woeful tales of "the high price

of easy credit," you’ll find that they’ve managed to cut their credit-card

debt in half over the past two years, have built a savings account with $5,000

in it, and have also been contributing to Christine Moellering’s retirement

account at work. Add it all up, and they’ve basically managed to sock away $30,000

in two years, which they’ve put into savings and paying down debt. They’re not

living beyond their means at all. In fact, they’re living well within their

means – no easy feat for a family in their position, where the pressures

of work and children always take precedence over issues of personal finance.

Posted in personal finance | Comments Off on Adventures in Personal Finance, Part 1: The Middle-Class Family

Jerry Falwell is Dead

Posted on May 19, 2007 by Felix

This is why God invented Christopher Hitchens.

(Via)

Posted in Not economics | 6 Comments

Debt Datapoint of the Day, EMBI+ Edition

Posted on May 18, 2007 by Felix

I’m not sure if the concept of a "credit bubble" makes sense. To

me, a bubble is something speculative, where people buy in the hope and expectation

of flipping to a greater fool. Debt is being offered at ridiculously low interest

rates, to be sure, but the people buying it aren’t usually looking to flip it.

On the other hand, it’s worth at least noticing that JP Morgan’s EMBI+ index

of emerging-market bond spreads hit

an all-time high yesterday, yielding just 144 basis points over Treasury

bonds. Of course, the index now is full of countries with enormous foreign-exchange

reserves and rising creditworthiness: S&P just upgraded Brazil to one notch

below investment grade, and with a positive outlook to boot. It’s almost impossible

to imagine a situation in which a country like Brazil or Mexico or Russia would

default on its dollar-denominated bonds, as Argentina did only a few years ago.

And so it’s reasonable for an index of emerging-market sovereigns to trade tighter

than high-yield debt from the likes of Ford and Chrysler, where default is far

from unthinkable.

On the other hand, sovereigns do default, and much more frequently than the

capital markets like to think. Ecuador, for one, has a very high probability

of defaulting on its external debt if populist president Rafael Correa stays

in power — and there’s no indication of his being kicked out any time soon.

Ecuador is trading at 632 basis points over Treasuries, according to JP Morgan,

which is where the EMBI as a whole stood not too many years ago. Credit spreads

are bound to widen from these levels; the only questions are when and by how

much.

Posted in bonds and loans | Comments Off on Debt Datapoint of the Day, EMBI+ Edition

Derivatives and CLOs: The Scaremongering Continues

Posted on May 18, 2007 by Felix

Greg

Ip and Gillian

Tett both have pieces today on that old friend of ours, systemic risks to

the financial system. Ip has found a Wall Street doomsayer:

Like many pessimistic observers, Richard Bookstaber thinks financial derivatives,

Wall Street innovation and hedge funds will lead to a financial meltdown.

What sets Mr. Bookstaber apart is that he has spent his career designing derivatives,

working on Wall Street and running a hedge fund.

Tett, meanwhile, is worrying about European collateralized loan obligations:

The CLO sector is opaque, and pipelines operate with a long timelag. It is

thus entirely possible to imagine a scenario where CLO activity suddenly collapses,

producing a shock for debt prices, which could be a tipping point for credit

markets that are already overstretched.

I’m not sold on Bookstaber, who seems to be talking his own book, both literally

(he’s written a book on this) and figuratively (he runs a hedge fund whose trades

reflect his ideas). He also seems to give himself rather too much credit for

world-changing events:

Mr. Bookstaber, who sold portfolio insurance to investors in Japan and managed

it for such Morgan Stanley clients as Chrysler, Ford Motor Co. and Gillette,

writes, "Through my role in implementing portfolio insurance, I had helped

precipitate a financial crisis of monumental proportions." [He’s talking

here about the 1987 stock-market crash.]

In 1998, as head of Salomon Brothers’ risk-management team, he tried to find

out why a strategy employed by the firm’s bond arbitrage desk, with some of

Wall Street’s smartest minds, was facing more than $100 million in losses.

Even after intensive study, the cause remained an "enigma," Mr.

Bookstaber writes. But he did conclude that declining interest rates were

causing the strategy to lose money even though it was designed to be interest-rate

neutral. His findings, he says, encouraged the new owners of Salomon, which

had just merged with Smith Barney, to close the bond arbitrage unit and liquidate

its positions.

Mr. Bookstaber says as Salomon closed out its positions, other traders stepped

out of the way and liquidity — the ease of trading — in the underlying markets

dried up. This, he said, precipitated LTCM’s crisis.

Wow! The two biggest systemic meltdowns of the past 20 years, and they were

both Bookstaber’s fault!

As for Tett’s CLO worries, she does concede that the market should be self-correcting,

and that she’s not actually predicting a crisis. On the other hand, it’s perfectly

rational to be worried about things which have a small but meaningful probability

of happening. I’m just not convinced that a collapse in new CLO formation would

have the effect that Tett thinks it might have. Rather, I suspect that hedge

funds and others will step in as and when CLOs step back — as has happened

in the US mortgage market.

