How Models Caused the Credit Crisis

Posted on July 7, 2008 by Felix

Ryan Chittum asks if we want to know what caused the global credit crisis, and suggests that if we do, we should "start here", with a 22-page report about subprime lender IndyMac from the

Center for Responsible Lending and former WSJ reporter Mike Hudson.

The report certainly manages to be both shocking and depressing at the same time. But by this point it’s well known that subprime lenders often behaved in an irresponsible and predatory fashion. What’s more, that behavior wasn’t a cause of the global credit crisis, so much as a symptom of it.

As Wolfgang Münchau says in today’s FT:

If this had been a mere financial crisis, it would be over by now. The fact that we are suffering its fourth wave tells us there might be something at work other than merely financial euphoria and bad regulation.

This is true, even if you don’t buy Münchau’s assertion that the real cause of the crisis was New Keynesianism and the dynamic stochastic general equilibrium model in particular. I would rather place the blame at the acceptance of models in general. Gillian Tett explains:

This decade, financiers have invented so many brilliantly clever mathematical tools to repackage risk that the industry has slipped, almost unthinkingly, into an assumption that "credit" is a collection of abstract equations, stripped from any human context.

Thus banks have become so dazzled with their powers that they have ignored how they interact with the rest of society – or how the tribal aspects of their own institutions can create dangerous traps.

Meanwhile, the cult of models has become so extreme that banks have believed them even when this collides with common sense. Yet, as any Latin scholar knows, the word "credit" hails from credere: "to trust". It is, in other words, also a social construct.

And bankers forget this human dimension to their cost.

Sam Jones has one striking visual of that cost: a bar chart showing the current ratings of 469 CDO tranches which were rated AAA at issue. Fewer than a quarter of them retain that top rating; a lot of them are now CCC rated, and a fair few even have a D rating.

The reason that IndyMac was writing so many horribly bad mortgages was that there was no shortage of investors willing to trust models telling them that the bonds secured by those mortgages were incredibly safe. They didn’t need to look at the mortgages themselves, since they had bankers using models to do that for them.

In other words, IndyMac’s behavior was certainly irresponsible, probably illegal, and also entirely predictable. Could we have known that IndyMac specifically would extend a loan against a stated Social Security income of $3,825 a month, even when the maximum Social Security income at the time was barely half that? No. But inevitably someone would, just because of the ease with which lenders were able to sell all their downside at a substantial profit.

Hudson concludes his report by calling for "rigorous oversight" of lenders, and "rules that will prevent such disasters from happening again". But that’s only half the solution. The real art is to try very hard to design a financial architecture where rules and incentives work with each other, rather than in opposition to each other. Because when there are billions of dollars to be made by breaking the rules, you can be sure that the rules will end up being broken.

Posted in banking, bonds and loans | Comments Off on How Models Caused the Credit Crisis

Chart of the Day: They are the Eggmen

Posted on July 7, 2008 by Felix

SPEggs.jpg

This is a chart of the S&P 500, priced in terms of eggs. Notes DeForest McDuff:

With the price of eggs going up 75% since 2001, one share of the S&P 500 used to buy as much as 1200 eggs and now it buys only 600 eggs. That’s a 50% decline in the number of eggs your stock portfolio can buy!

There are two more serious points here. The first, from McDuff:

Investment returns matter only to the extent that you can buy more "stuff" in the future. The U.S. stock market has been slowly losing real purchasing power for almost a decade, with no signs yet of a trend reversal.

It’s true that the prices of hard assets like oil, gold, and omelettes have been increasing rapidly, but this is a direct consequence of decades of underinvestment in these asset classes. If you’re not thinking about investing in terms of purchasing power, then you’re playing the wrong game.

The second comes from SAR:

Remember the good old days when Bush was going to privatize Social Security and we were all going to invest in the stock market and be rich forever? The S&P 500, adjusted for inflation, has lost 32% since then.

Most individual investors are in the happy situation of never needing to worry overmuch about the cost of eggs. Yes, the price of eggs might have gone up, but the price of iPhones has gone down; the official CPI is not understated, for these people.

On the other hand, if you’re talking about pension plans, the calculations change a lot. Many pensions belong to working-class people without other savings, who will be counting pennies in their retirement. For these people, keeping up with the price of eggs is very important, and investing in equities over the past decade has turned out to be a pretty gruesome decision.

I’m not sure if it’s possible for a pension fund to benchmark a food basket. But there are lots of fund managers out there who are responsible for the life savings and wellbeing of people who are going to spend their retirements living on low incomes. Such managers might well want to start spending less time looking at absolute returns, and more time keeping an eye on the cost of living, and how it might be hedged.

Posted in charts, commodities, stocks | Comments Off on Chart of the Day: They are the Eggmen

Blogonomics: Gawker’s Latest Pay Cut

Posted on July 3, 2008 by Felix

Choire Sicha has the latest update on Gawker’s payroll, and it’s pretty ugly. Gawker writers get paid per pageview, remember, and that pay, as of the beginning of Q3, has fallen by 23%, from $6.50 to $5.00 per thousand pageviews. That’s on top of the 13% pay cut they took at the beginning of the second quarter, to $6.50 from $7.50 per thousand pageviews.

Nick Denton, Gawker’s owner and editor, tries to explain what’s going on:

Denton wrote: "[Gawker Media Managing Editor] Noah [Robischon]’s calculations would suggest a rate of $4.15. I’ve got it up to $5.00 per 1,000 views…

Denton notes that this item is missing the "To Be Sure" paragraph, in which we fairly note that his young writers are paid more than other young writers at other print and web outlets.

The first statement, first. Nick owns the sites: he’s Noah’s boss, and can pay whatever he likes. I asked him about this; he told me that he has to be fair to the business side of Gawker, and that there’s a limit to the degree to which he can play favorites with Gawker just because he’s editing it right now.

But why should the pageview rate of $6.50 per thousand pageviews be cut at all, let alone dropped all the way to $4.15, as the initial calculations might suggest? At the end of the first quarter, the pageview rate was dropped on the grounds that first-quarter pageviews had far exceeded expectations, and that the writers had taken home much more than had been budgeted. But that argument doesn’t seem to fly for the latest pay cut. Gawker got 51,144,948 pageviews in the first quarter and 49,439,769 pageviews in the second quarter: total pageviews actually went down, not up. (Note that Denton doesn’t pay for all or even most of those pageviews: visits to the home page, or search results, or blog entries by people who no longer work for Gawker are all unpaid.)

