Portfolio.com: Market Movers

Moving Towards Exchange-Traded Credit Default Swaps

Felix Salmon — Tue, 13 May 2008 09:29:03 GMT

Ken Griffin wants to move to a system of exchange-traded credit default swaps:

Mr. Griffin wants the government to require the use of exchanges and clearing houses for credit default swaps and derivatives.
That way, instead of investment banks playing matchmaker between parties, an exchange will do it with strict rules in place, eliminating billions of dollars in exposure and creating more transparency.
"It's not sexy, but it's simple, it's cost forward, its straightforward, and it's what we should have done after 1998," referring to the collapse of Long-Term Capital Management, a big hedge fund. He added that it "is a very sad commentary on where we are from a regulatory perspective" that such a move hasn't happened already.
Of course, most big investment banks would hate such a plan, he acknowledged by telephone last week. "The investment banks and commercial banks benefit from the lack of transparency because they are the intermediary," he said.

It's a great idea, and I'm all in favor. For one thing, it would cut out the inter-dealer brokers, who cost a huge amount of money, leaving more for everybody else.

What are the obstacles? I don't think it's opposition from the big investment banks - the answer there is to simply get them to set up the new CDS exchange, which could well be worth billions within a couple of years.

There are big problems surrounding the whole issue of counterparty risk. The idea behind an exchange is that if A wants to buy a derivative, he can look at bids from B and from C and take the one quoted at a lower price. That's then the market-clearing price for that contract, and the price can be made public for anybody else who wants to mark their positions to market.

With a CDS, however, A might prefer to do business with C even if C's price is higher, if A has worries about B's reliability as a counterparty.

These problems should not be insurmountable, and indeed a CDS exchange might be able to add a lot of value to the CDS market if the exchange itself somehow licensed its members and guaranteed their obligations. The cost of that counterparty insurance, it seems to me, shouldn't be more than the amount of money currently skimmed off by the inter-dealer brokers.

The difficulty, of course, is how do we get there from here. Griffin blames the US regulators for not having done this already, but it's not obvious whether they're really the ones to do it. Then again, if the regulators don't force the issue, there's a good chance it'll never happen.

Extra Credit, Monday Edition

Felix Salmon — Mon, 12 May 2008 21:10:03 GMT

Calling oil wrong: Futures prices bear no relation to future prices.

Let's not write the Fed a blank check: Why not? Isn't that precisely what a central bank should have?

So much for the efficient markets hypothesis: Bad results, rising share price: Today it's MBIA's turn.

Hold the Presses: Rupert Outbid! "We’re sure the folks at Cablevision know what they’re in for: just think how they’ve elevated professional sports in New York City."

Buying Chanel (All of It): Would cost at least $10 billion, and possibly as much as $15 billion.

Hail Emily Oster! If at first you don't succeed, change your mind.

Banshou: Blogging the search for a job in the City.

What Does an Appraiser Do? When a pointy-head (Steven Levitt) meets the real world, house-appraising edition.

Ethical finance standards must be restored: Says Evelyn de Rothschild.

Why do Universities Have Tax-Exempt Endowments?

Felix Salmon — Mon, 12 May 2008 19:08:26 GMT

The debate over the proposed tax on Harvard's endowment continues, with my favorite contribution coming from one of Brad DeLong's commenters:

Harvard is an investment bank with a mom-and-pop non-profit enterprise attached to it for tax purposes.

It's a good point: what would happen if Goldman Sachs decided to buy back all its shares, start up a small university in Boston, and declare itself an endowment?

DeLong's point is more substantive, and concentrates on universities as providers of educational services: by that light, Harvard has been much less successful than, say, the University of California. John Gapper concentrates more on universities as centers of "research expertise and prestige", which is all well and good but isn't quite as obviously reason to exempt them from taxes.

And this argument of Gapper's just doesn't work for me at all:

The reality is that Harvard and the other universities contribute an enormous amount to Boston and Massachusetts and it is not as if they are squirreling their money away in Swiss bank accounts. Eventually, it will flow back to benefit the institution.

My problem with the Harvard endowment is that to all intents and purposes it is squirreling its money away in a (very high-yielding) Swiss bank account, and that only a tiny proportion of it ever flows back to benefit the institution. Gapper's argument is far too trickle-down in feeling for my liking: you can oppose any tax on the basis that the money "will flow back" eventually.

Still, at least Gapper attempts some kind of a coherent argument. The Boston Globe, by contrast, simply denounces the plan as "economic suicide" and leaves it at that, spending the rest of the editorial doing no more than enumerating all the wonderful things that Boston's universities do. Well yes - and I'm sure that the sponsors of the proposed bill envisage those universities doing just as many wonderful things in future. The question is whether the tax would drive the universities out of Massachussetts: my feeling is that it would have to be a lot bigger than 2.5% for that to happen. After all lots of people are happy paying a 2% tax on their wealth: they're called hedge-fund investors, and they pay a 20% performance fee on top.

