Felix Salmon - All posts

Art market datapoints of the day

Mon, 06 Feb 2012 18:21 GMT

Many thanks to Zac Bissonnette for fisking the latest Bloomberg gushery on art funds for me, so I don't have to. This fund isn't going to produce disappointing returns: it's probably not even going to get off the ground to begin with. Does Bloomberg's Scott Reyburn have a clue what “unconfirmed commitments” are? I suspect they're the fund-world equivalent of vaporware.

But the fact is that the intersection of money and art is a busy place these days. You have what John Powers cleverly calls Spot Markets, for starters — the global Hirst-spot bazaar is in full flower right now. And then there's that $250 million Cézanne — a figure confirmed by “multiple sources” of Alexandra Peers, and which, as Marion Maneker says, serves to validate other nine-figure prices paid for important works.

Interestingly, the Cézanne is particularly special in that it's a 19th-Century work: everything else north of $100 million has been 20th Century. This could be the beginning of a relative-value trade, where older masterpieces finally converge in value on the silly prices being paid for modern and contemporary works. Or it could just be an outlier: there are precious few undisputed masterpieces of this sheer size in private hands. The Cézanne is 130 centimeters wide — that's over 51 inches, which is huge by the artist's standards. (Some of The Bathers are significantly bigger, but all of those are in museums.) If you want a trophy painting, it's still the case that you're going to want something big.

So when Peers quotes the venerable Gary Tinterow describing the Cézanne as “the darkest, the most stripped down and essential” of its series, that's all well and good — but the real driver of the $250 million price was, I suspect, its square footage.

Alice Gregory has a great piece in the latest n+1 magazine about working at Sotheby's during the run-up in prices following the 2009 crash. Here's a taster:

After a few months on the job, I was assigned a new duty—writing the essays that are printed beneath and between the reproduced images in the sale catalogue…

I sprinkled about twenty adjectives (“fey,” “gestural,” “restrained”) amid a small repertory of active verbs (“explore,” “trace,” “question” ). I inserted the phrases “negative space,” “balanced composition,” and “challenges the viewer” every so often. X’s lyrical abstraction and visual vocabulary—which is marked by dogged muscularity and a singular preoccupation with the formal qualities of light—ushered in some of the most important art to hit the postwar market in decades… It was embarrassingly easy, and might have been the only truly dishonest part of the Sotheby’s enterprise. In most ways, the auction house is unshackled from intellectual pretense by its pure attention to the marketplace…

Sotheby’s felt detached from the posturing that happens in Chelsea galleries and the gnomic garbage that counts for art-world conversation. Auction house employees don’t invoke half-remembered poststructuralism or make inapt analogies. They don’t have to. The prices speak for themselves.

We're in a world right now where distinctions between art and money and value are becoming increasingly blurred, in a way which plays straight into the hands of the nouveau riche and the hedge-fund managers who love to splash millions on big and shiny work. This is a fad, and it will pass, along with former M&A dealmakers who think that owning an expensive art collection gives them the ability to make money flipping paintings on a six-year time horizon. Sociologically, it's fascinating. But when the crash comes, it's going to be very, very painful for anybody in the art world who's gotten used to today's excesses.

Greek talks descend into finger-pointing

Mon, 06 Feb 2012 08:31 GMT

This isn't good; the Greece talks have now moved past their clear deadline and have reached the finger-pointing stage. The broad outline of the dynamics here is now very clear: you need three different parties to agree on a deal for the whole thing to have a chance of success. Private-sector bondholders need to agree to a very deep cut in the value of their bonds; the Greek government needs to agree to enormous spending cuts over and above the 1.5% of GDP that they've already offered; and the Troika of the EU, ECB, and IMF needs to agree to pony up extra bailout money to cover the larger-than-expected deficits that Greece is running.

Of the three, the bondholders are the least of anybody's problems. In fact, almost everything they've done in recent months can be viewed as a way of showing that if and when everything goes pear-shaped, it's not their fault. They will talk to anybody, agree to pretty much anything, and be perfectly reasonable all along; it's the various governments, here, which are finding it impossible to come to terms.

And it's easy to see why. The Greek economy is in a very severe recession, exacerbated by the spending cuts already imposed. Every extra euro cut will only serve to shrink the economy even further — and no country in the history of finance has ever achieved a sustainable debt level by reducing its GDP. It almost doesn't matter whether government spending on things like unemployment benefits is too high on an absolute level: if you cut it now, you doom the Greek economy to perpetual recession, and Greek society to ever-greater levels of political unrest.

On the other hand, you can see why German taxpayers — or anybody else in the rest of Europe, for that matter — have no particular inclination to continue to pay for Greece's high benefits, especially when the Greek government seems incapable of raising the taxes needed to pay for those benefits itself, and when, as Euro Group president Jean-Claude Juncker says, “there are elements of corruption at all levels of the public administration”.

The result is an impasse which, the longer it goes on, the harder it becomes to break; the Troika won't even let the Greeks do a bilateral deal with bondholders unless and until there's a much bigger agreement between Greece and Europe. Which means, in turn, that the bondholders are staring down a worst-case scenario — a default outside the context of any kind of negotiated exchange offer — through no fault of their own at all.

The Troika doesn't want that — banks across Europe would suffer much-greater-than-necessary losses as a result, both on their Greek holdings and on their holdings of newly-endangered debt from Portugal and other countries on Europe's periphery. But at this point, it's probably easier for France and Germany to bail out their domestic banks directly for their sovereign-debt losses than it is for them to shovel any more cash in Greece's direction.

If the Troika fails to save Greece, the past 66 years of ever-increasing European unity will come to a sudden and drastic halt, and all eyes will turn to Portugal, asking if it will be next. (The Europeans will say no, and indeed already the ECB seems to be pre-emptively shoring up Portuguese bond prices; the bond markets will say yes.) There will also be a second sovereign default, sooner rather than later, in Cyprus, and at that point the European and international communities will have essentially no credibility in terms of its ability to prevent dominoes from falling.

But I've never seen less appetite, at the European level, for a policy of continuing to kick the can down the road. Which means that there's a very good chance that the long-awaited and long-feared crunch might soon be upon us. Greece and the Troika might not be able to agree on whether the latest deadline has been missed, but there's one deadline no one can move: March 20, when Greece's big €14 billion bond issue comes due. Either there's an exchange offer in place by that point — or else the European project will have failed.

Elizabeth Spiers and the reinvented New York Observer

Sun, 05 Feb 2012 23:11 GMT

There are three main reasons that I like entering into bets with people. The first is, simply, that it's fun. The second is that I love to win bets. And the third is that I love to lose them. I don't ever trade the markets: all of my investments are strictly buy-and-hold, with a time horizon measured in decades. That rule has saved me a lot of money over the years, not that I ever had much inclination to trade in the first place. But it has also prevented me from learning the kind of lessons that all traders learn early and often.

For pundits, it's easy to be wrong: in many ways, it's what we're paid for. If what you want is facts and certitude, stick to old-school journalism. But it's much harder for us to learn from our mistakes, precisely because the cost of being wrong is in many cases negative. So when I get the opportunity to express a conviction in the form of a wager, I tend to jump at it, partly because it's one of the very few ways for me to be forced to admit that I was wrong about something, and to ask myself what the lessons are.