It seems that when pageviews go up, the per-pageview pay rate is slashed. And when pageviews go down, the per-pageview pay rate is slashed even more.

I asked Nick about this, too. He said that pageviews were much higher than expected not only in the first quarter but also in the second quarter: given the pageviews which attached in Q1 to big stories surrounding Tom Cruise, Heath Ledger, and Eliot Spitzer, he’d anticipated a significant drop in pageviews in Q2. Which never happened. Given the difference between $4.15 and $6.50, it seems he anticipated a big drop indeed, on the order of 36%.

The way Nick explains his system, there’s an editorial budget for the entire group of Gawker sites every month. The budget is basically Gawker Media’s advertising revenues, minus its non-editorial expenses: rent, servers, sales people, tech people, that sort of thing – and probably some kind of income for Denton personally, too. This alone is interesting to me: the editorial budget is what’s left over once everything else has been paid for.

The editorial budget is then divided up between sites. "We allocate that budget to new site launches, young sites which are growing fast, established ones which still have momentum," said Denton. "The general rule is that we apportion editorial spending according to a site’s long-term potential." And the budget for Gawker, right now, turns out to be $30,000 a month.

From then on its a simple matter of division: take the budget, and divide it by the number of paid author pageviews that you expect the site will get over the upcoming quarter. In Gawker’s case, that’s about 7 million: it’s basically the number at the lower right hand corner of this page, minus a bunch of pageviews from people no longer working for Gawker, and minus Denton’s own pageviews. $30,000 divided by 7 million pageviews works out at $4.30 per thousand pageviews: the new pageview rate. Gawker writers should feel fortunate to be getting $5!

Assuming that the $30,000-a-month editorial budget has been constant for the past two quarters, it’s easy to see why Denton’s trying to bring down the pageview rate. At $7.50, which is what the writers were paid in the first quarter, the total payout would have been over $50,000 a month. And at $6.50 – well, I can actually tell you exactly how much each of the Gawker writers were paid last quarter.

In the second quarter, Richard Lawson made $29,850, Hamilton Nolan made $24,883, Ryan Tate made $20,296, Alex Pareene made $17,426, Sheila McClear made $14,063, Ian Speigelman made $12,930, and Nick Douglas made $5,840. Add that up, and it comes to $125,288, or $41,763 per month. And that doesn’t include payments to video editor Richard Blakeley, cartoonist Jim Behrle, and other guest contributors.

Now there’s two ways of looking at that extra $12,000 a month which Denton ended up paying over and above the budgeted payroll. The obvious way of looking at it is that it’s cheap price to pay for the millions of unexpected pageviews he got, and indeed it’s the expected and intended consequence of a pay-per-pageview system which encourages editors to maximize their monthly pageviews. If the editors can pull off the same feat next quarter, then they should get the same pay.

Denton, however, looks at it a bit differently. The $12,000 a month, to him, is bonus money – and bonuses are by their nature one-off things. The pageview rate is essentially a target: the number of pageviews you need to get to earn out your base salary. If you exceed that number, congratulations, you get a bonus. If you fall short for more than a month or two, then you’re fired.

That’s a tough business to be in, as a writer, because writers never feel as though they have much control over their pageviews. They’re at the mercy of their readers, and if the readers turn fickle, they could be out of a job before the quarter’s over.

Here too is the explanation for why Denton ends up paying healthy amounts of money to his writers – the other point he says should be considered here. Let’s say that Gawker’s pageviews, and Ryan Tate’s, stay constant over the year – and that he earns $5 per thousand pageviews for the rest of the year. That would put his total 2008 income at $75,000, which is pretty respectable compared to many of his media-industry peers. But psychologically, it doesn’t feel that great. For one thing, it would be steadily decreasing: $23,400 in the first quarter, $20,300 in the second quarter, and $15,600 in each of the last two quarters. In the second half of the year, he wouldn’t be earning at a $75,000 rate, but rather at a $62,000 rate. Seeing your income decline is just demoralizing – and then add to that the fact that even if Gawker’s pageviews, and Tate’s, were entirely steady, by the second half of the year he would be very close, every month, to his earn-out target. Which means that he would be very close, every month, to "you’re fired" territory. Not a pleasant position to be in, at all.

Most jobs pay a steady amount of money every month. Some jobs are different: sales jobs, in particular, are often based on commission. Most people prefer the steady salary to something volatile: they want to know they can pay the rent each month. But some people thrive on commission: they feel that they’re really in control of their own income.

Paying bloggers by the pageview seems to me a bad idea for two reasons: firstly, most bloggers are the kind of people who prefer a steady income to a volatile one. And secondly, bloggers aren’t in control of their pageviews. The number of posts they write? That, they can control. But the number of people worldwide who are going to download their blog entries each month? If they’re lucky enough to have a blog entry "go viral", then yes, they can make a lot of money. But it’s the nature of internet memes that they’re unpredictable. And that unpredictability of income does not make for happy workers. So yes, Denton might pay more than his peers at places like the Observer or Radar. But the extra money just compensates his bloggers for their income volatility and job insecurity.

What’s more, Denton himself is warning that "now comes that slow-news time of year that–in ancestral Hungary–they call the cucumber season". What happens if, during "that slow-news time of year," Gawker, which is reinventing itself as a news site, gets substantially fewer pageviews than it’s been getting until now? Essentially all the contributors would come down to their base salary, since at $5 per thousand pageviews they wouldn’t be getting enough traffic to earn out their advances.

If that happened to all the Gawker bloggers, Denton wouldn’t fire them all; he might even raise the pageview rate a bit the following quarter. But at that point the employee dynamics would change markedly. The whole point of pay-per-pageview is that writers don’t need to play politics any more, or agitate for a raise, or anything like that: everything is on a level playing field, and a 17-year-old kid who can bring in a million pageviews a month is just as valuable as a veteran with the same traffic figures.