Posted in derivatives | Comments Off on Derivatives and CLOs: The Scaremongering Continues

Tech Bubble Redux

Posted on May 18, 2007 by Felix

The one silver lining for Microsoft, when Google bought DoubleClick for $3

billion a month ago, was that Google was suffering from the winner’s

curse, and paid way too much for the internet advertising company. Naturally,

then, it took Redmond’s best and brightest only a few short weeks to manage

to spend

$6 billion on their own internet advertising company, aQuantive.

Dana

Cimilluca notes today that the deal leaves Citigroup analyst Mark

Mahaney with a huge amount of egg on his face. He downgraded

aQuantive at the end of April, when it was trading at just over $30 per share,

saying that the best-case scenario for the company gave it an upside of no more

than 14%. (And remember, this was after the DoubleClick deal.) Oops.

Microsoft’s paying $66.50 per share.

Mahaney’s problem is not that he doesn’t know how to value a company; it’s

that he does know how to value a company. But web and tech companies

aren’t changing hands based on rational valuations these days. Truly, the happy

days are here again.

Posted in stocks, technology | Comments Off on Tech Bubble Redux

World Bank Stitch-Up to Continue

Posted on May 18, 2007 by Felix

When it comes to cozy duopolists, any future friendliness between Thomson-Reuters

and Bloomberg pales next to the selfishness and nearsightedness of the G2 when

it comes to leading

the World Bank and the IMF. No sooner had Paul Wolfowitz

resigned than Hank Paulson was telling PBS that his replacement

would be chosen by the Americans, and it wasn’t long until the Germans chimed

in too:

German Chancellor Angela Merkel‘s spokesman today rejected

a suggestion by Finance Minister Peer Steinbrueck that the

U.S. should consider giving up its lock on the World Bank presidency.

"For the German government, it’s completely beyond all question that

the United States of America will continue to occupy the top job at the World

Bank and has the first choice," spokesman Thomas Steg said at a press

conference in Berlin today.

What’s fascinating to me is that no one seems to be spending any time drawing

the distinction between America nominating the next president, on the one hand,

and it nominating an American, on the other. For reasons I genuinely don’t understand,

it seems to be some kind of inviolable rule that if the US has the privilege

of choosing the next president, it will always choose an American citizen.

Never mind that the result of such idiocies is that you end up with people

like Jim Wolfensohn actually taking US citizenship for no other

reason than to become World Bank president. (Note to self: Ngozi

Okonjo-Iweala has lived in America since 1972, and her children are American;

could she do the same thing?) The bigger point is that it’s trivially true that

America’s best interests are not necessarily served by having an American in

the top job — even assuming that the White House is so selfless as to be trying

to serve its own best interests here, rather than those of the world’s poor.

Even if the Americans do show the imagination necessary to nominate a non-American,

however, the process remains fundamentally flawed. As dsquared notes in a comment

on this blog,

Going in for rushed and non-transparent selection was how we got into this

mess in the first place. Replacing Wolfowitz has to be used as the opportunity

to put in place a proper selection process. The WB can function without a

President for a short while, but it can’t go on without big changes to the

top job system. I would be much keener to see an interim appointment of one

of his deputies (or even a real steady-the-ship exercise, appointing someone

like Michel Camdessus pro tem) and taking the opportunity for some real sensible

long term thinking about how to fill these jobs (which would obviously have

to chuck the IMF top job into the pot too as it is only pure chance that this

broken system happened to have its first meltdown at the WB rather than IMF).

The only thing I’d add to that is that the IMF top job (managing director)

— which always goes to a European — is balanced out somewhat by the IMF number-two

job (first deputy managing director) who is in many ways more important, on

a day-to-day basis, and who is, naturally, an American.

I’m not at all sure what a proper selection process would look like, although

there’s no doubt that it would give great weight to the views of the developing

world. But I do know that just about any process would be better than what we

have now, which is no process at all.

Posted in world bank | Comments Off on World Bank Stitch-Up to Continue

Wolfowitz Finally Wakes up to Reality, Resigns

Posted on May 17, 2007 by Felix

Talk about a lame duck. Paul Wolfowitz will resign

as president of the World Bank on June 30, a month and a half from now, during

which time he will earn $50,000, tax-free, and do substantively zero useful

work. Then again, it’s not a lot of time to find a replacement. Ngozi,

of course, has an easily-leavable job at the Brookings Institute, and she’s

in Washington already. It would be silly to look at anyone else, if you ask

me.

Over at worldbankpresident.org,

there’s speculation that Wolfowitz will be put on mandatory leave effective

immediately, with Graeme Wheeler, Lars Thunell, or Vincenzo la Via stepping

in until a permanent replacement is found. Seems like a good idea to me.