All of which is a very long-winded way of saying that I've gone and lost another bet, much to the delight of Elizabeth Spiers. She's firmly ensconced at the helm of the New York Observer, a year after being given the job; I said she wouldn't be. I didn't think that she was going to prove herself good at running a newspaper, and — more to the point — I didn't think that her boss, Jared Kushner, would stick by her.

In point of fact, Spiers has not been all that great at running a newspaper. Over the past year, I can barely remember a single time I've even so much as seen a physical copy of the Observer; I certainly haven't read one, and neither has anybody I know. And on the rare occasions that I've read an Observer story online, it's seemed under-edited and rather lightweight, for a newspaper which fancies itself the house organ of the elite.

But the point of hiring Spiers was never to get a great newspaper editor, some kind of heir to Peter Kaplan who would burnish its reputation as the paper slowly dwindled in relevance and lost a few million dollars a year. Instead, making a virtue of necessity, Kushner decided to go as webby as he possibly could, with the newspaper quite explicitly in the position of an afterthought — the legacy brand upon which the new business was going to be built.

And Spiers — to her credit — has absolutely executed on that strategy. The Observer is now, first and foremost, Observer.com. (It's a hugely valuable domain name, which, by some freakish accident of history, wound up getting snaffled by a dilettantish New York weekly before it could be claimed by the venerable newspaper in England.) There's a slew of verticals, running the gamut of New York interests — Wall Street, media, art, real estate — as well as a bold attempt to break into the tech blogosphere with BetaBeat. Page design is sophisticated and effective, with all sites linking generously to all other sites, with the emphasis on dynamic headlines rather than bland navbars.

The Observer's inimitable voice is gone, replaced by a barrage of bloggish posts by a group of writers so young that many of them can't even remember a time before Gawker. (Which was birthed, by Spiers, in 2003.) The old Observer was edited, on a story-by-story basis, in a way that the new online Observer isn't — Spiers doesn't have either the time or the money to have a layer of experienced journalists reworking her bloggers' prose before it's published.

And so, in the proud tradition of good blogs everywhere, readers are left with a highly variable product. The great is rare; the dull quite common. But — and this is the genius of the online format — that doesn't matter, not any more, and certainly not half as much as it used to. When you're working online, more is more. If you have the cojones to throw up everything, more or less regardless of quality, you'll be rewarded for it — even the bad posts get some traffic, and it's impossible ex ante to know which posts are going to end up getting massive pageviews. The less you worry about quality control at the low end, the opportunities you get to print stories which will be shared or searched for or just hit some kind of nerve.

Add in a few linkbait listicles, and you've got a recipe for a successful website — which can only be helped by its association with an honest-to-goodness print newspaper which, still, has extremely good name recognition with most New Yorkers and which we generally think fondly of. There are even nods to the old Observer's buttoned-down worldview, here and there, if you look hard enough. For instance, there's the way in which striking photos and videos are largely notable by their absence. The Verge this is emphatically not; while gorgeous design has its place in the Observer media empire, for the time being it seems to be confined largely to glossy magazines. Even hyperlinks are generally confined to web-first content: when stories from the physical paper appear online, they rarely have any at all.

Spiers's Observer is not the one that her predecessor Tom McGeveran dreamed of when she was hired — one which serves to remind the rich of themselves, on which manages “to speak the patois that is being developed at Le Cirque at the table with Michael Bloomberg”. That kind of thing would always be too precious, too nichey, to work in a medium where the table stakes, in terms of reach and scale, are rising very quickly indeed. Instead, the new Observer is carving out new audiences, is aggressively embracing social media, and has much more attitude in common with HuffPo than it does with, say, the New York Review of Books. That's something that Spiers is good at, and it's something Kushner is happy to encourage.

I'm happy that I was wrong about the NYT paywall, and I'm happy too that I was wrong about the Observer. My mistake in both cases was to be too conservative: to think that change was probably going to be a bad thing, even in the context of a broader media world where change is the only possible alternative to death.

Both the NYT and the Observer threw out the old and did something brave and new; there are many people, in both cases, who preferred things the way they were. Myself included, truth be told. But it's profoundly fallacious to believe that what you want is what should be, in some kind of normative sense. Spiers has come up with a formula which works, in practice, significantly better than its immediate predecessors. In the world of professional journalism, that's something to celebrate. So, if she wants to join me and John Carney for our forthcoming lunch, she's more than welcome. It's on me.

Fantastic news on jobs

Fri, 03 Feb 2012 07:56 GMT

What mean reversion? This is two fantastic jobs reports back-to-back, with the second even better than the first.

You thought the December jobs report was great? I certainly did — but it's been revised, now, and it's even better than was first reported. And the January report is positively glowing.

Unemployment was just 8.3% in January, marking three successive months where it fell by 0.2 percentage points. This time last year, there were 13.9 million unemployed; that figure has now dropped by 1.2 million people, or 8.3%. That's really impressive for an economy which is hardly booming. And it's a real decline, too: the employment-to-population ratio is just as high as it was a year ago, even as the total population has risen by 3.6 million people.

One glance at these charts is enough to show that there's still a very long way to go. Unemployment is far above where it should be; payrolls need to stay strong for a long time to make up for all the jobs lost during the recession; much more of the population needs to be working; and, most importantly, we need to do something about the stubbornly large ranks of the long-term unemployed.

But none of these things can be addressed in a single month: creating jobs takes time. And what we've been seeing over the past couple of months is an economy moving smartly in exactly the right direction.

And lookie here! If you check out Table A-5, and look at the unemployment rate for male Gulf War-era II veterans (that is, veterans of the wars in Iraq and Afghanistan), you'll see that it's fallen from 15.5% to 7.7% in one year. If that's not great news, I don't know what is.

So while there's a lot of work to be done, let's allow ourselves a bit of celebration today. For all the problems in the world — and the US economy could still be derailed if something nasty happens in Europe — things are moving very much in the right direction for the time being. Long may it last.

The craven SEC, part 196

Fri, 03 Feb 2012 07:22 GMT

Edward Wyatt makes a very good point today — why is the SEC doing big favors for big banks, every time it slaps a fine on them?

If a bank settles a fraud case, it automatically loses certain privileges, like the ability to issue debt securities opportunistically, without going through laborious SEC filings, and the ability to shelter forward-looking statements against lawsuits from investors.

It's worth noting here that no company has any kind of right to these privileges. If a company tells lies to investors, those investors should be able to sue it. And if a company wants to issue securities to the public, it's the SEC's job to examine the proposed offering first.

But somehow, along the way, a handful of very big companies — especially banks — managed to persuade the SEC that they were trustworthy corporate citizens, and that they didn't need to be bound by those rules.

That's a little bit suspicious just for starters. But it gets much worse. The SEC, quite naturally, put in place a policy which said that if any of those companies ended up being fined by the SEC for violation of securities laws, then it would lose its special privileges.

And then the SEC proceeded to ignore that policy.

An analysis by The New York Times of S.E.C. investigations over the last decade found nearly 350 instances where the agency has given big Wall Street institutions and other financial companies a pass on those or other sanctions. Those instances also include waivers permitting firms to underwrite certain stock and bond sales and manage mutual fund portfolios.