If the bloggers start getting paid just their monthly base salaries, however, then suddenly large differences are liable to emerge. A rising tide lifts all boats, but when the tide goes out, some end up much higher up, on the rocky seabed, than others.

Gawker employees who joined after pay-per-pageview started know nothing of living on their base salary: many of them have been earning much more than that since day one. There’s a disconnect, here: the way Denton views things, the base salary is what they should expect, and any bonus is just gravy. On his view, most Gawker bloggers have been unusually well paid so far this year; that’s great for them and not so great for him, and going forwards they’re going to come down to a more reasonable income, much closer to their base salary.

From their point of view, however, their income was always determined not by their base salary but rather by their pageview rate. If a blogger joined at $7.50 per thousand pageviews and is now getting paid $5 per thousand pageviews, that’s a 33% pay cut, even assuming pageviews stay flat. If pageviews decline at all in the cucumber season, it’s even worse, and the bloggers who weren’t smart or fortunate enough to negotiate a reasonably high base salary are going to be the ones hit the hardest.

I think that Denton’s found himself in a bit of a pickle, here. On the one hand, Gawker’s done extremely well this year. It served its 100 millionth page of the year by the end of June, which is a positive thing which no one expected, not even Nick. On the other hand, the unexpected surge in pageviews happened to coincide with the introduction of the pay-per-pageview system, which means that his bloggers have now had six months to become accustomed to a level of income he never intended them to have. His business model requires that he bring their payroll down, and that’s never going to be pleasant for anyone concerned.

And I do think the business model leaves a lot to be desired. Budgets aren’t set according to sites’ revenues, but rather according to their potential: Nick’s favorite example is his gaming site, Kotaku, which is only now getting significant advertising revenue, after three years of building up a large and dedicated audience. "Jezebel or io9," he says, "new sites which don’t yet get the advertising they one day will, we’ll support for years to get them to the point of critical mass".

This is basically a cross-subsidy model: the cashflow from established properties is used to build new ones. And the model makes sense from the point of view of Gawker’s shareholder, Nick Denton. From the point of view of his bloggers, however, it makes much less sense.

If you’re a blogger at an established site like Gawker, it’s quite obvious that for every dollar you make in bonus pay, Denton has made much more in terms of extra advertising revenue. You really earned that dollar. But then, at the end of the quarter, Denton pushes your income back down to its base rate, and spends the excess advertising revenue not on you, any more, but rather on his newest properties – properties which, if and when they start making money, will benefit him but not you. If I were in such a position, I’d think that Denton should fund new blogs out of his profits and not out of my bonus: after all, they’re his new blogs, not mine.

How can Denton respond to this? One way would be by making it clear that he doesn’t much care what his bloggers think. Once upon a time, Denton suffered a genuinely damaging departure, when Pete Rojas left Gizmodo to found Engadget. Ever since then, however, every time one of his writers makes a name for themselves and moves on elsewhere, his sites continue on without them, stronger than ever.

In January, after all of Gawker’s long-standing editors left it in short succession, I said that the site would not quickly recover. I couldn’t have been more wrong. Denton has never really erred by underestimating the importance of editors; if anything, his real respect and regard for the likes of Choire Sicha and Alex Balk maybe led him to let them keep their jobs too long. Yes, Gawker got more respect back then – but it also got fewer pageviews, and Denton’s always been very clear about which of those two he cares about, and which he doesn’t.

So let the editors kvetch, he could say: let them leave, if they don’t like sudden 23% pay cuts arriving at the beginning of the quarter. The editors don’t matter, the brand is bigger and stronger than any of them. And he might well be right.

To be fair to Denton, the reasonably long history of Gawker Media is one in which salaries have been steadily rising, to the point at which the likes of Hamilton Nolan make significantly more money blogging than they did working for a magazine. Denton could probably cut salaries significantly, and still find takers for his high-profile jobs; he might yet do so, if online advertising craters.

For the time being, however, the pain caused by the latest pay cut is mainly a result of Denton not really thinking through the consequences of setting the initial pay-per-pageview rates at more than he was willing to pay over the long term. That made a lot of people happy in Q1, but it’s turning out to be causing some very real unhappiness in Q3. And really there’s no point in anyone – not even Nick Denton – needlessly antagonizing a group of Gawker bloggers.

Posted in blogonomics | Comments Off on Blogonomics: Gawker’s Latest Pay Cut

Extra Credit, Thursday Edition

Posted on July 3, 2008 by Felix

The V-Word and Dick Grasso: "Vindication is not what just happened".

Contented Streets: Why Copenhagen Is the World’s Happiest Capital

Google must divulge YouTube log: 12 terabytes of information must be handed over to Viacom. I hope that Google can and will successfully appeal this dreadful decision.

Dead men walking, USB-stick variety: "Book of Common Prayer: ‘Man that is born of a woman hath but a short time to live, and is full of misery. He cometh up, and is cut down, like a flower.’ Tech world: ‘Back up your backup.’ It comes to the same thing."

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

Good Old News

Posted on July 3, 2008 by Felix

Clive Crook on Walt Mossberg:

I never miss his column, even though I cannot remember a single occasion when it told me something I didn’t already know. (There must have been some; they just don’t spring to mind.) Do not misunderstand me: Mossberg’s popularity is entirely deserved. There is something very satisfying about reading an engaging, straightforward, intelligible treatment of familiar facts. It is a rare treat. They should teach that in journalism school.

This is a powerful idea, I think, and one which the best politicians understand intuitively: if you say something which everybody already knows, that doesn’t automatically make you boring.

Journalists live to report the "news" – something new, something different. The idea of recapitulating the already-familiar is, as a rule, scorned. But if Mossberg can do it, others can too – although I’ll admit I’m having difficulty coming up with examples. Might Brian Burrough on Bear Stearns count? Maybe if he hadn’t felt the need to add something new by speculating about a cabal of short-sellers, he would have done.

Posted in Media | Comments Off on Good Old News

When Oil Strength Isn’t Dollar Weakness

Posted on July 3, 2008 by Felix

Barry Ritholtz asks:

Here’s a question — at what point does ECB Central Bank Chief Trichet realize that every time the ECB hikes rates, it pummels the dollar and sends oil higher?