Posted in defenestrations, world bank | 1 Comment

Why Venezuela Won’t be the Next Zimbabwe

Posted on May 17, 2007 by Felix

Simon

Romero has a reasonably balanced feature on Venezuelan land reform in today’s

New York Times. Land reform is one of those dreams which never seems to work.

The dream never loses its strength (cf 40

acres and a mule), but the reality never seems to pan out.

It’s not just socialists who don’t understand this. Organic farmers in Vermont

or Yorkshire who complain that they can’t make a living from their smallholdings

are in much the same boat as their counterparts in Jamaica who have lost the

artificial subsidies they used to get from Europe. I once spent a couple of

weeks on a farm in Tuscany which had magnificent food, but which realistically

could barely feed itself, let alone any of the surrounding population. Yet the

owners passionately defended their agricultural subsidies on national-security

grounds: what would happen to Italy if the rest of the world stopped exporting

food to it?

The fact is that these days efficient agriculture is big agriculture, and any

attempts to give small amounts of arable land to large numbers of people are

liable to end in something which is very economically inefficient.

In any event, Venezuela stands at the end of a very long history of land reform

in Latin America, whereby huge estates were taken away from the landowning elites

and given to the people. Bolivia, Cuba, Ecuador, Mexico, Peru – what’s

going on in Venezuela is nothing new. So when Matt

Cooper says that "once the land grabs start, they take on a life of

their own," and immediately starts comparing Venezuela to Zimbabwe, I’m

tempted to tell him to slow down a bit. Land grabs happen in different countries

with different regimes for different reasons: in the case of Peru, for instance,

it was a military junta which confiscated the land, not a socialist idealogue.

And as Robert

Waldmann notes, sometimes land reform even, you know, actually works:

Latin America is not the whole world. Consider some countries which have

had massive Top-down land redistribution projects : Japan, Taiwan, South Korea

and Italy. Italy might seem to be l’uomo dispari fuori (odd man out) but experienced

an economic miracolo from the year of the reform 1953 through 1962.

Waldmann also notes that Venezuela’s current landowners are far from being

economically efficient themselves, which gives the land reform greater upside

and lower downside. (The Rhodesians, by contrast, were generally efficient farmers,

on a purely economic level.)

My gut feeling is very much that Venezuela is not Zimbabwe. Yes, Hugo Chavez

is making very bad economic decisions — but then again, his elitist predecessors

were hardly much better. And very bad economic decisions don’t in and of themselves

lead to Zimbabwe-style disaster. For that, you need a power-mad lunatic like

Robert Mugabe. And while Chavez might be distasteful to many Americans, a Mugabe

he is not.

Posted in economics | Comments Off on Why Venezuela Won’t be the Next Zimbabwe

Ngozi Okonjo-Iweala for World Bank President!

Posted on May 17, 2007 by Felix

Barrie

McKenna of the Globe and Mail has a tantalizing and wonderful suggestion

today:

The British media is already floating Tony Blair as a possible

successor. The British Prime Minister, who is due to meet Mr. Bush at the

White House today, announced last week that he’s stepping down after a decade

in power.

Some World Bank critics want a more radical leadership change, proposing candidates

such as South African Finance Minister Trevor Manuel and

Nigeria’s former finance minister, Ngozi Okonjo-Iweala.

In September 2005, I gave Okonjo-Iweala Euromoney’s Finance Minister of the

Year award as the best finance minister in the world. It was an award for which

she was more than qualified, and her departure from Nigerian government was

a major setback for that country.

Okonjo-Iweala knows the World Bank inside out and backwards, having spent most

of her career there; she’s hard-headed yet also very good at building consensus.

She’s incredibly smart, very hard-working, and has first-hand knowledge of the

problems of running a developing nation’s finances. Most importantly, as an

African, albeit one who’s spent most of her life in the US, her appointment

would be a concrete sign that the Bank exists for the benefit of the world’s

poorest nations, and is not seen by the White House as being an instrument of

US foreign policy.

Notes worldbankpresident.org:

I doubt any of the American names mentioned as possible replacements to Wolfowitz

can match someone like Ngozi’s experience and record on the key issues of

aid to Africa, Anti-Corruption, and the credibility needed to raise the IDA

funds.

Her experience, both as a secretary to the board of executive directors and

as a long time bank career member that rose through the ranks to the level

of VP, also put her way ahead on both the question of building trust with

the staff of the bank and also rebuilding the relationship with the board

of directors.

The only questions about her chances have to do with whether the President

of the US , who has the power to do this, is smart enough to name the first

woman, the first African, and the first non-American as the head of the World

Bank.

Ngozi would be better suited for the job than any American, Bill Clinton

included. She’s certainly better qualified than Hank Paulson,

who seems to be cropping

up as another possible World Bank president. He knows how to run a big organization,

and he has solid environmental credentials, but his development experience is

slim, and in any case it’s long since time that someone other than an American

gets the gig.