JPMorganChase, for example, has settled six fraud cases in the last 13 years, including one with a $228 million settlement last summer, but it has obtained at least 22 waivers, in part by arguing that it has “a strong record of compliance with securities laws.” Bank of America and Merrill Lynch, which merged in 2009, have settled 15 fraud cases and received at least 39 waivers.

Wherefore these waivers? Former SEC chairman David Ruder says that were it not for their privileges, these poor banks might have difficulty staying in business. Which, it seems to me, is a very good reason to remove those privileges. Too-big-to-fail banks should be rock-solid, with fortress balance sheets, able to withstand big and unexpected shocks. If their ability to operate as a going concern would be threatened by forcing them to comply with standard SEC regulations, then there's something very wrong with them indeed, and they don't deserve special waivers at all. Instead, they require extra-close scrutiny.

But in fact losing the privileges is not the end of the world for a bank. Look at Citigroup, which lost its privileges for three years in October 2010, and is certainly in poorer financial shape than, say, JP Morgan. It's still chugging along quite happily, making a net profit of well over a billion dollars per quarter.

The SEC does seem to be far too cozy with America's biggest banks, going soft on them when they commit fraud just because it fears for their livelihood if it gets tough. That's wrong. America can live without big banks; what's truly dangerous is a world where too-big-to-fail banks have de facto impunity and can do what they like. Right now, the fines banks pay to the SEC are like protection money: they pay a few million bucks here and there every so often, and in return get to continue doing whatever they like. It's time the SEC put a stop to this. But I'm not holding my breath.

NYT paywall datapoints of the day

Thu, 02 Feb 2012 16:39 GMT

Ken Doctor has a very smart and interesting take on the news that the NYT now has 390,000 paying digital subscribers — plus another 16,000 at the Boston Globe. It's unambiguously good news, on many fronts.

First, and most importantly, digital ad revenues went up by 10% in the area of the business with the paywall, while plunging by 26% at About Group, which doesn't have one. The big worry about the paywall was always that it would eat into ad revenues, and that really doesn't seem to have happened. Of course, it's impossible to know what the NYT's digital ad revenues would have done sans paywall. But my gut feeling is that it's a net positive: it allows for much more targeted advertising and therefore higher ad rates.

What's more, the NYT still has massive reach outside the paywall: it has at least an order of magnitude more unique visitors each month than it has paying subscribers. The NYT can still sell those other visitors just as it always could; they certainly haven't become less valuable since the paywall went up.

The only possible cloud in this picture is in overall traffic growth: the NYT doesn't give pageview numbers, but sites like Quantcast and Compete say that they see no real growth in traffic to nytimes.com, and possibly a small decline. Again, the counterfactual is impossible to know: would traffic have been bigger had the paywall not been in place? I don't think that the paywall has reduced traffic very much, but I do think that the amount of time and money and editorial effort which went in to constructing the paywall might well have found its way into other innovations, had the paywall not happened, which would have made the NYT an even better and more popular product.

That said, the paywall has probably paid for itself already, and with luck some of the extra cashflow it throws off will be reinvested in more consumer-friendly innovations.

The other big news today is this:

Churn is less with digital than print customers: Skeptics opined that people might sign up, but then flee after sampling the paid digital product. The opposite appears true: Smurl says digital churn is less than print churn.

I didn't expect this, but I believe it, and it's really great for the NYT. It's easy to cancel a NYT subscription, but by the same token it's easy to keep one, too. And it seems that once you've taken the plunge and started paying for the NYT, you keep on paying — even more than with a print newspaper.

The result is that the NYT's digital subscribers are a bit like a bank's depositor base: although in theory they could leave at any time, in practice they're an incredibly stable funding source. Much more stable, to be sure, than any advertiser.

But while I'm happy about this state of affairs, I still don't really understand it. Here's Doctor, again:

It took about 12 seconds for Times’ readers to figure out the new subscription math, when the company when digital-paid last year. When they did the math and saw they could get the four-pound Sunday paper and “all-digital-access” for $60 less than “all-digital-access” by itself, they took the newsprint. Which stabilized Sunday sales, and the Sunday ad base. Then the Times was able to announce a near-historic fact in October: Sunday home delivery subscriptions had actually increased year-over-year, a positive point in an industry used to parsing negatives. Now, Sunday is emerging a key point of strategic planning.

This is great news for the Sunday newspaper, which is highly profitable for the NYT. But it also raises the obvious question: why are 390,000 NYT readers eschewing a Sunday paper they could get for less than nothing? Some are IHT subscribers who don't have that option; others are naturally peripatetic. And the cheapest digital subscription is actually still cheaper than the Sunday-only delivery.

It seemed to me, when I entered into my ill-fated bet with John Gapper, that NYT readers would go for the free access bundled with the paper, rather than plump for digital-only access. But increasingly it seems that readers actively dislike having to manage a physical paper, and are willing to pay for making the whole experience virtual.

If that's the case, then the least the NYT can do is to continue to invest in its iPad app. Right now the website is still superior to the app, except for offline reading. The app desperately needs search, and it needs to retain hyperlinks from the original articles, and it needs to somehow build in the sense of serendipity and of relative importance which newspaper readers love so much. It's hard to tell what's important, in the app, once you move off the front page. And it's hard to have your eye caught by a great story you didn't know you wanted to read. But those things will come, I'm sure. If only because there's now a very healthy income stream — Doctor estimates it at more than $80 million per year — which can pay to help develop them.

Why jobs require cities

Thu, 02 Feb 2012 06:15 GMT

Many thanks to Mark Bergen for finding me this data; I asked him for it because I thought that maybe we could learn something from the way in which China has managed to keep employment growing steadily through some extremely turbulent economic times.

What you're looking at here is total Chinese employment from the All China database. Primary industry is commodities, basically, including agriculture; secondary industry is manufacturing; tertiary industry is services.

It comes as little surprise to see that agricultural employment has been falling steadily for 20 years. But it is surprising to see that if you take out the services sector, total Chinese employment has been going nowhere, and basically falling, for the same amount of time.

Caroline Baum, using a different data source, says that China lost 15 million manufacturing jobs between 1995 and 2002; according to these figures, employment in “secondary industry” was flat in those years, going from 156.6 million to 156.8 million before starting to rise again and reaching 218.4 million in 2010. (It's worth pausing here to appreciate the sheer scale of this chart: each horizontal line is another 100 million workers.)

Meanwhile, the services industry — tertiary industry — has been on fire: it now employs 263 million people, more than are employed in secondary industry, and has doubled since 1992. All this, remember, in a country with more or less flat population growth, thanks to the one-child policy.

Of course it's hard to find work in the services industry if you're a rural peasant: tertiary industry is a fundamentally urban thing, which brings me to my second chart.

It comes as no surprise to see that urban employment is growing incredibly fast — 13.7 million urban jobs were created in China in 2010 alone. What does come as a surprise is to see that urban jobs are still in the minority in China — which means that there's a lot of room for growth going forwards.

