Felix Salmon - Econoblog

The Beginning of the End of the Credit Crisis?

Felix Salmon — Wed, 14 May 2008 20:59:41 GMT

David Gaffen is watching the VIX decline to levels well off its March highs, and back towards its lowest point of the year to date. Meanwhile, Alea is watching financial-instution credit default swap spreads decline to levels well off their March highs, and back towards the lowest point of the year to date. Could it be that we really are at the beginning of the end of the credit crisis? Has Ben Bernanke been successful in averting disaster?

"For the most part, investors appear to view the credit crisis as having passed over," says Gaffen - and this of course is one of the areas where investor sentiment has a tendency to become self-fulfilling. Of course, it helps that the Fed has turned the faucets wide open and is likely to keep them that way for the foreseeable future: if Ben wan't dropping money from helicopters, things would surely be very different.

Still, if Nassim Taleb is to be believed, the time to worry is not when volatility is high, but rather when volatility is low.

Also, he says, people do not understand the link with the concept of volatility. In a market, if returns do not follow a "normal" bell curve distribution (as appears to be the case), volatility will actually be less than the bell curve would predict. For much more than the predicted two-thirds of the time, returns will be very close to the average. Such low volatility, counter-intuitively, is a danger sign that there is a greater risk of true "black swan" events, when returns do deviate from the norm, because it shows that returns do not follow a normal bell curve.
His geopolitical analogy is with Italy and Saudi Arabia. Italy has had many different governments since the war, while the same family has retained power in Saudi Arabia. This means that Italy is the more volatile but, he says, that Saudi Arabia is more risky, because if something does change in the political situation there, it will have much greater consequences.

On the other hand, if Saudi Arabia goes volatile and then settles down again, it's likely to be in a more sustainable place than it was originally. The people who mistrusted the Great Moderation were right. But if the world is really de-risking right now, rather than just mispricing risk, then this time around volatility might be falling for all the right reasons.

Why Agricultural Subsidies Don't Mean Lower Food Prices

Felix Salmon — Wed, 14 May 2008 17:19:56 GMT

Do agricultural subsidies lower food prices? When I looked at this question last month, I dismissed it as a second-order effect: they might, they might not, either way it's not going to be a big deal when compared to the enormous swings in food prices that we've seen of late.

But Dean Baker is still bashing his drum, and now, after what I learned yesterday about rice in Japan, I'm much less indulgent of this sort of thing:

The truth is that the U.S. and European subsidies that cause the Post, the NYT, the World Bank and many NGOs to get apoplectic have the effect of lowering world food prices. That means that fewer people go hungry than would be the case without these subsidies.
This isn't rocket science, it's almost definitional. The U.S. and European effectively pay their farmers to keep farming, thereby producing more food than otherwise would be produced. This may have negative consequences for farmers elsewhere in the world, but it does mean that supply is greater and prices are lower than they would be in the absence of the subsidies.

Dean seems to live in some kind of frictionless econoworld where prices fall as supply rises. But the world of agricultural subsidies is anything but frictionless: for one thing, it's dominated not by direct subsidies so much as by tariffs. And so you end up in a situation where Japan is sitting on 1.5 million tons of rice, which it's not allowed to sell at any price to, say, the Philippines, which is in desperate need of it. Instead, the rice will be allowed to rot to the point at which it's useful only for pig food. High rice prices aren't a function of low supply - rice production is at record highs. But the market is broken, thanks largely to the system of subsidies and tariffs which distorts incentives and prices around the world.

As Paul Collier says, what's needed is much more large-scale agricultural production in developing countries. The model he uses is Brazil, which by no coincidence is a major agricultural exporter. In order for the supply of agricultural goods to rise substantially, we need much more in the way of agricultural exports, especially from the developing world. And one way to get there is to increase the demand for agricultural imports from Europe, Japan, and the US. No one in Africa is going to bother trying to grow sugar for export to the US, not with the present subsidies and barriers in place. But if they came down - then we might see some large-scale agricultural investment in Africa.