I doubt that Bush has the vision to nominate Ngozi. But it would be a wonderful

day if he did.

Posted in world bank | Comments Off on Ngozi Okonjo-Iweala for World Bank President!

Fantastic News on Immigration

Posted on May 17, 2007 by Felix

The immigration

agreement which has been hammered out between the Senate and the White House

is some of the best news I’ve heard in ages, and I’m keeping lots of fingers

and toes crossed that somehow it makes its way into law.

There’s some very clever stuff in the agreement, and I’m particularly impressed

with the new Z visa:

The proposed agreement would allow illegal immigrants to come forward and

obtain a "Z visa" and — after paying fees and a $5,000 fine —

ultimately get on track for permanent residency, which could take between

eight and 13 years. Heads of household would have to return to their home

countries first. They could come forward right away to claim a probationary

card that would let them live and work legally in the U.S., but could not

begin the path to permanent residency or citizenship until border security

improvements and the high-tech worker identification program were completed.

The great thing about the Z visa is that once illegal immigrants get one, they’ll

be able to go back to their home countries without worrying that if they do

so they might never be able to make it back into the US. As a result, a large

number of immigrants will start moving out of the US, partially offsetting the

number of immigrants coming in.

There’s good news on the skilled-immigrant

front, too:

In perhaps the most hotly debated change, the proposed plan would shift from

an immigration system primarily weighted toward family ties toward one with

preferences for people with advanced degrees and sophisticated skills.

Now that Democrats control the House, I’m hopeful that this bill can get passed,

albeit in the face of a lot of noise about "amnesties" and whatnot.

If George Bush wants to leave any kind of positive legacy for his country, he’d

do well to spend a lot of political capital here.

Posted in immigration | Comments Off on Fantastic News on Immigration

Explaining the Dentist Puzzle

Posted on May 17, 2007 by Felix

Greg

Mankiw today wonders about "the dentist puzzle," quoting Robert

Frank:

Others have argued that inequality has increased in the United States because

globalization has put unskilled American workers in competition with low-wage

workers from other lands. Yet the basic pattern of inequality growth has been

the same even among dentists, who are largely immune from foreign competition.

Most dentists today earn little more than their counterparts from 1979, but

the best paid dentists earn almost three times as much.

Mankiw rightly dismisses Frank’s "superstar" hypothesis for why this

should be the case, but doesn’t try to explain it himself. So let me explain

it with two words: health insurance.

I’ve thought for a while that what I’d really like the market to provide would

be a very low-cost health and dental insurance plan with a 100% deductible,

and then an extra plan on top for catastrophic expenses.

Why would I be willing to pay money for a plan with a 100% deductible? That’s

easy: the insurance companies pay much less money than the health-care providers

charge. I recently got an "explanation of dental plan reimbursement",

for instance, which broke down like this:

Amount claimed: $765

Amount allowed: $250

My co-pay: $59.50

Amount paid by the insurance company: $190.50

In other words, the cost of the treatment is $765, but the amount that the

dentist ends up getting paid is just $250 – less than one third of the

total.

This, I think, helps to explain why some dentists get paid three times more

than others. Most dentists accept insurance, which means they end up being paid

roughly one third of what they bill out. A few dentists, on the other hand,

don’t accept insurance, which means they get paid in full.

And if I had a 100% deductible, I’d end up paying $250 for my dentistry. If

I had no insurance at all, the bill would be $765.

Posted in economics | Comments Off on Explaining the Dentist Puzzle

Bernanke on Housing: No Sign of a Rate Cut

Posted on May 17, 2007 by Felix

Ben Bernanke gave an important

speech on subprime mortgages in Chicago today. The whole thing seems balanced

and sensible to me: he understands that there’s a problem, but he doesn’t think

it’s worth panicking over. He says that the weak housing market "is an

important source of" the slowdown in economic growth, and that we’re not

necessarily out of the woods yet; at the same time, however, he concludes that

given the fundamental factors in place that should support the demand for

housing, we believe the effect of the troubles in the subprime sector on the

broader housing market will likely be limited, and we do not expect significant

spillovers from the subprime market to the rest of the economy or to the financial

system.

Bloomberg

says that "Bernanke didn’t discuss monetary policy in his remarks,"

but the speech reads very much to me as though he’s saying that the Fed is not

going to cut interest rates in response to housing-market weakness. And really

there’s no other reason to cut rates, given nascent inflation. So my

feeling is that hopes for a rate cut any time this year could well end up being

dashed.