Overall, I'm struck by the weakness of the arguments against this proposed tax. That doesn't mean that the tax is a good idea, of course, but it maybe does mean that the existence of tax-exempt university endowments is probably more of a historical curiosity than an educational necessity.

Update: See also Jim Manzi.

Disclosures: The Long/Short Dual Standard

Felix Salmon — Mon, 12 May 2008 16:49:53 GMT

In Jesse Eisinger's column this month, he makes an interesting observation about David Einhorn in particular, and short-sellers in general:

Whenever a short-seller criticizes a company, the firm and the media go out of their way to disclose that the critic stands to gain financially. This is proper. Often, however, the disclosure serves to undermine the messenger and distract from the issues.

I asked Jesse why he thought such disclosures played such a central role. After all, Eliot Spitzer forced investment banks to disclose when they have a business relationship with the companies their analysts are rating - and all those disclosures are greeted with an enormous yawn, and generally ignored.

The answer, said Jesse, is that there's a world of difference between a disclosure that you're long and a disclosure that you're short. Investment-banking analysts tend to be biased to the long side: the corporate clients that the bank wants to attract are the same companies that the analysts are rating. Short-sellers, of course, are biased to the short side: since they're short the stock, they want it to go down whether it deserves to fall or not.

Now for some reason shorting "provokes a visceral reaction" - that's how Jesse puts it, anyway. It seems somehow un-American, and short-sellers are never treated as heroes in the way that other successful capitalists are. Indeed, they're often vilified.

It's silly, of course. If you want to buy a stock, you're going to have a huge amount of difficulty doing so unless you can find someone willing to sell it to you. That person might not be selling short, but the effect of the sale on the stock price is the same either way. You can't have buyers without sellers, and any market requires both in equal numbers.

But it's worth noting that the media are at fault here too. Yes, as Jesse, says, they properly disclose the fact that hedge-fund managers criticizing a company tend to be short that company. But they don't generally bother with repeating the disclosures found in analysts' reports, that the investment bank in question makes a lot of money by serving the company in question. If they did, perhaps the public would start treating longs with as much suspicion as they do shorts. And that would be a good thing.

ExpressJet's Cashflows, Part 2

Felix Salmon — Mon, 12 May 2008 16:16:35 GMT

I spoke to ExpressJet's investor-relations chief Kristy Nicholas today, in the wake of my blog entry last week about the company. She helped clarify a couple of issues:

Firstly, the 100% holdback on credit-card income isn't nearly as damaging to ExpressJet as an increase to 50% was to Frontier. ExpressJet says it's likely to have $18 million tied up in credit-card holdbacks on any given day in 2008; that's not chump change, but it's still only about 1% of the company's 2007 revenue of $1.7 billion. Most of ExpressJet's business is contract flying, mainly for Continental, and none of that business is affected by holdbacks.

Secondly, all of ExpressJet's auction-rate securities are backed by student loans, and they're all triple-A rated, for what that's worth. The company did take an $8.7 million charge against its portfolio of auction-rate securities, because when it asked some investment banks to bid on its portfolio, that was the number that came back. But so far ExpressJet has not realized any losses on its $65 million ARS portfolio, and Nicholas said that she's started to see "a little bit of traction in the last week or two," with some auctions starting to succeed again.

In the meantime, the student-loan-backed ARSs are paying very high rates of interest, on the order of 18-20%, in stark contrast to some municipal ARSs which have much lower maximum interest rates. As and when the auctions start clearing again, ExpressJet will of course sell (or not roll over) its holdings. But so long as the market remains locked up, the company is getting a healthy income on its unfortunately-illiquid investment.

None of this means that ExpressJet is out of the woods, by any means. My personal feeling is that the share price is being held up by takeover hopes more than anything else, and that the credit-card companies have good reason to be very worried about ExpressJet's counterparty risk. But give Nicholas points for imaginative spin, at least: "You hope to see your holdback percentage go up," she told me, "because that means you're selling more tickets." Nice try.

Has Tim Geithner Been Captured by Wall Street?

Felix Salmon — Mon, 12 May 2008 13:35:23 GMT

Gary Weiss has a long profile of Tim Geithner in the June issue of Portfolio, and although he does give Geithner's side of the story, he gives a lot of space to some very harsh criticisms of the New York Fed chief.