The answer, it would seem, is "not today":

The euro fell against the dollar as European Central Bank President Jean-Claude Trichet signaled one interest-rate increase is enough to control inflation…

The euro dropped 0.7 percent to $1.5766 at 9:01 a.m. in New York, from $1.5882 yesterday.

Yep, the ECB hiked rates today and the dollar rose in response. You can blame today’s rise in oil prices on many things, but dollar weakness ain’t one of them.

Posted in commodities, foreign exchange | Comments Off on When Oil Strength Isn’t Dollar Weakness

WSJ.com Will Go Free, Eventually

Posted on July 3, 2008 by Felix

Congratulations to wsj.com for posting impressive growth in both pageviews and unique visitors over the past year. Don’t pay too much attention to the numbers quoted: they’re "based on the company’s internal traffic numbers," and therefore not much use in apples-to-apples comparisons. But the rate of change is probably reasonably reliable, and it’s high.

Does this mean that Rupert Murdoch was right not to make the website free? No, it doesn’t. And in fact I’m still convinced that the site will end up going completely free, if not sooner then later.

If you look at the Mediaweek story, there’s one statistic conspicuous by its absence: what has happened to the number of subscribers to wsj.com over the past year. Betcha it hasn’t grown at all, and that substantially all of wsj.com’s new uniques are there for the free content only. (That would help explain why pageviews are growing much more slowly than uniques are.)

One can assume, then, the subscription revenue stream from wsj.com is stagnant, even as the advertising revenue stream is rising. And clearly if the site went free, then the number of pageviews per unique visitor would rise, which would mean a substantial increase in advertising inventory even if the number of unique visitors didn’t increase much at all. Keeping a large amount of content behind a subscription firewall only serves to alienate non-subscribers and mimize the degree to which wsj.com’s new uniques can be monetized.

Still, I no longer expect wsj.com to go free in the near future. As the US moves into a recession, a reliable income stream like that from subscriptions is going to be much more valuable than a volatile one like that from advertising – especially when most of the advertising on wsj.com comes from financial-services companies who are mostly struggling themselves, and always looking for areas where they can cut costs.

In the longer term, however, it just doesn’t make sense to reserve a majority of your content for a minority of your readers. The publishing industry is all about building lasting relationships with readers, and you don’t do that by putting walls in their faces. The wall will come down: it’s only a question of when, not if.

Posted in Media, publishing | Comments Off on WSJ.com Will Go Free, Eventually

The Rule That Reduced Banks to a Quivering Blob of Matter

Posted on July 3, 2008 by Felix

Andrew Ross Sorkin’s article about Steve Schwarzman and FAS 157 is the gift that keeps on giving. First Barry Ritholtz took a swipe, then Jack Ciesielski attacked it forensically from a professional accountant’s point of view, and now Gari has taken the rabid I’m-not-an-accountant approach, which might not be as clean as Roger Ehrenberg’s considered essay but is certainly more fun:

Now, you will point out that several of the banks that are taking hideous write-downs might properly be called mega-banks, strange and loathesome combinations of investment banks and commercial banks, which in the current market are looking a bit like that dog that got caught in the Fly’s matter transporter…

If you want to be in the business of cooking up debt obligations, and you either wish to be bailed out if the process goes wrong, or financial stability demands that you be bailed out if the process goes wrong, then absolutely a horde of regulators should be crawling over your books at all hours. Absolutely some incredibly conservative leverage levels should be applied to your business. Absolutely your masters of the universe should be incredibly boring people in bad ties and spiritual affinities with Germans.

But hey, I’m not accountant.

What no one has bothered to point out, maybe because it’s so obvious, is that Sorkin’s entire article is basically Schwarzman talking his book. Schwarzman runs a private-equity shop, which buys up companies with a little bit of equity and a lot of bank debt. Right now, the banks can’t extend new loans, because they’ve lost so much money as a result of writing down the old ones. So Schwarzman’s bright idea is that maybe if they didn’t need to write down the old loans, that would make it easier for him to get new ones. Good luck with that, Steve. You’ll need it.

Update: James Mackintosh notes that Schwarzman seems to have done a complete U-turn on this issue.

Posted in accounting, banking | Comments Off on The Rule That Reduced Banks to a Quivering Blob of Matter

A Friendly Poaching

Posted on July 3, 2008 by Felix

We’ve seen the stories dozens of times: a second- or third-tier European bank gets the bright idea that it really needs to beef up its investment-banking business. But it can’t afford to buy an investment bank outright, so instead it goes out and poaches, at vast expense, entire teams from other, more established, shops. These deals normally come with massive guaranteed bonuses, and invariably end in tears.

So kudos to Italy’s Unicredit for trying an interesting new twist on the old model. No, it hasn’t woken up and realized that it doesn’t need to be in the high-end investment-banking business at all. But at least this time it’s bought a ten-man team at NewSmith Capital Partners, rather than poaching them.

The difference is that this is an entirely friendly deal, complete with upbeat quotes from NewSmith; Unicredit is even taking a 5% stake in the firm it’s depleting. It makes sense to do it this way: the exiting team presumably gets to keep their equity stake in NewSmith, Unicredit gets the team it wants, NewSmith gets fresh capital, and no bridges are burned.

But I still think that Unicredit is being overly optimistic. NewSmith seems to be happy to let the team go because although their advice was valuable, no one was particularly keen on paying a lot of money for it. Simply changing the letterhead from NewSmith to Unicredit is unlikely to change that. Some things never change: European commercial banks always dream of making lots of money in investment banking. They never do, but it does help support Wall Street salaries, at least.

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Making Money in the Airline Industry

Posted on July 3, 2008 by Felix

Eos? Dead. Maxjet? Dead. Silverjet? Dead. Clearly, anybody starting a business-class-only airline would be better taking classes in business. But astonishingly, it seems that the founders of the last airline standing in this market, L’Avion, are actually going to make a profit on selling out to British Airways:

BA said it would pay ߣ54m ($107.6m) for the French airline, which includes ߣ26m of cash in the business…

Christophe Bejach, co-founder and chairman of L’Avion, said it made sense to gain the protection of being part of a much bigger group in the face of the sharp rise in fuel costs, which was increasing its losses. A total of E50m ($79.4m) had been invested in L’Avion to date.