Of course, none of this would change food prices overnight. But if our goal is feeding the planet over the long term, then it would be a great idea to abolish agricultural subsidies and tariffs. Defending them on the grounds that they lower food prices is therefore counterproductive, and largely wrong. They might lower food prices in theory; in practice, I doubt they do.

(Is this the same argument which I dismissed last month as being "all a bit vague and hopeful"? Yes. The rice-bubble paper changed my mind on this one, and moved me from the subsidies-are-irrelevant camp and into the subsidies-are-actively-harmful camp.)

Why Bank Debt Looks Attractive

Felix Salmon — Wed, 14 May 2008 15:38:56 GMT

Pimco's investment professionals spent three days this month with the likes of Alan Greenspan, Nassim Taleb, and Mike Spence in something the bond manager calls its "Secular Forum". It fell to Mohamed El-Erian to sum it all up, and to draw some investing ideas from the discussion. The most interesting one, to me, is that this might be a great time to buy bank debt. Writes El-Erian:

As investment banks are forced to converge over the next few years towards the lower leverage model of commercial banks, they will seek ways to secure a deposit base that can reduce their cost of funding, including through merger and acquisition. This process of de-leveraging and, if done properly, de-risking will have a number of implications for investors...
Expect us to search for value in the re-alignment of the financial system that is heavily influenced by regulatory-induced de-risking: The regulatory reaction serves to clip part of the tail risk of institutional failure but at the cost of an unambiguous decline in the expected return on capital - a phenomenon that will tilt relative value in the direction of bond holders and away from equities.

While there might yet be a few unexploded grenades in banks' balance sheets, I think El-Erian is probably right that over the foreseeable future, banks are likely to become safer, not riskier, institutions. If that's the case, then buying bank debt now, when spreads are extremely wide, makes a lot of sense. Yes, there's risk involved - but you're being compensated for the risk with the spread. And over the medium term, those spreads are likely to come in substantially - even if the share prices of the banks in question don't recover at all.

(Plus, of course, there's the moral hazard play. If Bear Stearns and Northern Rock bonholders came out of an ignominious collapse whole, then the chances are most other bank bondholders are likely to get bailed out as well.)

Extra Credit, Wednesday Edition

Felix Salmon — Wed, 14 May 2008 14:23:58 GMT

The Discord in Similarity: John Thain is doing a better job than Vikram Pandit.

Of Hedges, Hot Dish, and Hogwash: The Ben Stein Watch to end all Ben Stein Watches.

Australian Bank Acquires Rival for $17.5 Billion: Apparently there's a bank in Australia called St George. Which is worth $17.5 billion. Good to see some banks are still spending their capital, rather than raising it.

FHA Chief Criticizes Rescue Plan: "I think the president is right to veto" Barney Frank's bill, says the man who would largely be in charge of enacting it.

Bubble Land: On the semiotics of the Blackstone annual report. Wherein Blackstone Goes “Reservoir Dogs”:

Martin Sullivan Deathwatch

Felix Salmon — Wed, 14 May 2008 11:58:13 GMT

In terms of Jack Flack's five levels of CEO media hell, AIG's Martin Sullivan has now graduated from "on the ropes" to "dead man walking". The WSJ's headline says it all: "AIG's Chief Faces Worries Of Investors and Directors" - which means that board members are now grumbling to the press, rather than to the CEO directly. When that happens, it's all over - especially with Hank Greenberg grumbling loudly on the sidelines:

Several top shareholders of AIG have called me expressing deep concern about the persistent and seemingly endless destruction of value at AIG. They, and I, are deeply distressed by the excessive loss of value...
AIG is in crisis.

There's no way that Sullivan can survive this. The question isn't whether he'll be ousted, only when.

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Overkill on the Profanity Desk

Felix Salmon — Wed, 14 May 2008 11:27:19 GMT

Dear NYT,

What the fuck are you doing?