In the U.S., we had a huge construction boom in the aughts, which was concentrated on building bigger suburban and exurban residential houses. That's good for homebuilders and makers of granite countertops, but it doesn't really boost the economy more broadly. The Chinese construction boom, by contrast, is building cities and roads and crucial infrastructure, which allows the service economy to keep on growing at a torrid place.

Realistically, there is very little chance that global manufacturing employment is going to increase in future at a rate which will provide jobs for a growing global population. If we're going to find jobs in the U.S. and the rest of the world, they're going to have to be found in exactly the area where China is finding them — tertiary industry, or services.

How do you create service-industry jobs? By investing in cities and inter-city infrastructure like smart grids and high-speed rail. Services flourish where people are close together and can interact easily with the maximum number of people. If we want to create jobs in America, we should look to services, rather than the manufacturing sector. And while it's hard to create those jobs directly, you can definitely try to do it indirectly, by building the platforms on which those jobs are built. They're called cities. And America is, sadly, very bad at keeping its cities modern and flourishing. 1950s-era suburbia won't cut it any more. But who in government is going to embrace our urban future?

Broke bureaucrat of the day, St Louis Fed edition

Wed, 01 Feb 2012 11:54 GMT

Binyamin Appelbaum has helpfully aggregated all the Fed presidents' financial disclosure statements in one place. The richest Fed president is Dallas's Richard Fisher, who used to run an investment fund called Value Partners. And the legacy of Value Partners is still visible in Fisher's statement: he owns more than $500,000 of stock in an obscure clothing company called Cherokee Inc, for instance, which was one of Value Partners's biggest investments.

But the most striking disclosure comes at the other end of the scale, from St Louis Fed president James Bullard. Bullard's a career central banker who has never had a lucrative private-sector career, but he's still doing OK for himself: his annual salary is $281,300, which should be more than enough to bring up a family of four in St Louis.

Here's the thing, though: Bullard's disclosure form is completely blank. Which means that, except for his house and his Federal Reserve retirement benefits, he has no investments at all worth more than $1,000 — not even a savings account. Or, to put it another way, the president of the St Louis Fed, earning well over a quarter of a million dollars a year, is living paycheck-to-paycheck. Every two weeks, he gets paid $10,819, less taxes and deductions, and yet by the end of the year he still doesn't have even $1,000 in a checking account.

Now there might be a good reason why Bullard was completely cleaned out for some reason and left with absolutely nothing but the roof over his head. Maybe there was a lawsuit, or medical bills, or something like that. But still, Bullard's balance sheet is quite astonishingly bare, for someone in his exalted position.

Which makes a cynical old journalist like me start wondering about the revolving door. It actually makes perfect sense to live beyond your means when you're in the public sector, if you know that you're going to make a lot of money in the private sector later on. It's called consumption smoothing, and it's entirely rational. You might not be able to lavish money on your family from a cashflow perspective, but that's fine, because you're still a wealthy man if you take into account the present value of massive future earnings.

So James Bullard, regulator of financial institutions in the mid-west and across the country, has an incentive to be very nice to those institutions, since they're capable of rewarding him with lucrative work if and when he leaves the Fed. Work which he's likely to want, if he continues as broke as he is right now.

Bullard, at just 51 years old, has a pretty long and lucrative private-sector career ahead of him, should he be so inclined. And when he filed that financial disclosure form, I wonder if he was thinking about the day when he would be able to fill it out with more than nothing.

Update: The instructions do say that Fed presidents should “exclude any personal account”; I'm unclear on what that means. Certainly other Fed presidents include checking accounts in their disclosures; Richard Fisher's contain more than $500,000 in aggregate, on top of various money-market funds and the like, one of which contains more than $1 million.

The true costs of prepaid debit cards

Wed, 01 Feb 2012 07:48 GMT

Anisha Sekar of Nerdwallet has officially launched a comparison tool which allows you to work out which prepaid debit card might be best for you — and, crucially, allows you to compare the cost of a prepaid debit card to the cost of a bank account. Nerdwallet has run the numbers about as many ways as is humanly possible, and has come to the empirical conclusion that it “is very rarely the case” that prepaid debit is cheaper than checking.

Suze Orman and other prepaid-debit apologists, of course, won't agree with Anisha here. They're all convinced that even if checking accounts don't have higher-than-prepaid-debit fees now, they will in future. And that therefore it's a good idea to switch to prepaid debit now, before you get hit with those hypothetical future fees.

But the fact is that checking accounts, now and for the foreseeable future, are nearly always the best bet for people who want to maximize the number of things they can do with their money, while minimizing the amount of money they're paying for the privilege.

I encourage you to use the Nerdwallet tool yourself. It has a bunch of default settings which may or may not correspond to your own particular circumstances, but even those are very interesting. For instance, Suze Orman, pushing her card, says you should never pay more than $36 per year in fees. But under Nerdwallet's defaults, her card ranks 11th out of 46 cards, with fees of $192 per year.

How come? Well, the one thing that everybody needs is cash — and so Nerdwallet assumes that you'll make two ATM withdrawals per month. And it also assumes that you need to put cash onto the card as well — and that you'll be doing that by reloading your card twice a month at $125 a pop. All of those transactions cost money. In order to bring Orman's card down to $36 per year, you have to never reload your card; instead, you have to set up a direct-deposit operation where your paycheck gets automatically deposited onto your card. That, in turn, allows you to use in-network ATMs at no cost.

Are you willing to do all that? In that case, push the “cash reload” slider down to 0, and switch the answer to “Will you use direct deposit?” to “Yes”, while selecting some non-zero amount for that deposit, say $1,000 per month.

Now, Orman's card looks much better — and does indeed charge only $36 in fees. But that's still only good enough for 5th place. The Green Dot card is the cheapest, at $5 per year, while Capital One and American Express both have options running about $2 per month.

Then, click on the button saying that you want to compare debit-card options to checking-account options. At that point, Perkstreet's checking-account debit card immediately tops the list, costing absolutely nothing; indeed, its cost is negative, since it rebates money back to you every time you use the card. Capital One and Bank of America, too, offer online checking accounts which are genuinely free. And the Suze Orman card is now down to 8th out of 57 options.

The fact is that debit cards, just like checking accounts, will happily let you run up enormous fees if you're not careful. And they never allow you to do simple things like deposit checks or cash at no fee — something that all checking accounts do as a matter of course.

In principle, it shouldn't necessarily be this way. Checking accounts are inherently quite expensive things, involving statements and branches and a lot of bank infrastructure which prepaid debit cards don't need. On top of that, prepaid debit cards get much more interchange income for their issuers than checking-account debit cards do, since they're not subject to Durbin Amendment caps.

Certainly there are bad-deal checking accounts out there, and if you have one, you should close it. But between online bank accounts and your friendly neighborhood credit union, it's extremely unlikely that a prepaid debit card is your best option. Being banked is nearly always better than being unbanked. So move your money to a bank which doesn't charge you fees, rather than moving to a prepaid debit card.

Prepaid debit cards can be useful for purposes other than replacing a checking account, of course, but they still charge fees. So if you're thinking of using a prepaid debit card as a way of paying your child's allowance, then fire up that Nerdwallet tool, and work out which one is cheapest. And, at the same time, ask yourself whether a checking account might not be better in that case, too. Not all checking accounts are good. But many are. And most prepaid debit cards are pretty bad.