In general, I’m impressed by Bernanke’s laissez-faire approach to the housing

market. The problems, including lax underwriting standards, came from the market,

and the solutions, including tighter underwriting standards, are also coming

from the market. Lenders and borrowers who behaved in a financially irresponsible

manner have lost money – that’s how markets should work. It’s

not the job of the Fed to step in and change that. What’s more, Bernanke notes

that the market itself can provide solutions that the Fed can’t:

Even as purchases of securitized subprime mortgages for collateralized debt

obligations–an important source of demand–have declined, increased purchases

by investment banks, hedge funds, and other private pools of capital are beginning

to fill the void.

And nobody cares if they end up losing money on their bets.

Posted in fiscal and monetary policy, housing | Comments Off on Bernanke on Housing: No Sign of a Rate Cut

Contemporary Art: Strength, or Frothiness?

Posted on May 17, 2007 by Felix

They came like a one-two punch: First the Sotheby’s

auction, raising $254.8 million on Tuesday night, then the Christie’s

auction, raising $384.6 million on Wednesday night. The headlines, naturally,

went to the megastars: $72.8 million for Mark Rothko, $71.7 million for Andy

Warhol. But I’m more impressed by the depth of demand in the maket, with an

astonishing number of artists’ auction records being not so much broken as shattered.

The art world generally considers the Rothko to be overpriced, or rather priced

for provenance (David Rockefeller) rather than for anything inherent to the

work. I’m not so sure – Rothko’s a real blue-chip artist, and this particular

painting is stunningly beautiful. It really belongs in the Modern Art sales,

with pink period Picassos, rather than in Contemporary Art with Eva Hesse and

Richard Prince.

The Warhol, on the other hand, a disturbing and powerful painting from his

car crash series, is a truly contemporary work. Its astonishing price tag marks

Warhol’s official elevation to the ranks of the all-time greats, putting him

up there with Jasper Johns.

And buried beneath the Rothko hype was the news that a Francis Bacon pope had

sold for $52.7 million, obliterating the artist’s previous auction record of

$27.6 million.

Looking past the eight-digit sales to the mere seven-digit sales, however,

reveals the true frothiness strength of the contemporary art market these

days; it’s worth scrolling through the detailed post-mortems by Carter Horsley

(Sotheby’s, Christie’s)

for details.

At Sotheby’s, a particularly ugly Tom Wesselmann went for $5.9 million, more

than doubling the artist’s auction record. A good-but-not-great Basquiat would

have counted as a seven-digit sale except that it went for $14.6 million –

no previous painting by the artist has sold at auction for more than $5.5 million.

Rauschenberg, too, joined the eight-figure club, with his "Photograph"

selling for $10.7 million.

Christie’s was more impressive still. Cindy Sherman was surely very pleased

by the fact that one of her pieces went for $2.1 million, if annoyed that her

ex-boyfriend, Richard Prince, got even more, with one of his cowboys fetching

$2.8 million. There was also an interesting Sotheby’s versus Christie’s fight:

Sotheby’s set a John Baldessari record of $992,000, for instance, only to see

Christie’s shatter it by selling another Baldessari for $4.4 million. Christie’s

Prince was more expensive than the record price set the night before, $2.5 million

at Sotheby’s. And after And after Sotheby’s set an auction record of $1.1 million

for Cecily Brown, Christies beat it with a different one selling for $1.6 million.

Elsewhere at Christie’s, a gorgeous Damien Hirst pill cabinet fetched $7.4

million, a Lisa Yuksavage sold for $1.4 million, a Gerhard Richter sold for

$6.2 million, a Hiroshi Sugimoto sold for $1.9 million, a Donald Judd sold for

$9.8 million, an Eva Hesse sold for $4.5 million, an Agnes Martin sold for $4.7

million, a Susan Rothenberg sold for $1.5 million, a Richard Artschwager sold

for $1.3 million, and even a Marc Newson chest of drawers sold for $1.05 million.

All set new records.

It’s simply not feasible that all of these artists just happened to have their

very best work coming to auction at the same time. Rather, there has been a

wholesale rerating of contemporary artists which looks a bit like the wholesale

rerating of Nasdaq stocks in 1999. In 20 years’ time, a lot of these prices

are going to look idiotic – but some aren’t.

If you look at the art stars of the last bubble – Schnabel, Fischl, Longo

– most of them are still nowhere to be seen, as far as the auction houses

are concerned. Basquiat, of course, is the exception. With the present crop,

working out who’s the Fischl and who’s the Basquiat is the real multimillion-dollar

question.

Posted in art | Comments Off on Contemporary Art: Strength, or Frothiness?

When Politicians Go Private

Posted on May 17, 2007 by Felix

It’s no secret that high-profile public servants can make a lot of money in

the private sector after they leave their jobs. Sometimes, they go back into

government again later, and we all get to see how much money they’ve made in

the interim: Dick Cheney and Don Rumsfeld

spring to mind. And, now, Rudy Giuliani, who made at

least $17 million last year, not including his profits on the sale

of Giuliani Capital.