Bejach got lucky: BA wasn’t interested in his passengers or his business model, so much as his landing slots at Orly. But in a shrinking global aviation market, it’s pretty impressive that even they managed to rise in value.

Posted in travel | Comments Off on Making Money in the Airline Industry

Extra Credit, Wednesday Edition

Posted on July 2, 2008 by Felix

S&P 500: Closed today at 1,261.52. The all-time high is 1,576.09, which puts official bear market territory at 1,260.87. Less than a point away!

Personal economics in three easy pictures: "Our dollars earn very little interest sitting in an account at home, and they can earn 7 or 8 percent a year just by being traded into RMB. "

Pervasive Pollyannas of Prosperity

Your Creditor is Silently Juding You: By using your purchase history to help determine your credit line.

My $650,100 Lunch with Warren Buffett

Online study groups: Threat or menace?

JPMorgan Chase Accidentally Breaks Into Your House And Steals Everything You Own: "After the Dickson’s bought the house back in May, the foreclosure proceedings were supposed to have been stopped. They weren’t."

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Cognitive Disconnect of the Day

Posted on July 2, 2008 by Felix

Susan Pulliam reports on hedge fund manager Thane Ritchie, son of options trader Joe Ritchie:

Mr. Ritchie, who is tall, with blond hair, lives with his wife and three children in a modest, four-bedroom house. He says he doesn’t own a vacation home, a boat or many of the other trappings that often go hand in hand with managing a hedge fund.

"I was brought up to see money as a curse," he says. He notes that his stepfather drove a "beat up Dodge Dart," even after he had grown rich from his options business.

Yet Mr. Ritchie admits that he started a hedge fund because he "wanted to make money," adding, "I way exceeded my expectations." He declines to comment on his current net worth…

He launched Ritchie Capital Management in 1998 with $15 million of his own money and $10 million from Joe Ritchie.

Why would a multimillionaire with a very modest lifestyle, who starts off with more money than he’ll ever spend, decide to start up a hedge fund, of all things? I suspect that if you need to ask, you’ll never understand.

Posted in hedge funds, wealth | Comments Off on Cognitive Disconnect of the Day

Blogonomics: The Subscription Model

Posted on July 2, 2008 by Felix

Since September, Jack Ciesielski’s Accounting Observer blog has been hidden behind a subscription firewall. That’s not a great way to get inbound links or traffic, obviously. But does it make sense for other reasons? I asked Jack why he’s hiding his blog from public consumption – and why he’s barely ever publishing anything on Seeking Alpha, either.

Jack was very clear on the economics:

I wouldn’t recommend it to bloggers. Stick with advertising.

So why does he do it? Basically, the subscription product predates the blog, and is Jack’s main source of income. He considers his subscribers to be his employers, and said that he never really felt like he was working for his employers when he was giving his stuff away online.

I really enjoyed doing a lot of the blogging. But advertising wasn’t going to be serious enough money to warrant allowing it on the site, and I felt like I should be devoting more of my time to Observer readers.

Jack also felt that by placing the blog behind a subscription firewall, he could put stuff there that he’d never feel comfortable giving away for free:

Firewalling the blog allowed me to do extensions of the pieces I write in the Observer – stuff that’s data/staff intensive, that I would never want to simply "give" away.

In other words, by firewalling the blog, Jack felt he had managed to professionalize it, to make it an integral part of his day job, rather than it being a none-too-effective marketing tool.

The blog attracted many readers – but near as I could tell, they were individuals, CFOs, controllers, and a few investment players starting out who wanted something for nothing. In short, nobody who was interested in subscribing to the research service. From the stats I was able to gather and the kind of feedback I received, I never got any kind of traction with the folks I wanted to work with: analysts in research departments.

I do wonder what would happen if Jack made his blog public again. There’s certainly stuff there of general interest, such as an elegant take-down of Andrew Ross Sorkin’s article on FAS 157 yesterday:

For the record: Statement 157 didn’t extend fair value reporting to new classes of assets. Statement 157 greatly expands the disclosures related to fair value reporting, requiring more rigor in applying fair value reporting where it had always been done in the past. Remind yourself: what was the rule before Statement 157 – all historical cost, forever? No. If an asset wasn’t worth its cost, it still needed to be written down to what it was worth, period.

Obviously Jack’s subscribers would still have access to just as much analysis as they do now. But maybe they would feel as though they’re not really getting their money’s worth, any more, if a large part of what they used to be paying for was now being given away for free. And maybe analysis is like wine: people value it more if they’re paying for it.

So if you already have a subscription product, then there can be colorable reasons to make your blog a subscription product too. But for the rest of us, I can’t believe it would ever make sense.

Posted in blogonomics | Comments Off on Blogonomics: The Subscription Model

Iceland’s Crunch

Posted on July 2, 2008 by Felix

You’ve got to feel for Iceland. Not only do you have an economy in recession and a plunging currency, but you also have to put up with columns from LSE professors using 20-20 hindsight to tell you that you were obviously going to end up in this mess all along.

Robert Wade, in the FT, pulls no punches: "the size of the accumulated macroeconomic imbalances beggars belief," he says, but then just comes up with a list of percentages of GDP. In Iceland, anything looks big as a percentage of gross domestic product, because there’s very little produced domestically. That’s why Icelandic businesses were so keen to expand abroad in the first place. But then Wade’s article gets even weirder:

How could such a minnow exercise so much leverage? The answer starts before 2000, when most of the banks were still publicly owned and run like government departments. Real interest rates were low and even negative for long periods. Facing excess demand for credit, the banks operated like political patrons, allocating credit to favoured business clients. The resulting inefficiencies in resource allocation were offset by ever-rising amounts of debt relative to equity and by the longest hours of work in western Europe. These factors helped Iceland to become one of the most prosperous countries in the world in terms of per capita income and several indicators of quality of life.

If there’s any kind of causal chain hidden in that paragraph, I can’t see it. I’m reasonably sure Wade’s not saying that if your banks operate like political patrons then you’re bound to end up as one of the most prosperous countries in the world – but it kinda seems that way.