Freddie Mac and the inverse floaters, cont.

Wed, 01 Feb 2012 04:44 GMT

Jesse Eisinger is back with a follow-up to his original piece about Freddie Mac and the inverse floaters; he's also left a long comment on this blog, responding to various criticisms of his story which appeared in the blogosphere.

There are two main pieces of new information in the update. The first is that the size of Freddie's inverse-floater position is even greater than we previously thought — $5 billion, rather than $3.4 billion. And the second is that the FHFA forced Freddie to stop making these trades last month, before the original ProPublica piece appeared. Now the FHFA, under Ed DeMarco, is a highly obstructionist agency which will always protect Frannie's short-term interests over the broader health of the housing market and American homeowners. If even the FHFA was expressing serious concerns about these deals, that's very strong evidence that something fishy was going on.

To get a feel for the tenor of the debate, check out the official FHFA response to Eisinger's story:

The inverse floater leaves Freddie Mac with a portion of the risk exposure it would have had if it simply held the entire set of mortgages on its balance sheet. The CMO structuring activity results in some portion of the mortgage cash flows being sold off and a smaller amount needing to be financed by Freddie Mac with debt securities. It also results in a more complex financing structure that requires specialized risk management processes.

And here's Eisinger, in his comment on this blog:

[Freddie] could have sold MBS on its portfolio outright and rid itself of the prepayment risk. The market for simple MBS with a government guarantee attached is liquid and deep – and certainly was then, in late 2010 and early 2011 when Freddie’s inverse floater bets ramped up.

Instead Freddie had the securitization structured, then retained the inverse floater portions. In other words, Freddie undertook transactions in which it retained a piece of a newly created deal that has basically the same risk profile as the original holdings. And what Freddie retained carried new risks: liquidity and LIBOR risks. Freddie engaged in reverse alchemy: it turned a position of gold into lead.

Moreover, these trades didn’t happen in a vacuum. Freddie is under a mandate to sell down its portfolio. Implicit in that mandate is that Freddie reduce its risk. In these trades, Freddie sells something notionally, so that the assets on its balance sheet fall, but it keeps most of the risk — and adds new risk. That raises the question of whether it is subverting the spirit, if not the letter, of its agreement with the U.S. Treasury.

I'm with Eisinger on this one. Let's say you own a big house with a cottage in the back, which you're renting out to tenants. And let's say that you've been ordered to sell as many assets as you can. You can sell your property easily to homeowners who will be happy to take the rental income on the cottage. They know that the tenants can move out any time, so they won't pay a huge premium for the cottage, but they will pay you extra for it.

Instead, you go to a very expensive lawyer and you carve your property up into two pieces. You then sell off the house, but hold on to the cottage yourself. You get less money for the house than you would have done if you'd simply sold the whole property. And what's more, you now own a cottage, on its own, which is much harder to sell than either the house was, on its own, or the big house-plus-cottage property was before you split it into two.

The FHFA's argument is, basically, “look, the cottage is smaller than the original property and the total risk associated with the cottage is, by definition, lower than the total risk associated with the cottage-plus-house original property. So we're selling off assets, just like you asked.”

But this doesn't make sense. Why go to the trouble of breaking the property up into constituent parts, at non-negligible expense, only to hold on to the more illiquid of those parts? If the sum of the parts were worth more than the whole, I could see it: breaking the property up makes sense if you sell the house to one person, the cottage to another person, and end up with more money than you could fetch for the property as a whole.

But that's not what happened, because of the simple arbitrage in the markets: there are lots of traders out there happy to break up mortgage securities if doing so is profitable. There's no need or reason for Freddie to start doing that itself.

It seems to me that Eisinger is right and that Freddie is violating the spirit of the Treasury's instructions. Treasury wants Freddie to sell down and derisk its balance sheet. Freddie, in response, started selling down its balance sheet, but kept as much risk as it possibly could, in the form of inverse floaters.

And does anybody really believe that Fannie and Freddie should be taking on more risk, in relation to the size of their balance sheets? I'm sure that doing so is good for the annual bonuses of someone getting paid $2.5 million a year to run Freddie's mortgage portfolio. But it's unlikely to be a good idea for anybody else.

As for the now-famous Silversteins, the couple who aren't being allowed to refinance their property — well, that addresses the one case where it does make sense for Freddie to be taking on this prepayment risk. And that's the case where Freddie itself controls the rules as to whether or not homeowners are allowed to refinance.

To go back to that property with that cottage, suppose that if you sold the property with cottage attached, the new owner would have no control over whether or not the tenants in the cottage moved out. But you, the seller of the property, do have control over the tenants — you can force them to continue paying rent in a manner that the new owner can't. In that case, it makes sense for you to hold on to the cottage, because it's worth more to you than it is to anybody else.

And that's what Eisinger was alleging in his original piece. That the only reason it makes sense for Freddie to do these complex trades which leave it with significant holdings of inverse floaters, is that Freddie actually controls whether or not people like the Silversteins are able to refinance and thus prepay their mortgage. And because Freddie has that control, inverse floaters are worth more to Freddie than they are on the open market.

Basically, Freddie can't have it both ways. Either it is preventing the likes of the Silversteins from refinancing so that it can maximize the value of its inverse floaters or it has no particular reason to carve up its mortgage securities and retain an illiquid inverse-floater tranche. Which is it to be?

Germany, Greece, and the conspiracy of the technocrats

Tue, 31 Jan 2012 16:56 GMT

Der Spiegel has a long and meticulously reported piece on the state of affairs as it exists right now between Germany and Greece, naturally concentrating on attitudes within Germany. Meanwhile, Yanis Varoufakis has a much more Greek take on the same subject at CNN. And by far the most striking thing, here, is how similar the two pieces are.

The German article is headlined “European Politicians in Denial as Greece Unravels”, while the Greek one plumps for “Why it's too late to save Greece's sovereignty”. They're both saying the same thing: Germany has been treating Greece's insolvency as though it were some kind of liquidity crisis, which can be solved by lending Greece more money. But of course that's the worst possible thing you can do with an insolvent debtor: it only makes things worse rather than better.

Here's Varoufakis:

German leaders, unwilling to confront their bankers and the fault lines developing throughout the eurozone, pretended to believe that the problem was Greece and that Greece could be “cured” by means of loans and austerity. At the same time, Greek leaders, unwilling to confront their electorate, pretended to believe that they could deliver the targets demanded by Germany.

This can be seen as a conspiracy of the technocrats: both sides deliberately agreeing to the impossible so that Europe would be dragged into ever-greater fiscal union. After all, the more money that Germany lends to Greece, the more control it's going to demand, and the greater the gap between Greece's promises and its reality, the more control it's going to feel the need to concede.

But the problem is that the technocrats aren't managing to bring the two countries' respective populations along for the ride. The Spiegel article is full of various German politicians saying in no uncertain terms that more money is simply not forthcoming. And the Spiegel article has some very strong demonstrations of why Greece is going to need to devalue if it's going to have any hope of growing:

In Mediterranean tourism, Greece has to compete with non-euro countries like Croatia, Tunisia, Morocco, Bulgaria and Turkey, which can offer their services at significantly lower prices. The per-hour wage in the hospitality industry was recently measured at €11.39 in Greece, as compared with only €8.49 in Portugal, €4 in Turkey and as little as €1.55 in Bulgaria.