Giuliani, 62, a former New York mayor who has led in polls for his party’s

presidential nomination, earned $11.4 million in speaking fees, according

to his disclosure filed with the Federal Election Commission. He received

$4.1 million from his New York-based consulting firm, Giuliani & Co. LLC;

$1.2 million from his Houston law firm, Bracewell & Giuliani LLP, and

$146,092 in royalties for his 2002 book, “Leadership.”

When Giuliani left the mayor’s office in 2002, he reported assets between

$1.2 million and $1.9 million. According to his disclosure to the FEC, his

assets had grown to at least $17 million last year and perhaps as much as

$70 million. His share of the consulting firm was worth between $5 million

and $25 million.

Giuliani’s brace of seven-figure salaries makes the $479,000 paid

to John Edwards by Fortress Investment Group seem positively

modest. And it also raises the question of the opportunity cost to public servants

of staying in the public sector. The president of the World Bank, for instance,

makes $400,000 tax-free: a hefty sum, by normal standards. But were Tony

Blair, for instance, to take the job, he might be giving up the opportunity

to ensure that all his children live very comfortably for all their lives.

Posted in Politics | Comments Off on When Politicians Go Private

Is Chrysler worth -$30 billion?

Posted on May 16, 2007 by Felix

The Wall Street Journal, it seems, can read my mind. No sooner do I ask

why Chrysler is going to be borrowing as much as $65 billion in new debt, than

Serena

Ng and Jason Singer do their best at answering. (Many thanks to Steve

Waldman for the heads-up.)

I can’t pretend that I really understand what’s going on, even after reading

the WSJ article, but at least the broad outlines are there. It turns out that

at the moment, some $38 billion in Chrysler debt is guaranteed by Daimler. So

Cerberus needs to raise at least that much in order that Daimler is no longer

responsible for a company it doesn’t own.

Quite why Cerberus needs to raise another $24 billion on top of that is less

clear. (The WSJ puts the total debt requirements at $62 billion.) We’re told

it’s to "fund the business," although it smells to me a little bit

like old-fashioned private-equity leveraging-up, as well.

The interesting thing is that the lion’s share of the borrowing will be done

by Chrysler Financial, not the auto company. The auto company will borrow "only"

$12 billion in total, which will make it less leveraged and more creditworthy

than either GM or Ford.

A lot of Chrysler Financial’s debt will be auto-loan securitizations:

Chrysler Financial’s expected sale of securities backed by auto loans may

be the biggest issue the $200 billion market for such debt has seen. Chrysler

has held many of those loans and now is effectively selling them by issuing

securities backed by their payments. Some analysts say the company could sell

up to $30 billion of such securities.

Let’s be conservative, and say that if Chrysler Financial’s loan portfolio

can be securitized to the tune of $30 billion, that means that the portfolio

is worth $33 billion today. Cerberus bought Chrysler Holding for $7.4 billion.

Chrysler Holding comprises Chrysler Financial and Chrysler Corp, the auto maker.

Let’s say that the value of Chrysler Financial is the value of its loan portfolio,

nothing more. And let’s say that F+C=H, where F is the value of Chrysler Financial,

C is the value of the automaker, and H is the value of the holding company that

Cerberus bought.

What do we conclude? That C, the value of the automaker, is H-F = -$26 billion.

Now in fact, Chrysler Financial is probably worth more than $33 billion, and

the holdco is probably worth less than $7 billion, since Daimler is actually

losing money on this deal. So the value of the automaker on its own might well

be a negative number well in excess of $30 billion. Or am I missing something,

here?

Posted in M&A | 4 Comments

When a $7 Billion Deal is a $70 Billion Deal

Posted on May 16, 2007 by Felix

Does anybody have a clue what kind of numbers are involved in the Chrysler-Cerberus

deal? On Monday, the WSJ’s Dennis

Berman told us that Cerberus was spending a total of $7.4 billion: $5 billion

to the new company, $1.05 billion to the financial business, and $1.35 billion

to Daimler. Meanwhile, Daimler is getting that $1.35 billion, but spending or

loaning a total of $1.6 billion, which means it’s actually paying money to get

rid of the asset.

With me so far? If you take the $6.05 billion that Cerberus is putting into

the company, and add the $1.6 billion "cash outflow" from Daimler,

the total amount of money being spent seems to come to $7.65 billion.

Yet today Dana

Cimilluca manages to pull some much, much bigger numbers from somewhere:

The underwriters of the $50 billion to $65 billion in debt that will be raised

to help finance the deal and Chrysler’s operations going forward may

share fees in the neighborhood of $320 million, according to Thomson/Freeman.

$50 billion to $65 billion in debt? Where did that come from?

I understand that Cerberus is going to want to invest money in Chrysler going

forwards, and that it might lose money during that time. But still – $65

billion is one hell of a lot of money, and dwarfs even the $18 billion in pension

liabilities that Daimler was seemingly so keen to get rid of. Add on $5 billion

or so in equity, and you have yourself a $70 billion deal.