In a nutshell, Weiss accuses Geither of having been captured by those he would regulate, and of working for Wall Street rather than Main Street, especially when he helped to orchestrate the acquisition of Bear Stearns by JP Morgan:

It has become something of a Wall Street parlor game to try to figure out why Geithner got as involved as he did in the Bear mess and whether he was had by crafty bankers. Geithner insists that the Bear deal benefited the public and not just the other big banks, who stood to gain from their competitor's going out of business...
Questions linger as to whether Geithner, who's supposed to represent the public interest, ended up with the best possible deal. He's an experienced negotiator, having wrangled with foreign powers during his days at Treasury, but some critics contend that he may have been outmatched by Jamie Dimon, J.P. Morgan's chief executive, and Alan Schwartz, Bear's C.E.O.???

"Misgivings about the deal," says Weiss, "are hard to ignore". Maybe so - but I think it's also easy to overstate the case that Geithner should have stood up more to Wall Street.

Weiss does a reasonably good job of laying out the first best defense against such accusations - that the risks of doing nothing were so enormous that Geithner was forced to act. Once you've accepted that, everything else is niggling: did the Fed use too much of its own balance sheet? Could Geithner have designed a different kind of bailout? The answers to those questions are unknowable, and in any case don't change the fact that Geithner averted something which could have been truly disastrous.

But the fact is that the accusations themselves are a little incoherent. In what way could Geithner have been "outmatched" by Alan Schwartz, when he forced Bear Stearns to be sold for a peppercorn, wiping out its executives' enormous equity holdings? If anybody was bailed out, it was Bear's bondholders and its counterparties, not its executives.

And I think it's simply false to say that Bear Stearns' competitors "stood to gain" from Bear going out of business: the collapse of one investment bank is bad news for all of the others, since it forces a 360-degree reevaluation of counterparty risk. Weiss makes great play of the fact that Geithner is heavily influenced by Goldman alumni such as Gerry Corrigan and John Thain (not to mention Hank Paulson) - but the biggest winner in the Bear Stearns deal was Jamie Dimon. And a victorious JP Morgan is a much bigger competitive threat to Goldman Sachs and Merrill Lynch than Bear Stearns ever was.

Weiss is right that the New York Fed is a creature of Wall Street, but that's what it's meant to be. If you want a sense of perspective, and you're worried that Wall Street has too much influence over the Fed, then you should be looking not to Geithner to rectify that state of affairs but rather to Ben Bernanke - a man whose name, tellingly, appears only in passing in Weiss's piece.

Barry Diller: Not Dead Yet

Felix Salmon — Mon, 12 May 2008 13:10:28 GMT

Duff McDonald has a piece on Barry Diller in the June issue of Portfolio. I asked him what he thought of the mogul, after following him through a long and painful trial with John Malone. It seems there might yet be life in the old dog yet:

FS: Barry Diller might have won the court battle with John Malone, but he's also conceded defeat on a big-picture level: he's breaking up his company, IAC, into five pieces, of which he will control only one. Is this the end of Barry Diller, new-media mogul?

DM: Not yet. If he gets his way, he's actually shaking off all the non-new-media assets, such as HSN, Interval, and Ticketmaster, as well as the albatross LendingTree. What's left? All new media. So it's not the end. But it's pretty much his last shot at new media glory. If this one doesn't take, then he will go down with a new media track record like many others: smart enough to catch the first wave and at a serious loss for good ideas since. Even the guys from Pets.com could say something like that.

FS: Diller's already decided to reinvent ask.com as a niche site targeted at middle-aged women, and his new-media future seems wan. What has happened to the aggressive and charismatic dealmaker of old? Why is he giving up valuable properties which he might otherwise be able to sell as part of an attempt to catch the next wave? After reading your article, it certainly seems as though Diller is on his back foot -- and that's without a possible appeal from John Malone of the legal decision which presently sits in Diller's favor. Also, Diller's 66 years old, and has made more money than he'll ever be able to spend. Does he still have the fire or the hunger to go on the offensive and fight to build something great again?

DM: They talked about people calling Ask a niche site, and pointed to the $$ it brings in. I'm not sure conceding defeat to Google is an indication of failure. It is an indication that you are everyone who isn't Google. And he's not "giving up" the other properties. He's loading them with debt and spinning them off, keeping the cash with so-called "new IAC." So he's milking them one last time, capitalizing them like their peers, and stocking new IAC's war chest with coin. And then he's going to try and be a content provider of Web 2.0 and beyond. You're right, there's no clear path here, and no reason to think he'll succeed, save for the fact that he has done so before. Would I buy the stock? Probably not. Would I short it? Definitely not. So while I think there are better ways to take a bet on the web, I certainly wouldn't bet against him. Perhaps that's the point of the piece. Despite all odds, he's still here. And doesn't seem to be slowing down. (Seriously. He doesn't.)

Beware Skidmarks

Felix Salmon — Mon, 12 May 2008 11:47:29 GMT

A pair of sentences I'm sure Dan Ariely never thought he'd write (they appear in a blog entry about the uses of branding):

I can't just try to make myself feel better by imagining that I'm wearing Ferrari underwear. I have to actually wear them in order to make myself feel better.