Wade goes on to complain that Iceland’s banks "operated like hedge funds, financing their expansion largely from foreign borrowings rather than domestic deposits". Are hedge funds known for funding in foreign currencies? It makes sense to me that if you’re investing abroad, it makes sense to borrow abroad as well – especially when the total domestic deposit base is far too small in any case to fund your investments. Besides, would Wade have preferred that Iceland’s banks fund their foreign adventures with the money of their domsetic depositors?

Wade is so keen to blame lax regulation for all Iceland’s ills that he even complains that high interest rates had the effect of strengthening the currency. Well, yes, that is a well-known effect of high interest rates. Would he prefer that interest rates had been kept low?

Nowhere does Wade mention the real cause of Iceland’s present troubles – that it’s got the smallest free-floating currency in the world, which is easily buffeted by international capital flows going in and out of the carry trade. "A more Scandinavian model where finance does not rule the economy" is all well and good, but wouldn’t have prevented what happened in Iceland. On the other hand, if Iceland had joined the euro, the problems would never have arisen in the first place.

Posted in economics | Comments Off on Iceland’s Crunch

Quote of the Day: Jamie Dimon

Posted on July 2, 2008 by Felix

Jamie Dimon’s in Aspen right now, and Charlie Rose asked him last night about the amount he paid for Bear Stearns. I love the metaphor Dimon used in response:

Buying a house and buying a house on fire are two different things.

He was even smarter, I guess, not to extend the metaphor any further: I don’t think anybody would appreciate talk of extinguishing the conflagration using a firehose of liquidity.

Posted in banking | Comments Off on Quote of the Day: Jamie Dimon

The Cost of Commuting: 500GD/M

Posted on July 2, 2008 by Felix

SAR asks:

Is there a simple formula that combines the price of gasoline, the one-way commute in miles, and per-hour wages that will let those in the exurbs (and soon, suburbs) figure out when it’s time to move back to the city?

Sure. Let G be the price of gas, M be the mileage you get on your car, D be the one-way commute in miles, R be your current annual rent (or mortgage payment), and C be the annual rent (or mortgage payment) in the city.

Then the annual savings of moving to the city, assuming 500 one-way commutes per year and zero commuting costs in the city (this is admittedly rough-and-ready), would be 500GD/M+R-C. When that number turns positive, it’s time to do something: if not move to the city, then maybe start carpooling, or find a more fuel-efficient car, or persuade your employer to switch to four 10-hour days rather than five 8-hour days.

Plugging in some typical numbers, let’s say G is $4.11 a gallon, M is 20mpg, and D is a 35-mile commute. Then the cost of commuting, 500GD/M, is $3,600 per year, or $300 a month. If you manage to increase your mileage to 30mpg, it goes down to $2,400, or about $200 a month. For people earning $10 an hour, $300 per month is 30 hours’ work, assuming zero net taxes.

Of course, communting was never free: if the cost of gas has doubled, then the extra cost of commuting might have gone up by "only" $150 a month. But it’s still a large burden for working-class families to bear.

Update: Ironman transforms this into a plug-in-the-numbers dynamic calculator! Brilliant stuff.

Posted in cities, commodities | Comments Off on The Cost of Commuting: 500GD/M

Jeffrey Epstein and the Private Banking Industry

Posted on July 2, 2008 by Felix

I’m glad to see that in between losing $57 million in Bear Stearns funds and spending 18 months in a Florida jail, Jeffrey Epstein managed to find the time to host the New York Times at his Caribbean island.

As his legal troubles deepened, Mr. Epstein gazed at the azure sea and the lush hills of St. Thomas in the distance, poked at a lunch of crab and rare steak prepared by his personal chef, and tried explain how his life had taken such a turn.

The article tries – and largely fails – to clear up the mystery of what exactly Epstein does for a living:

His business is something of a mystery. He says he manages money for billionaires, but the only client he is willing to disclose is Leslie H. Wexner, the founder of Limited Brands.

As Mr. Epstein explains it, he provides a specialized form of superelite financial advice. He counsels people on everything from taxes and trusts to prenuptial agreements and paternity suits, and even provides interior decorating tips for private jets. Industry sources say he charges flat annual fees ranging from $25 million to more than $100 million…

He never wears a suit, preferring monogrammed sweatsuits and jeans. And he rarely attends meetings — “I never have to be anywhere,” he tells his pilots, when he cautions them to avoid flying through chancy weather.

$100 million a year is serious money even for a multibillionaire: ten years of that and you’ve spent a billion dollars in consultancy fees alone. And doubtless Epstein’s fee comes over and above any management and performance fees charged by the hedge funds he invests his clients’ money in. It must be one of the most lucrative risk-free businesses in the world: while his clients can lose money, he pretty much can’t. Even arms dealers are probably looking at him jealously.

Boiled down to its essentials, it seems that Epstein is a super-high-end private banker. No wonder there’s so much competition in the financial-services industry to get the accounts of high net worth individuals: if Epstein’s any indication, there’s billions of dollars just sitting there for the charging. Nice work if you can get it.

Posted in wealth | Comments Off on Jeffrey Epstein and the Private Banking Industry

Defragging the CDS Market

Posted on July 2, 2008 by Felix

You know when you’ve had a computer for a long time, and the hard drive is full of crap, and some tech wizard comes up with a way of defragging it or something, and the idea is that suddenly it’ll be much leaner and cleaner and faster? Well, the CDS market is a bit like that hard drive, it would seem, and two firms in the CDS arena, Markit and Creditex, are the tech wizards who have a bright plan to come in and clean it up.

The new compression approach improves on previous tear-up processes by delivering significantly better compression results while leaving market risk profiles unchanged. The process involves terminating existing trades and replacing them with a far fewer number of new “replacement trades” which have the same risk profile and cash flows as the initial portfolio, but with less capital exposure.

The idea is to reduce the nominal amount of CDS outstanding – currently $62 trillion or something equally impossible to grasp – by tearing up trades which offset one another and generally reducing the market to the smallest possible number of contracts on any given name. Counterparty risk won’t be reduced a lot, but documentation risk will be. Consider for instance an anecdote in today’s FT:

In one case the seller of credit protection recently discovered that the final agreement on insuring a portfolio of collateralised debt obligations had never been signed, either by it or a French bank which in this case was buying protection. Now, with the meltdown in that market, the seller has returned all the premium payments to the buyer and torn up the agreement, saying that because it was never signed, it has no legal obligation to pay up.