It seems to me that Chrysler is valued at, approximately, zero. Who on earth

is going to lend $65 billion to a loss-making company with no clear turnaround

plan as of yet? Or does Chrysler already have a vast amount of debt outstanding,

and now Cerberus wants to refinance it all? I have to admit to being utterly

confused.

Posted in M&A | Comments Off on When a $7 Billion Deal is a $70 Billion Deal

Why Economic Advisers Advise

Posted on May 16, 2007 by Felix

I asked

yesterday how the whole system of economic advisers worked, and today, I got

an answer, from someone who’s helping to advise one prominent presidential candidate:

People in the policy world get to know one another. People seek advice first

casually and, if there’s a fit, more formally. The record of advisers

getting senior administration posts is very good, you’ll find. That

said, there are plenty of folk who have no Potomac fever. That’s likely to

be true of some, but not all, of the prominent academics advising candidates.

But if their guy or gal gets into the White House, there’s wonderful access

from the early involvement at a minimum.

I think that most of us have the occasional "if I were president"

moment. And so I suppose it’s only natural that for anybody who’s never going

to be elected president themselves, the next best thing would be to have real

policy influence over the president – which is something you might be

able to get by hitching your star to a campaign early on.

My informant is currently working on an unpaid basis, so one can only assume

that s/he does genuinely support the candidate in question. On the other hand,

maybe the benefits of working for the eventual winner mean that people will

work even unpaid for a candidate they think has (a) a good chance of winning,

and (b) a good chance of taking at least some of their advice.

Posted in technocrats | Comments Off on Why Economic Advisers Advise

News Doesn’t Matter, Dell Edition

Posted on May 16, 2007 by Felix

Megan

Barnett has a great little story today about the stock market’s reaction

to news that Dell has been hit with a lawsuit from New York Attorney General

Andrew Cuomo: the company’s shares were last

seen up $1.25 apiece, or more than 5%. To put it another way, Cuomo would

seem to have increased the value of the company by $2.8 billion.

There’s even a great quote from one of those people who is convinced that news

moves stocks, even when it’s obvious that it doesn’t:

Goldman Sachs analyst Laura Conigliaro said she thinks investors might be

pleased the suit wasn’t connected to a separate investigation by the S.E.C.

into Dell’s accounting practices, the Associated Press reports.

Oh, for an analyst or a journalist to be able to admit that there isn’t always

a causal relationship between news releases and stock-price moves! The fact

is that Dell stock went up and (weak version) nobody knows why, or (strong version)

there simply isn’t a reason at all.

Posted in stocks | Comments Off on News Doesn’t Matter, Dell Edition

Using Credit Cards Abroad

Posted on May 16, 2007 by Felix

One of the more annoying of the world’s bank charges is the fee that banks

charge you when you make a purchase on your credit card overseas. In fact, there

are often three fees:

  • The 1% fee which Visa and Mastercard charge the issuing bank, and which

    is usually passed on to the cardholder;

  • An extra fee of up to 2% charged by the issuing bank for no obvious reason;

    and

  • The hidden fees which may or may not be found lurking inside the exchange

    rate conversion.

Bankrate.com has a good

overview of how the first two fees differ from issuer to issuer: Bank of

America and Citibank charge a total of 3% after conversion to US dollars, for

instance, while Wachovia and WaMu charge 1%, and Capital One actually eats the

charge from Visa and Mastercard and charges 0%. As for the stand-alone cards,

American Express charges 2% while Discover charges 0%.

Not a single bank would tell Bankrate why they might charge more than 1%, maybe

because they were embarrassed to admit it was just a scheme for making money

without any effort.

But I’d be very interested to see not how the fees compare in theory, but how

they compare in practice. If you bought four identically-priced items overseas

at exactly the same time, using a Visa card, a Mastercard, an Amex card and

a Discover card, how would your charges differ? Discover, with its 0% fee, might

look like the best option – but if it whacks you on the exchange rate,

you might be better off elsewhere.

There are two reasons I’m a little bit suspicious of Discover’s 0% fee, and

they both come down to the fact that the Discover card is basically a US card,

not a global one. As a result, relatively few overseas locations accept it in

the first place, which means that currency conversion is less easy and common

for Discover than it is for other cards. More importantly, there’s no netting

out: while lots of Americans use their Discover cards abroad, there aren’t any

Europeans, say, using their Discover cards in the US. So every time a Discover

cardholder makes a purchase, Discover really does need to convert dollars into

that foreign currency.

Visa, Mastercard, and Amex, on the other hand, have revenues in lots of different

currencies on a daily basis. If American cardholders spend $1 million in Europe

on the same day that European cardholders spend $1 million in America, everything

can pretty much cancel itself out, and no actual FX trade needs to be done.

Still, this is all very theoretical. Does anybody know how and whether FX conversion

rates differ in practice?