False Positives at Blogger

Felix Salmon — Mon, 12 May 2008 11:30:31 GMT

What's going on with Blogger? Both Yves Smith and Brad DeLong have run into problems of late, and I have a nasty feeling that it's an unloved orphan stepchild within Google, and that it's likely to continue to deteriorate further and lose market share to nicer, cleaner, friendlier alternatives like Wordpress and Tumblr.

At the end of April, Naked Capitalism had some nasty tech woes: Google/Blogger determined somehow that the blog was a spam blog, prevented Yves Smith from posting any new entries, and made it very difficult for her to persuade them in a timely fashion that the blog was for real. The weirdness there was twofold: on the one hand Google owns Feedburner, and the number of Feedburner subscriptions alone should have been an indication that the blog was not spam. And what's more, Google was happy keeping the site up; it merely prevented the posting of any new entries. If the blog was spam, it's far from clear what such actions would achieve.

Now, Brad DeLong is being prevented from even viewing Abu Muqawama, on the grounds that he "looks similar to automated requests from a computer virus or spyware application". (Maybe he hadn't had enough of his morning coffee that day, or maybe he'd had too much?)

False positives are always a problem in any attempt to fight spambots and viruses and the like, but the Blogger/Google response seems far too heavy-handed to me. It's increasingly hard to prove you're a human these days, but they shouldn't make it impossible.

For what it's worth, this is the official statement I got from a Google spokesperson when I asked them about Yves Smith's Blogger troubles:

We think blog spam is a serious problem and we have spam detection software to try to eliminate it. We're aware that false-positive matches sometimes happen, and when they do, we have a process in place so that we can quickly review a blog that has been marked as spam. If we determine that the blog is not spam, we work to quickly restore the blog. We're always innovating to improve our products and services and are working on making this process even better in the future.
As for FeedBurner, we have a lot of ideas for how to incorporate other content authority signals into blog spam detection, but we don't have anything specific to announce at this time.

I guess it's inevitable that when a company grows to be as big as Google now is, it will revert to this kind of overlawyered corporate-speak. Is that evil? Maybe not, but it's a step in the wrong direction.

Why Citi Can't Be a Global Universal Bank

Felix Salmon — Mon, 12 May 2008 10:32:25 GMT

Vikram Pandit still needs to do some work on the Vision Thing, I think. His big idea, as unveiled on Friday? Citigroup is - wait for it - a "global universal bank". At this point, he's perilously close to a tautology masquerading as a strategy.

"Global universal bank," as a concept, is not entirely meaningless, however. It's just impossible to achieve.

A universal bank is a soup-to-nuts operation, something which provides banking services to everybody from cash-poor individuals to huge multinational corporations. And there are a few national universal banks: Deutsche Bank in Germany, for instance, or UBS in Switzerland. Even Citigroup can be considered a national universal bank in Mexico.

But in the US, there aren't any universal banks. If you just got back from the Berkshire Hathaway AGM, for instance, you might have noticed that there is no Citibank in Omaha. Look down the ten largest corporations in the US, according to Fortune, and one of them is Citi; of the other nine, four are in places without a Citibank. And that's not just because some of them are based in obscure places like Bentonville, Arkansas; huge cities like Detroit and Seattle have no Citibank.

If you can't even be a universal bank in the US, it's a bit silly to suppose that you can be a universal bank globally. Besides, Pandit is considering selling off Citibank Germany - how can you be a global universal bank without retail operations in Germany? But then again, Citibank doesn't even have much in the way of a retail presence in the UK, either: it never seems to be able to make up its mind whether it actually wants to do retail banking in much of the world. Poland, yes; Mexico, yes - but those two were by acquisition. And when Citi did have a strong organically-grown local presence, like it did in Paraguay, it sold most of its branches to ABN Amro.

In order to come close to being a global universal bank, Citi would have to grow a lot - probably by an order of magnitude. And long before it got there, its regulators would step in to stop it getting any bigger. But in any case, it's shrinking. It needs to work out what it's going to concentrate on, and do that very well. And deciding that it wants to be a "global universal bank" is not a useful way of doing that.

Update: A couple of good comments over at Seeking Alpha. First this, from Syndicat:

Citi is not even a statewide institution. In 2006 Citi sold its upstate banks to M&T, effectively leaving Buffalo and Rochester, the #2 and #3 cities in New York State.

And then this from Corossis:

I don't think you need to be in every big US city to be considered 'universal'. To me, it just means that you have enough retail operations to be substantially consumer deposit-funded.

If Corossis is right, then a universal bank is basically just a corporate bank with a relatively low-cost funding base of checking accounts. Try telling that to HSBC.