Felix Salmon

Bloomberg’s Katya Kazakina has done the rounds of various real-estate appraisers, asking them how much Annie Leibovitz’s property might be worth, and it turns out that the real estate alone – never mind her life’s work – could well sell for substantially more than she owes Art Capital Group. But, as Kazakina says with delicious understatement:

Whether the appreciation of the real estate, in Manhattan and upstate New York, will offer the photographer a path out of her financial troubles is unclear.

For one thing, Leibovitz has to repay Art Capital the sum of $24 million, plus $2.9 million interest, plus fees, by September 8. As one appraiser told Kazakina, “It’s not going to sell in a week” – especially not her West Village live/work studio, renovated at enormous expense, and custom-designed to the specific needs of Annie Leibovitz. And there’s another major impracticality: according to Art Capital’s complaint against Leibovitz, she has refused to allow Art Capital’s real-estate brokers to show her property to interested potential buyers.

For there’s the rub: as part of the loan agreement, Leibovitz authorized Art Capital to act as the “irrevocable exclusive agent” for the sale of both her photography and her property. Neither Leibovitz nor anybody else can sell these properties, the liens on which are held by Art Capital. Only Art Capital can do that. And the way that Art Capital’s sales agreement with Leibovitz is structured, there’s very little incentive for them to sell any property before September 8. As Kazakina reported on August 18, quoting Art Capital spokesman Montieth Illingworth:

Goldman and Art Capital stood to gain 12 percent interest from their one-year loan to Leibovitz, Illingworth said. This means, Leibovitz would have to pay $2.9 million on top of the $24 million loan…

If Leibovitz doesn’t default, Art Capital would receive a 10 percent commission on copyright and real estate sales, Illingworth said. If she does, the commission would increase to 25 percent of the sale of the collateral (the higher rate includes 11 percent to 13 percent in legal, real estate and other fees, Illingworth said.)

How many people, working on commission, will sell an item at a 10% commission today if they know full well that the commission rate rises to 25% in little more than a week’s time?

It’s not just the sales agreement which gives Art Capital an incentive not to sell the property. There’s the loan agreement, too: Art Capital’s Ian Peck told me in June, talking about his business in general rather than Leibovitz in particular, that his “commissions and fees are designed to be prohibitive” in the event that a borrower defaults on her loan. Come September 8, Art Capital won’t just be collecting a 25% commission on any real or intellectual property it sells on behalf of Annie Leibovitz. The amount which Leibovitz needs to repay Art Capital will also spike significantly: the interest rate on the loan will go up to some unknown penalty rate, from 12%, and Art Capital will almost certainly charge Leibovitz substantial (and also unknown) fees on top for going into default.

What’s more, since Art Capital is now working on a 25% commission, it’s also clear that it has every incentive to sell both the real estate and the intellectual property, rather than the real estate alone, since the best-case scenario for Art Capital involvesmaximizing its total sales commission.

The subtext to the Bloomberg article, as elucidated by the likes of Jessica Pressler, is that if she’s really lucky, Leibovitz might be able to pay off her whole loan just from real-estate proceeds, without having to touch her intellectual capital. But that seems improbable to me. Clearly, no real estate deal is likely to get done between now and September 8 — so if and when the property is sold, Art Capital will take a 25% commission off the top. Using the high end but not the highest end of the estimates in the article, the Rheinbeck property could sell for $6 million, with the West Village property going for $24 million. That’s $30 million together, or $22.5 million after commission – not enough even to repay the loan principal, let alone the interest and any unknown default penalties.

Art Capital would, I think, then be fully within its rights to continue to shop Leibovitz’s full archive of photographs, which it values at $50 million, to the highest bidder – and to take its full 25% commission on any sale before repaying the balance of the loan plus interest. Let’s say it sold the archive for $30 million: again there would be that $7.5 million in sales commission, leaving $22.5 million to repay $1.5 million loan principal, plus interest and unknown penalties. Even with no penalties at all, there’s $2.9 million in interest already accrued: in the wake of her real estate and life’s work being sold off for a total of $60 million, Leibovitz would be left with just $18 million, or less. The rest of the proceeds ($42 million plus) would be kept by Art Capital. Oh yes, and Art Capital would also be entitled to a 25% commission on any income from photography which Leibovitz makes for two years after the loan is paid off.