Devaluation alone isn't enough, of course; it has to be accompanied by a large number of defaults and insolvencies. As the Spiegel article notes, thousands of companies and banks could be forced to declare bankruptcy. But maybe that's exactly what Greece needs. Bankruptcy is a cleansing process which gives the opportunity to start over.

The Eurocrats are petrified of a Greek insolvency because they know it risks spilling over into Portgual and the rest of the continent. Sovereign defaults tend to be contagious — look at Latin America in the 1980s. But since a default in Greece is inevitable at this point, best it get done sooner rather than later. The German press has worked this out; it remains to be seen how long Europe's technocrats can remain in denial.

Udacity's model

Tue, 31 Jan 2012 08:36 GMT

Robert Reich has three very good questions about Sebastian Thrun's new online university, Udacity, which I wrote about last week. I spoke to Thrun yesterday, so I took the opportunity to clear them up.

Reich begins:

1. Why did Thrun need to quit Stanford? Why not pursue the project under the umbrella of Stanford, with its enormous and global reputation? Indeed, hadn’t he already carried out a demonstration proof of the concept with his Artificial Intelligence class at Stanford? Why not just continue with that in expanded form at Stanford?

As Thrun says on his homepage, he quit Stanford on April 1, 2011 — before offering the free class in artificial intelligence — “primarily to continue my employment with Google”. Thrun is a very senior and successful Google employee, and he had somehow been combining that, before 2011, with being a fully tenured professor at Stanford. That was done through something called “leave time” — but leave time is finite, and eventually Thrun ran out of it. When that happened, Thrun told me, “I said I'm not ready to leave Google just yet”. So he gave up his tenure at Stanford, and became an unpaid Stanford research professor.

This helps to answer another of Reich's questions. “If Thrun developed [the AI] class as a faculty member at Stanford,” he asks, “then doesn’t Stanford have some claim on at least the course content?” The answer, it seems, is that Thrun developed the class after he gave up his position at Stanford. And as a result, the course content belongs not to Stanford but rather to KnowLabs, Thrun's company.

What's more, the online version of the course, which was not hosted at Stanford's website, was very careful with its Stanford branding. Yes, the online course made no secret of the fact that it was basically exactly the same course that Thrun was teaching a group of Stanford undergraduates. But the final certification made no mention of Stanford.

Leaving Stanford, Thrun told me, “was the only way I could pull this off. The statement that we could let the students take exams and compare themselves to Stanford students, is something I don't think the university would have approved.”

When NPR interviewed Thrun for a story about Udacity, they also got a none-too-enthusiastic statement from Stanford:

Thrun's colleague Andrew Ng taught a free, online machine learning class that ultimately attracted more than 100,000 students. When I ask Ng how Stanford's administration reacted to their proposition, he's silent for a second. “Oh boy,” he says, “I think there was a strong sense that we were all suddenly in a brave new world.”

Ng says there were long conversations about whether or not to give online students a certificate bearing the university's name. But Stanford balked and ultimately the school settled on giving students a letter of accomplishment from the professors that did not mention the university's name.

“We are still having conversations about that,” says James Plummer, dean of Stanford's School of Engineering. “I think it will actually be a long time — maybe never — when actual Stanford degrees would be given for fully online work by anyone who wishes to register for the courses.”

Stanford, then, has managed to come out of this story smelling reasonably good: it helped give Thrun the launching pad for Udacity, and didn't visibly complain about his course material appearing online for free. But it didn't really help him in an active way, and probably, if Thrun had been affiliated with Stanford going forwards, would have ended up hindering what Thrun wanted to do.

Thrun isn't upset about that: he understands why his dream isn't really compatible with what Stanford does. “If you grade external people without checking identity,” he says, “you open the floodgate to fraud. Stanford's position was very well justified. They weren't being anal, they were concerned. But I felt we should just teach students online for free, and that the engagement we get from this exceeds the uncertainty that comes from these new certificates.”

Indeed, the sign-up rate for Udacity's new courses seems to be exactly the same as the sign-up rate for the AI class which was co-branded with Stanford: the lack of a Stanford branding doesn't seem to have hindered Udacity much. And similarly, the incredible success of Khan Academy has taken place without any co-branding with a venerable legacy institution.

There's no doubt that Stanford is extremely good at doing what Stanford does — which is to hire great research professors, select a tiny minority of the students who want a Stanford degree, and then bring the two groups together in a productive manner, while building up a world-class reputation and acting as the beating heart of Silicon Valley, pumping knowledge out into its surrounding neighborhoods and creating what is arguably the single most innovative region in the world.

But both Stanford and Silicon Valley more broadly are elite institutions, home to the ultra-productive 1%. Thrun's ambitions are more demotic, and in that sense cut against what Stanford stands for.

Udacity is very much a teaching institution rather than a research institution. “At Stanford, priority is your research career,” says Thrun. “That is counter to teaching 100,000 students, who generate 100,000 emails.” Looked at from a 30,000-foot view, Stanford is the institution being disrupted here, it's not the institution doing the disrupting.

And that also helps explain why Thrun isn't doing Udacity under the auspices of Google. He says that Udacity does fit quite easily into Google's mission of making the world's information available for free, but that at the same time Google doesn't need a dog in this particular fight. “Having a clean slate is a better way to start,” says Thrun. “The last thing I want is people asking whether Google is disrupting education. Better to ask if Sebastian is trying to disrupt education.”

(That said, Thrun's friend and boss Sergei Brin does feature prominently in the launch video for Udacity's first course; it's clear that Udacity has Brin's strong support. And of course Google is also a big supporter of Khan Academy, having gifted it some $2 million.)

So it's pretty easy to see how Thrun, if he wanted to create an organization which could grow incredibly fast around the world, might want to do so without having to get Stanford's sign-off on everything first. But that doesn't answer Reich's second question:

2. Why is Udacity a for-profit company? Thrun said that Udacity courses would be free to students, and Thrun cited Salman Khan and Khan academy as inspiration and model for what he’s doing. But Khan Academy is non-profit. Stanford University is a non-profit. Thrun says he wants to democratize higher education, offering knowledge to the world for free. How does this mission fit with his for-profit online university?

I asked Thrun about this, too, and he replied by saying that “for profit is not forced to make profit. I needed to get people together really fast, and it's much easier to do that under the ways of a Silicon Valley company.”

Certainly the speed with which Udacity launched, complete with a high-quality staff, is testament to the natural velocity with which things get done in Silicon Valley. Driving the launch was seed funding from Charles River Ventures, while the site's jobs page proudly offers “Competitive salary, benefits, and Series A stock options” to anybody thinking about working at Udacity.

This is an interesting model, and it's not necessarily the one I would have chosen. Salman Khan, for instance, is quite vocal about why it's good that he's a non-profit, and the way in which the dreams of venture capitalists who have approached him conflict with his fundamental vision. What's more, Khan did end up receiving $5 million from Irish venture capitalist Sean O'Sullivan — just as a philanthropic grant, rather than as an equity investment. And certainly Thrun has no desire to join the ranks of America's for-profit colleges, which make their money from tuition fees.