I wish that Henny Sender had more details here on both the buyer and the seller of protection; if I were the French bank in question, I wouldn’t have too much compunction about outing the culprit. But this kind of thing is clearly a risk to the CDS market, and if hastily-drawn-up contracts get torn up as part of the new scheme, that would be an excellent outcome.

The question of course is whether this is all too little too late. The tear-up process won’t even start until Q3, and even then will only be active on the minority of CDS contracts which are written on single names. The really hairy ones -߆the ones written on baskets and CDOs and other such creatures – won’t be touched. That’s a careful and responsible way of doing things. But it might need to be accelerated if things start getting really messy.

Posted in derivatives | Comments Off on Defragging the CDS Market

Further Tales of Microhoo Incompetence

Posted on July 2, 2008 by Felix

The WSJ reports today not only that some kind of Microsoft-Yahoo deal might be on again, but also that:

In mid-May — weeks after Microsoft withdrew its bid — Yahoo offered to sell itself to Microsoft for about $33 a share, a price Yahoo had earlier rejected, say people familiar with the talks. Microsoft rebuffed the advance.

Could this whole episode get any more Keystone Kops? Oh yes it could, the minute you read the details of exactly what happened, where it seems that more attention was paid to color signals than to price signals:

Microsoft took pains to ensure that the meeting remained a secret. It instructed Mr. Yang and his coterie of advisers to drive to the back of the building, where a woman holding a closed red umbrella would be waiting…

The two sides met at the airport, in a conference room overlooking the runway. The Yahoo camp was encouraged that Mr. Ballmer had donned a polo shirt in purple, Yahoo’s color.

And could the principals here be any more delusional? Here’s a description of a later meeting:

No bankers were present. Early in the discussion, Messrs. Bostock and Ballmer lamented the bankers’ influence on the negotiations, with Mr. Ballmer concluding that bankers had "screwed everything up." He said that Microsoft wasn’t there to reopen its bid…

Why have a meeting without bankers, in which you explicitly blame the absent bankers for screwing everything up, if you don’t then try to capitalize on the bankers’ absence by coming to some kind of agreement without them?

Both sides displayed astonishing amounts of incompetence in this deal, which obviously reflects badly on Microsoft and Yahoo. But there might be something else going on, too: big M&A deals in the technology space are so uncommon that to this day no one really knows how to get them done, absent a force of nature like Larry Ellison. Microsoft’s new plans to bring in other partners, like Time Warner and News Corp, will only complicate things further and be even less likely to come to fruition. Simply put, there’s only one conceivable winner here: Google.

Posted in M&A, technology | Comments Off on Further Tales of Microhoo Incompetence

Extra Credit, Tuesday Edition

Posted on July 1, 2008 by Felix

The global food crisis: A toolkit for audacious leaders: Sensible ideas from Arvind Subramanian.

The End of Naive Contrarianism: "While the investing pack is sometimes wrong, and big inflection points are often missed, the market’s investing pack is usually right."

Feds Press Swiss Bank

To Name U.S. Clients: This could be much worse for UBS than Arbizu is for JP Morgan.

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

Blogonomics: Market Manipulation

Posted on July 1, 2008 by Felix

For the past week, anybody going to this page at Seeking Alpha has found a blog entry that isn’t there. There are 42 comments, untouched. But the actual blog entry, we’re told, "has been removed, pending investigation of claims of material inaccuracies". Joseph Tartakoff has the story: the blog entry was written by one Liam Mulcahy, a purported hedge fund manager who was short the stock of Microvision. After it appeared, Microvision stock fell by as much as 20%, and closed down 10%. It was all very scandalous, with accusations of market manipulation being thrown around willy-nilly.

Here’s Michelle Leder:

It’s deeply disturbing that virtually anyone — or perhaps the word is no one since it’s not clear that Mulcahy actually exists — can go on to a major site like Seeking Alpha and post whatever they want about a publicly traded company with little or no consequence and make money in the process…

For all of us who write about publicly traded companies online — and there’s a lot more now compared to when I started nearly 5 years ago — this will hopefully serve as a wake-up call. Let’s hope that the SEC is also paying attention to the Microvision/SeekingAlpha mess. While the Internet gives people access to information that was never readily available before, it also makes it a lot easier for someone with questionable goals to game the system.

The reason I’ve held off writing about this until now was that I was waiting to see whether Seeking Alpha would reinstate the post. They certainly wanted to, as Seeking Alpha founder David Jackson wrote to me on Friday:

We’re aware that Seeking Alpha moves stocks. Despite the criticism of the lack of information about the author, we were happy with the transparency: there was a clear disclosure that the author’s fund is short the stock, there were no misleading claims about the author, and readers were free to provide an alternative viewpoint in comments below the article (which they did).

Seeking Alpha is widely read (over 3MM unique visitors a month) because we’re prepared to publish articles that are opinionated, by people with "skin in the game". We work to ensure that articles do not contain factual inaccuracies, that authors disclose positions clearly, and that authors aren’t using us to create movement in stocks to trade off. But we’re not in the business of censoring authors’ opinions.

We love that we publish articles on the short side; they help investors to avoid potholes, generate real discussion of companies and their businesses, and are a fresh change from the bland rehashes of press releases that are too frequent in financial media. In this case, the article made points that are of great importance to anyone who owns or is considering owning Microvision’s stock. We temporarily pulled the article because we received two disputes (via our article dispute process) that the article contained material factual inaccuracies. In looking into them, neither was sufficiently convincing. However, Microvision’s management has told us that the article contains factual inaccuracies, so we’ve given the company until the end of today to provide this information to us before we republish the article.