Posted in personal finance | Comments Off on Using Credit Cards Abroad

Goldman Sachs and Lord Browne

Posted on May 16, 2007 by Felix

Matthew

Lynn says that Goldman Sachs should have backed Lord Browne, rather than

firing

him. Matthew Lynn is clearly a very astute and intelligent man:

The New York-based investment bank still should have taken the opportunity

to make a stand for gay people and equal rights. It can draw no credit from

the episode.

I’m glad that Goldman is deservedly drawing some heat for its cowardly decision.

After all, Browne’s crime was minor indeed, and dates back to when he was trying

to suppress publication of details about his private life:

Browne was asked about where they had met. He claimed under oath that it

was while exercising in London’s Battersea Park.

The truth was they had met through a male escort agency…

For Browne, lying was foolish. Probably arrogant as well. No doubt he regrets

it. He would have been better advised to let the Mail go ahead and publish

its distasteful story.

And yet, let’s get some perspective. The lie was a very minor one — and probably

excusable. After all, it is slightly embarrassing to meet your partner through

an escort agency, whatever your sexual orientation. Not many of us would wish

to own up to that, either in court or among friends. Our first reaction might

well be to fudge an uncomfortable truth.

And there is no suggestion he has done anything else wrong. It is quite legal

in the U.K. to contact someone through an agency. Surely Browne can meet whomever

he wants.

It’s also worth mentioning in Browne’s defense that he and his boyfriend were

often asked, during their four years together, how they met. They decided early

on in the relationship that they would say that they met in Battersea Park –

a decision which certainly benefitted Chevalier more than it benefitted Browne.

Browne did not know exactly what Chevalier had told the Mail on Sunday, and

he might well have feared that he would be outing his ex-lover as a former escort

if he told the truth.

Goldman Sachs claims to value its gay employees highly. But in the wake of

this decision, those employees must be feeling that they’re getting rather mixed

signals.

Posted in defenestrations | Comments Off on Goldman Sachs and Lord Browne

White House Still Well Behind the Wolfowitz Curve

Posted on May 16, 2007 by Felix

The attempts

by the Bush administration to do right by Paul Wolfowitz are

touching, if laughably inadequate. Apparently the latest trial balloon being

floated by the White House is that Wolfowtiz gets absolved on the grounds of

"acting in good faith", and then, maybe, at some unspecified point

in the future, he resigns (or doesn’t) on fluffier grounds associated with his

leadership.

Not only is this idea clearly about a month too late, it also ignores the fact

that the Bank’s board has already found Wolfowitz guilty, not to mention the

fact that Wolfowitz’s whiny

pleas yesterday went into no little detail about how he wanted to change

his leadership style – thereby giving him a loophole which would allow

him, under the proposed US deal, to stay on.

Steven Weisman, of the New York Times, does raise one hope with his choice

of words, only to dash it later on in the sentence:

It appeared that the best the administration could hope for was the possibility

of President Bush appealing personally to Prime Minister Tony Blair, with

whom he is scheduled to meet at the White House on Wednesday, and to other

elected leaders.

I can’t imagine that there would be much opposition if Bush could persuade

Blair to replace Wolfowitz. But that option, it seems, is not on the table.

Posted in world bank | Comments Off on White House Still Well Behind the Wolfowitz Curve

Lampert’s Options at Citigroup

Posted on May 16, 2007 by Felix

What is Eddie Lampert intending to do with his $800 million

(or 0.3%) stake

in Citigroup? The general consensus is that Citi is simply a value stock

which fits Lampert’s investing style. It certainly looks cheap, notes Chad

Brand: it’s trading at 10 times earnings, and yields 4%. Plus, says Brand,

if Citi has problems with being big, then so does ESL, Lampert’s investment

vehicle:

His hedge fund is big enough that large cap stocks are the only kinds of

investments that he can really take a meaningful position in without buying

an entire firm.

On the other hand, Lampert might not be someone to be scared of, so much as

a useful investor to be embraced as a potential source of good ideas. He’s likely

to be around for a while, should management be so inclined. As Bloomberg notes,

"unlike many hedge funds, ESL takes large stakes in a few companies and

holds them for years."

And there’s always the possibility that Lampert has more aggressive moves in

mind. DealBook finds one investor who hopes as much:

Mr. Lampert, chairman of the parent of the retailers Sears and Kmart, “would

have the clout to make management changes,” Richard Sichel,

who oversees $1.5 billion as chief investment officer of Philadelphia Trust

Co., told the news service. “The market is hoping he can come in and

create value in one way or another by cost cutting or finding value in the

different parts.”

Lampert is certainly a rich and powerful man, but I don’t think he quite has

the power that Sichel attributes to him. His friendship with Bob Rubin

might get him a meeting on the third floor of 399 Park Avenue. But that’s probably

about it.

Posted in hedge funds, stocks | Comments Off on Lampert’s Options at Citigroup