But still, online education is young enough that it's worth trying many different models to see which ones work. Udacity seems to be built on the standard VC model of get scale first, worry about monetizing it later. And if Udacity does end up with millions of students, I should imagine that there are quite a lot of companies which would pay Udacity to be able to reach those students. Simply charging technology companies to put job opportunities in front of students with given grades and qualifications would probably generate quite hefty fees. So long as the education itself remains free, I don't think that being a for-profit is in and of itself a bad thing.

“We should try many different things,” says Thrun. “I believe in the educational revolution that Salman started. I believe that education can change the world. So why not try a hundred of those things.”

This seems reasonable to me. A large part of the success of both Khan's courses and Thrun's is the way that they're presented and executed, rather than any business model behind them. Khan, in particular, is a hugely gifted natural educator. And what both of them aspire to doing is to build what Thrun calls “magic” into the way that they teach. Thrun wants to add another element, too — community. His courses have a start date and an end date and deadlines, with thousands of students all taking the same class at the same time; that makes them inherently social in a way that Khan's YouTube videos aren't.

Finally, asks Reich,

3. What to make of Thrun’s apparent pleasure at the fact that 170 of the 200 Stanford students who had enrolled in the real, not online, version of the Stanford AI class stopped coming to class, preferring the online Thrun to the flesh-and-blood Thrun?

That pleasure, I'm quite sure, is genuine. I think that Khan and Thrun are at the forefront of a new, more personal way of teaching — think of them as having screen-actor skills in a world which has historically rewarded stage-actor skills. When you teach online, you're teaching in a conversational manner, in a one-on-one space. And it turns out that many students — quite possibly most students — prefer being taught that way, as opposed to the old-fashioned model where a lecturer stands up in front of a crowded classroom and declaims to many people at once. Most students are naturally shy; they don't like speaking up in class and saying that they don't understand something. Online, they can just rewind and replay, or pause and look it up on Wikipedia.

And then of course there's the fact that the incentives for the teacher are so much greater online, if like most teachers you're driven by the opportunity to impart knowledge to students. “This is the best thing I can do in my life,” says Thrun. “I empowered more students in 2 months than in my entire life before. On that scale, I was off the charts in the last quarter.” And of course Thrun is barely on the charts if you compare him to the number of students that Khan has reached.

What Khan and Thrun and others are creating is a new educational paradigm, which promises not only much greater scalability than anything we've had until now, but also higher-quality education. That's the real lesson of Thrun's Stanford students taking his class online: it means that the online model really can have its cake (reach millions of people) while eating it too (be better for students than the courses offered at elite institutions).

The trick is intimacy, in a way which takes full advantage of the lean-forward nature of computer screens. I'm in England right now, where the Open University has been around for over 40 years. The OU has historically reached students through the lean-back mediums of TV and radio, which in turn encouraged its lecturers to behave as though they were trying to reach a large audience. When you see Salman Khan or Sebastian Thrun drawing pictures on the computer screen in front of you, while listening to them talk to you through headphones you're wearing, the experience is very different — it's a much more immersive and intimate experience. Blow that YouTube video up to full screen, and jump down the rabbit hole. You might just learn something.

Freddie Mac gets paid to obstruct refinancings

Tue, 31 Jan 2012 03:10 GMT

Jesse Eisinger and Chris Arnold have a really good story about Freddie Mac today, a company which is preventing mortgage refis at the same time as it's making enormous prop bets that homeowners are going to continue to find it hard to refinance.

Back in September I noted that mortgage bonds are trading well above par just because investors are well aware that refis are hard to come by for many homeowners, and said that those investors were “taking unfair advantage of the fact that homeowners are locked into above-market mortgage rates”. What I never dreamed of was that the investors and the rule-setters were the same people — in this case, Freddie Mac.

But here's what Freddie is doing. In the past two years, it's bought $3.4 billion of hugely-risky “inverse-floater” notes — essentially bets that homeowners with above-market mortgage rates won't be able to refinance to market rates. And then it turns around and implements rules which prevent homeowners like Jay and Bonnie Silverstein from refinancing. The Silversteins have made all their mortgage payments on their current home in full and on time, despite the fact that they're paying an interest rate of 6.875%. They'd love to refinance to get that rate lowered, but Freddie Mac won't let them — because of the way they sold their previous home.

The Freddie Mac rule certainly maximizes Freddie Mac's income, but it's dreadful and unfair public policy. At the same time, it's also policy which is very much in line with the FHFA's stance on principal reduction, or anything else which might help homeowners. Given the choice between extracting short-term cashflows from homeowners, on the one hand, and improving the all-over health of the housing market, on the other, the FHFA will always choose the former.

Check out the long-awaited letter from FHFA director Ed DeMarco, for instance, justifying the fact that he won't allow Frannie or Freddie to do principal reductions. It's basically a long list of tables with precious little annotation or explanation, but at heart it seems to be based on two ideas. The first is that if you reduce principal to 115% of the value of the home, that doesn't help very much. Well, duh. The whole point of principal reduction is to give homeowners back some equity in their home, and if they're still underwater, you're not doing that. And the second reason is just that Frannie's computer systems aren't really set up for principal reductions:

Neither Enterprise can accommodate the new accounting and tracking of principal reduction without operationally challenging changes to the existing IT systems, which are outdated and inflexible. The team did not require the GSEs to provide FHFA with cost projections, but experience implementing the HAMP program suggests that each Enterprise would need substantial funds and would rely upon scarce personnel resources to make the necessary IT modifications.

This is pretty desperate stuff — “we don't know what the IT costs might be, and we didn't bother to try to find out, but trust us, they'd be substantial”. In the wake of ProPublica's story today, I don't trust the FHFA at all. It signed off on all of Freddie's trades, and its actions are entirely consistent with a regulator perfectly happy with Frannie taking on massive bets at the expense of homeowners, just to try to make some extra money. Oh, and the chap at Freddie in charge of buying these inverse floaters is paid $2.5 million a year.

It's all quite a disgusting spectacle, really. Matt Levine attempts some kind of defense of Freddie's actions, based on the idea that the inverse floaters are just what's left after Freddie sells off everything it can easily sell — but that's not what actually happened. In fact, Freddie went out and bought these instruments, on the open market. It almost looks like inside trading: they'll pay off handsomely, just so long as Freddie continues to make it hard for homeowners to refinance. Which means that refinancings in general, and principal reductions in particular, are still going to be rare to nonexistent going forwards. Which is bad for homeowners, bad for the housing market, and bad for the economy as a whole. Even if it's good for Freddie's prop book.

Jackie Ramos vs Bank of America, part 2

Mon, 30 Jan 2012 13:18 GMT

Click here to view the embedded video.

Remember Jackie Ramos? She caused a huge stir by going public, on YouTube, with her story of working for Bank of America, which fired her for allowing customers to pay off their debts with installment loans.

Now Ramos is back, and her latest story of Bank of America is even worse. The short version: BofA started charging her extra money, on her mortgage bill, for mortgage insurance she'd never asked for. Eventually, when she found out what the charges were for, she agreed to keep on making those insurance premiums, since they would allow her to stay in her home if anything ever happened to the other person on the mortgage, her son's father Tim.