It’s also worth putting Mulcahy’s alleged market manipulation in perspective. Here’s a year-to-date chart of the stock, with an arrow pointing out the Mulcahy-induced move, in case you would otherwise have missed it:

mvis.jpg

What’s more, there was enormous volume of over 6 million shares on Friday (three times the Mulcahy-induced volume) when Microvision got included in the Russell 2000 index. Yet even with huge numbers of index funds all having to buy the small-cap stock at the same time, the stock still contrived to close down quite substantially on the day; it fell yesterday, too. In fact, the stock has been going steadily downwards for a couple of weeks now, and Mulcahy’s post is looking more prescient than manipulative. If MVIS can’t get a bounce even on getting included in an important index and even after traders scramble to cover shorts put on too hastily as a result of a blog entry, how can it rise?

Microvision is a small-cap stock trading in the low single digits: by their nature, such stocks are likely to move around quite a lot. Yes, there was a swing of 18% from intraday high to intraday low on the Monday after the blog entry was published – but that was mainly a function of the fact that the stock was trading at a mere $3.30 to begin with: the actual drop in share price was only 60 cents per share, which is very common on the Nasdaq. Besides, back on January 16, the intraday swing was 84 cents, or 26%: such moves are hardly unprecedented, and they have to be expected by anybody holding such a volatile stock.

Michelle Leder told me that she’s upset about Seeking Alpha publishing the blog entry because it can "hurt small investors"; I, on the other hand, would think that such investors would welcome Mulcahy’s post. The only good reason for them to be invested in Microvision is that they believe in the company’s fundamentals, and think it’s undervalued on the stock market. If Mulcahy’s post is factually incorrect, then all it does is put the stock on sale, and create a fabulous buying opportunity. On the other hand, if Mulcahy has a point, then they learn about the company and can adjust their analysis of it accordingly.

My feeling is that it’s very hard for a blog entry from an unknown writer to move the market unless it touches some kind of a nerve and has at least an element of truth to it. Companies whose stocks fall, and their apologists, love to blame market manipulators for their falling market cap; sometimes, such accusations even make it into Vanity Fair. But 90% of the time, there’s no manipulation going on, just markets working as they should, with people buying stocks they think are cheap and selling stocks they think are overvalued. Seeking Alpha is a great way to bring those people together and have them debate each other in blog format; it’s silly to try to shoot the messenger.

Posted in blogonomics | 1 Comment

The Moody’s CPDO Scandal: Heads Begin to Roll

Posted on July 1, 2008 by Felix

The external review of the Moody’s CPDO scandal has now been concluded, and as a result Moody’s says that it "has initiated employee disciplinary proceedings". Such proceedings, it would seem, include firing the head of structured finance, Noel Kirnon.

Moody’s is, however, being less than transparent about what exactly these people did wrong, saying only that "some committee members considered factors inappropriate to the rating process when reviewing CPDO ratings following the discovery of the model error". In doing so, it seems to quarantine any blame at the level of the European CPDO monitoring committee, of which Kirnon was presumably a member. There’s no indication that there may have been broader problems with the whole way that structured products were rated, or with the increasingly-close relationship between Moody’s and its clients.

In other words, there’s something rather unsatisfying here. Does anybody really believe that the problems with European CPDOs were confined to the European CPDO monitoring committee, and were utterly absent elsewhere? That’s the Moody’s spin, and it is rather lacking in credibility.

Posted in credit ratings | Comments Off on The Moody’s CPDO Scandal: Heads Begin to Roll

Improbable Predictions, Airport Security Edition

Posted on July 1, 2008 by Felix

Joe Sharkey talks to Kip Hawley, the director of the

Transportation Security Administration, about new checkpoint-friendly laptop bags:

Mr. Hawley said he did not expect that the new laptops would create undue confusion after their introduction, since security officers would be well informed about them.

Mr Hawley then immediately caught a plane to Las Vegas, where he finds it much easier to monetize his poker face.

Posted in travel | Comments Off on Improbable Predictions, Airport Security Edition

Infectious Inflation

Posted on July 1, 2008 by Felix

Barry Eichengreen, via Brad DeLong:

There are now fifty countries in the world with inflation rates over 10%. It’s like the early 1930s, but just reverse the sign: back then everybody with their currency linked to the dollar imported deflation; now everybody is importing inflation.

The solution then as now is the same: delink your currency from the dollar.

It’s not just the dollar, of course: inflation is picking up in the eurozone as well. And it’s only partly US inflation which is being imported: much of the rest is US depreciation. But I do think that it’s a bit much to hope that even if both the US and the eurozone are seeing inflation pick up, other countries with much smaller currencies can somehow keep inflation under control.

Posted in economics | Comments Off on Infectious Inflation

Private Equity in Hedge Funds: A Weird Combination

Posted on July 1, 2008 by Felix

File under "things which really don’t make a whole lot of sense":

Lehman Brothers aims to raise $3 billion to $5 billion for a fund to buy strategic minority stakes in hedge-fund managers, according to sources at the bank. The fund, which has been called Omega, plans to invest in up to 12 hedge-fund managers.

The example given in the article is that of Aladdin Capital, which recently raised $39 million by selling a 19.5% stake in itself to Mitsubishi (!) implying a post-money valuation of $200 million. At that kind of valuation, Lehman’s $3-5 billion fund could easily buy 12 hedge-fund managers outright, rather than taking "strategic minority stakes".

What’s more, if Lehman is raising outside money for this fund, how can these minority stakes be strategic? I can see why Lehman itself might want to make strategic investments in the alternative-investment arena, using its own money, if it had any to play with. But this is other people’s money, and those people are going to want some kind of an exit, which doesn’t sound very strategic to me.

And in any case, why should small hedge fund managers want to sell minority stakes to any investor, financial or strategic? The barriers to entry in the hedge-fund world are significant, but they’re not really financial. If you can’t pay your overheads out of your management fees, you probably shouldn’t be running a hedge fund in the first place, and I can’t imagine that Lehman would be particularly interested in any hedge fund which was losing money on an operating basis.

So what is the purpose of raising equity in this manner? It’s not like the money will pay for some kind of expensive marketing push to drum up new clients. I can just about see the rationale for a huge, established asset manager like Fortress Group or Man Group to issue publicly-listed shares. But private equity in hedge funds makes almost no sense to me at all.

Posted in banking, hedge funds, private equity | Comments Off on Private Equity in Hedge Funds: A Weird Combination