How can Leibovitz get out of this mess? As I see it, she has two hopes. One is that Goldman Sachs, which owns part of the loan, takes pity on her and advances her the money to pay it off in full. The other, as sketched out by John Cook, is that she files for bankruptcy and throws herself on the mercy of a sympathetic bankruptcy judge:

Art Capital would still likely be able to force the sale and recoup some or all of its debt, but a judge might be convinced to reduce the amount, modify the interest rate, or alter the sales agreement under which Art Capital gets commission on the sale.

For Leibovitz, there’s a real risk that the bankruptcy strategy would gain her little and just end up diverting precious millions to two (or more) sets of bankruptcy lawyers. But I reckon it might well be her best hope.

Vanity Fair scores another bullseye this month with Todd Purdum’s 8,000-word article on what Hank Paulson was thinking over the course of the financial crisis, as revealed in a series of embargoed interviews he gave at the time — VF has, improbably, become the home of the best financial journalism in the world of magazines.

There’s more good stuff in this article than can easily be excerpted — go read the whole thing, which kicks off with Paulson throwing up in his private bathroom and just gets better from there. Barney Frank comes out very well indeed — better than Paulson, actually — while Barack Obama’s choice of Tim Geithner as Treasury secretary looks more than it did already like a vote for the continuation of the Bush administration’s status quo.

This article is interesting in that it does somewhat back up the official side of the story as regards Treasury’s (in)ability to bail out Lehman Brothers:

The meltdown at Lehman was catastrophic enough, and Paulson took enormous heat for its failure. Barclays, the British bank, had hoped to buy it, but British regulators blocked the deal, and Paulson saw no alternative. “Lehman Brothers was something that we had been focused on and worked on and worried about for a year. And we knew, and Dick Fuld [the Lehman C.E.O.] knew, and we kept telling him every way we knew how that if he announced earnings like he thought he was going to announce—right after he announced the second-quarter earnings—the company would fail. And when you’ve got an investment bank, no one had any powers to deal with that. I certainly didn’t have any powers to deal with that.”

It’s not clear when exactly Paulson said this, which is important: the decision not to bail out Lehman went quite quickly from being seen as bold and decisive to being seen as utterly catastrophic, and the story about Treasury’s hands being tied only really started to emerge after the latter view became conventional wisdom. But there’s no doubt that Paulson is throwing Fuld under the train here. Which is the kind of thing which Henry Paulson, former CEO of Goldman Sachs, probably wasn’t too upset about doing. Could Henry Paulson, Treasury secretary, really silence such internal thoughts? I doubt it, somehow.

Just a gentle reminder, if you haven’t got around to it yet, that you really have to read David Cho’s piece (and graphical sidebar) on how the too-big-to-fail banks are growing, both in size and profitability, at the expense of small-enough-to-fail institutions:

J.P. Morgan Chase, an amalgam of some of Wall Street’s most storied institutions, now holds more than $1 of every $10 on deposit in this country. So does Bank of America, scarred by its acquisition of Merrill Lynch and partly government-owned as a result of the crisis, as does Wells Fargo, the biggest West Coast bank. Those three banks, plus government-rescued and -owned Citigroup, now issue one of every two mortgages and about two of every three credit cards, federal data show…

In the last quarter, the top four banks raised fees related to deposits by an average of 8 percent, according to research from the Federal Reserve Bank of Dallas. Striving to stay competitive, smaller banks lowered their fees by an average of 12 percent…

Large banks with more than $100 billion in assets are borrowing at interest rates 0.34 percentage points lower than the rest of the industry. Back in 2007, that advantage was only 0.08 percentage points, according to the FDIC. Such differences can cause huge variance in borrowing costs given the massive amount of money that flows through banks.