Then, in April 2011, Tim died — and the mortgage insurance didn't pay out. Instead, BofA foreclosed on Ramos, and she lost her house. When she tried to ask why the insurance didn't pay out, they wouldn't answer her questions, on the grounds that she and Tim weren't married.

Over email, Ramos told me that the insurance in question was absolutely mortgage life insurance, over and above the standard mortgage insurance which they already were paying for from another provider. That's what BofA explained when they agreed to keep on paying the premiums. And Ramos also passed on a tax form 1098 from Bank of America to Tim, which clearly shows that Tim had paid mortgage insurance premiums in 2011 — even as the bank is now telling Ramos that there was no mortgage insurance at all.

At the very least, this is a case of Bank of America communicating in an absolutely atrocious manner with one of its homeowners. And at worst it's a case of BofA foreclosing on and evicting someone who should instead have had her home paid off. One can't expect that anybody at BofA realized that the person they were talking to was that Jackie Ramos. But it's unfortunate for them that they didn't. Because I suspect that this video might prove just as popular as the last one — which received more than 440,000 views, at last count.

The Troika vs Greece

Mon, 30 Jan 2012 07:19 GMT

Are you worried about Greece failing to come to some kind of agreement with its bondholders? If so, you're far behind the curve. Because the new big worry is that Greece will fail to come to some kind of agreement with the Troika — the official-sector entities which are going to fund its deficits for the foreseeable future.

To understand what's going on here, you really need to read two different things. The first is the latest paper from Mitu Gulati and Jeromin Zettelmeyer, entitled “Engineering an Orderly Greek Debt Restructuring”. It's clear, it's clever, and it explains exactly what Greece's options are. The second is the leaked document from Germany, which has effective veto control over the Troika, laying out proposed conditions under which it's willing to continue to fund Greece.

The mechanics of a Greek debt restructuring, as laid out by Gulati and Zettelmeyer, are absolutely fascinating to a sovereign-restructuring geek like me. But I'm not going to get into the details here. Suffice to say that in order for the restructuring to work, the Greek bonds currently held by the ECB need to be tendered into the exchange, somehow. There are various ways that this can happen: the ECB can tender its bonds directly; it can sell them to the EFSF, which would then tender them; or it could even sell them to Greece, which would tender them. But what it can't do is sit back and continue to collect interest on those bonds while expecting all the private-sector bondholders to voluntarily take a massive haircut. Too many hedge funds own Greek debt now; if the old bonds continue to get paid out, then the hedge funds will simply refuse to tender, and the exchange offer will fail.

The point here is that the Greek bond exchange has to be worked out in very granular detail with the Troika, because the ECB is going to have to play a central role in making it work. If the markets think for one minute that the ECB's bonds won't be tendered into the exchange, the deal is almost certain to fail. On the other hand, as Gulati and Zettelmeyer explain, if the ECB's bonds are certain to be tendered into the exchange, then Greece can structure a deal where it makes no sense to hold out at all, since holdouts would end up with illiquid and hair-cut Greek-law bonds, while anybody tendering would end up with English-law bonds which had much stronger bondholder protections and much greater liquidity.

So, what's the Troika going to demand, in return for cooperating with the exchange and helping to ensure its success? More of a fiscal union, that's for sure — which means real European control over how and where Greece spends its money. As the leaked document explains, “Greece has most likely missed key programme objectives again in 2011,” and “will have to significantly improve programme compliance in the future”, by “shifting budgetary sovereignty to the European level for a certain period of time”. That's the reality of how bankruptcy works: if you run out of money, then anybody willing to lend you money can generally call whatever shots they want. And the fact is that monetary union, as we've seen, simply can't work if there's no fiscal union, with Europe having some kind of fiscal control over its member states.

The big problem with the leaked document is not the violation of Greek sovereignty, then. Rather, it's the manner in which Greece's new fiscal overlords are intending to treat the country's debt burden. “Greece has to legally commit itself to giving absolute priority to future debt service”, it says, which is fair enough — California does something similar. Some bondholders like such things. But they don't mean much to me: as I said in the Californian context, if you can break your promise when you default, you can break your promise to privilege bonded debt over other obligations, as well.

But the document goes significantly further than just giving Europe a say in Greece's fiscal decision-making and asking for largely-meaningless promises from Greece. Check this out:

De facto elimination of the possibility of a default would make the threat of a non-disbursement of a GRC II tranche much more credible. If a future tranche is not disbursed, Greece can not threaten its lenders with a default, but will instead have to accept further cuts in primary expenditures as the only possible consequence of any non-disbursement.

In English, what this means is that Greece has to open itself up to a double fiscal whammy. Greece is going to be running deficits for the foreseeable future, and needs to get the money to cover those deficits from the Troika. Now, what happens in future, post-restructuring, if Greece gets into a fight with the Troika, and the Troika doesn't give Greece the money it needs? As things stand, that would be a very bad outcome indeed. Greece could default on all its debt obligations, but it's still running a primary deficit, so it would need to make even bigger fiscal cuts, or try to raise taxes even more, in order to bring its budget into balance. The result would be worse austerity, and an even deeper recession.

Under the German proposal, things get significantly worse than that, for Greece. Essentially, if the Troika cuts off funding, then Greece still needs to make all of its debt payments, on top of its primary deficit. The resulting austerity would be devastating — as Germany, of all countries, should know. After all, the burden of crushing German obligations after the Great War was largely responsible for the rise of… OK, enough. I'm not going Godwin here. But the point is that Germany is trying to take away Greece's option to default. Interfering with Greece's fiscal sovereignty is one thing, but this goes way too far.

I can see how Europe might want to give itself some kind of control over total expenditures and revenues in Greece. But the relative priority of expenditures — whether Greece wants to spend its tax revenues on debt repayment or on hospitals, for instance — must be left to the Greeks.

The reason all of this is going on, of course, is that the Troika's interests and Greece's are far from aligned. The Troika wants to stop having to fund Greece, and therefore wants Greece to regain access to private markets as soon as possible. Greece, on the other hand, is more interested in domestic growth at this point, so long as the Troika will continue to provide funding while private markets are closed. At the margin, then, the Troika wants more fiscal constraints (and hoped-for access to bond markets in future), while Greece just wants to get out of recession and start seeing some kind of light at the end of the tunnel.

Or, put it another way. Greece wants long-term debt sustainability, which means growth. The Troika, on the other hand, is less interested in the long term: it just wants the private sector to take over in terms of funding Greece as soon as possible. And the private sector, while it does care about long-term debt-sustainability calculations, also cares about many other things, like governing law and the constitutionality of default and the probability that Greece will continue making bond payments even if Troika funding dries up.

All of which means, weirdly, that bondholders would be better off lobbying the Troika than they are negotiating directly with Greece. After all, the Troika is really calling the shots here. And the Troika wants bondholders treated extremely well — after the restructuring. So if bondholders want things like English-law bonds and constitutional amendments, they should probably be asking the Troika for them, rather than Greece. Greece has no real reason to give them such things. But it can easily be forced to, if that's what the Troika demands.