The Gray Lady devotes 1,200 words and four reporters today to covering in mind-numbing detail the fact that a television anchor inadvertently said the word "fuck" live on air. (Of course, being the NYT, it can't actually print the word, which makes the whole story even sillier.)

How do I know about this story? Well, it's on the business home page, for starters - and in the NYT Business RSS feed. I do understand that New York is a media town. Even so, somebody's news judgment is way out of whack here.

IAC: Malone Concedes Defeat

Felix Salmon — Wed, 14 May 2008 10:58:33 GMT

Barry Diller, Condé Nast Portfolio cover star, has decisively prevailed in his fight with John Malone, the largest shareholder of the company Diller runs. Malone's Liberty Media won't appeal the court decision which went in Diller's favor in March, has agreed to Diller's breakup plan, has agreed not to increase its shareholding, and seems to be at peace with its 62% supervoting control of the company being diluted down to a simple 30% stake.

Rarely are such fights settled so unequivocally; one can't imagine that John Malone is a happy mogul this morning. At this point, I doubt he'll just passively sit on his 30% stakes in Lending Tree, Ticketmaster, and the like: he'll want to do some deals with those shareholdings as soon as the economic climate is right.

Contemporary Art: As Strong as Ever

Felix Salmon — Wed, 14 May 2008 09:32:03 GMT

Bursting art bubble? What bursting art bubble? The Christie's sale last night looked for all the world as though it was taking place at the height of the party: not only did it bring in a very impressive $348 million, but 70% of the buyers were American.

It also knocked Jeff Koons off his short-lived perch as the most expensive living artist at auction, when Lucian Freud's Benefits Supervisor Sleeping sold for $33.6 million. It's a great painting, which will surely stand the test of time much better than Koons's Hanging Heart.

And it established a precedent for including architecture in art sales: the Kaufmann house in Palm Springs, designed by Richard Neutra, ended up selling for $16.8 million, plus another $2.1 million for the orchard next door where one can find "three cacti that were a present from Frank Lloyd Wright to Mr. Kaufmann on his first visit to the home".

Oh, and for those of you keeping track at home, Richard Prince now has a new auction record: $7.3 million, for a nurse painting.

The artist of the week though is Francis Bacon. An enormous triptych is coming up for sale at Sotheby's tonight; Christie's had a smaller one which sold for $28 million. This one sold at Sotheby's in 2005 for $5.1 million, which corresponds to an annual rate of return of 176%, and a profit for the collectors, Richard and Elizabeth Hedreen, of $20 million in three years. No matter how committed you are to your collection, it's hard to pass up that kind of money.

Extra Credit, Tuesday Edition

Felix Salmon — Tue, 13 May 2008 22:13:17 GMT

Libor Set for Overhaul as Credibility Is Doubted

Investors Cool to HPQ-EDS Deal: "HPQ has lost more market cap over the past 24 hours than the total purchase price of EDS."

AT&T price cut could juice iPhone sales: Or, for the opposite view, try this: Apple Squash

Park the Car: Gasoline consumption is down 7% year-on-year.

Conflicted Agents and Platonic Guardians: Interview with Alex Pollock: On the impossibility of an optimal regulatory structure.

The Storm: Katrina's educational silver lining.

Robert Rauschenberg is Dead

Felix Salmon — Tue, 13 May 2008 20:35:11 GMT

Go read Michael Kimmelman's obituary, it's one of the best things he's written.

Kicking around Europe and North Africa with the artist Cy Twombly for a few months after that, he began to collect and assemble objects -- bits of rope, stones, sticks, bones -- which he showed to a dealer in Rome who exhibited them under the title "scatole contemplative," or thought boxes. They were shown in Florence, where an outraged critic suggested that Mr. Rauschenberg toss them in the river. The artist thought that sounded like a good idea. So, saving a few scatole for himself and friends, he found a secluded spot on the Arno. "'I took your advice,'' he wrote to the critic.

The ranks of Great American Painters are growing ever thinner. Johns is left, and Twombly; that's about it, I think.

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