It’s urgent that the government (probably through the FDIC) start imposing a surcharge on bank size. If this state of affairs is allowed to continue, there will be hundreds of unnecessary bank failures — maybe there already have been. And rather than the big banks getting smaller — which is what makes sense, from the point of view of the amount of systemic damage they can cause — they will continue to get bigger.

It wasn’t all that long ago that the 10% cap on national deposits was taken seriously: now it has been left far behind, even as the total deposit base has increased substantially. Wells Fargo, JP Morgan Chase, and Bank of America pose a real systemic threat to the US economy. They should be forced to start shrinking today.

Justin Fox has a very good post on the broken state of the commercial real estate, pointing to empty spaces on Broadway and in Newcastle, Australia. I could easily add my own street, Avenue B, which has an inordinate number of empty storefronts, or could point to Centre Point, in London, a skyscraper which stood empty from its completion, in 1966, until 1979.

Justin is absolutely right about the corrosive effect of bank rents on New York rental rates: all landlords want the kind of rents that only banks can afford, but of course not all landlords can have a bank as a renter. But the bigger picture is that commercial real estate in general often stays empty for extremely long periods of time — something which harms neighborhoods and lets huge amounts of economic value go to waste.

Why is this? I think the answer lies in the fact that commercial leases tend to be very long-term things — so long term, in fact, that the discounted cashflow from any given lease is likely, in a normal (non-bubbly) property market, to be more or less the same as the value of the commercial property itself. Looked at this way, a developer spends a certain amount of money on putting up (or simply buying) a building, and then sells that building, in lease form, for a profit.

If prevailing leases are low, or tenants hard to find, the developer will quite rationally choose to keep the property empty. Leasing at a low rate will lock in a loss, while keeping the property empty has significant option value: at some point in the future, rents might well rise, and the developer can at that point lock in a profit instead. This is why successful property developers generally need very deep pockets: anybody who needs immediate cashflow, in the form of rent today, is in an invidious bargaining position and is likely to lose out over the long term.

Marcus Westbury has manged, in Newcastle, to implement the obvious solution to this problem: short-dated leases, often just 30 days long, which roll over so long as the landlord hasn’t found a permanent tenant. That’s good for the neighborhood, and helps drive up prevailing rents, so everybody wins — except, of course, for the commercial real estate agents, who are disintermediated and who in any case are never going to make any money brokering 30-day deals. But many businesses are never going to find that kind of deal acceptable, even if they’re already in the space in question — remember that Kenny Shopsin, for instance, refused to extend his lease on the space he had occupied for years in the West Village by one year. “A one-year lease,” explained Calvin Trillin with no further elucidation, “is obviously not practical for a restaurant”. Yet somehow a brand-new teahouse in Newcastle manages to operate on a shorter lease yet.

My feeling is that commercial real estate in general has always operated on extremely long timescales, which can seem ridiculous to those of us not in the business. And it always will. Occasionally someone like Marcus Westbury will come along and shake things up. But more generally, many empty storefronts are likely to remain empty for years on end: it’s just how the business works.

A bear market is commonly defined as when you drop more than 20% from the high point; in Shanghai, stocks — which fell 6.7% today alone — have managed to drop more than 20% just in the month of August. But the other major Asian indices didn’t seem too perturbed — none dropped more than 2%, while Kuala Lumpur and Taiwan both rose — and the crazy volatility of the Shanghai bourse should really be put down to Shanghai-specific factors, including the monster run-up the index has had this year.

It both makes sense and is reassuring that global stock markets don’t seem particularly susceptible to contagion from China, either in terms of direction or just in terms of volatility. Traders see the data coming from Shanghai, and essentially ignore it: neither the level of the Shanghai stock index nor its first derivative is a useful piece of information for anybody not directly invested there. The Hang Seng, in Hong Kong, is much more grown-up.

That said, virtually all global stock markets, including that S&P 500, are looking pretty frothy these days, and in this kind of an environment you never know what will set them off. I’m not holding my breath, but at some point a relatively innocuous piece of data will be blamed for a massive global sell-off: while it might be something domestic and macroeconomic, it could equally easily be a movement in some foreign market. Stocks worldwide are going to remain very volatile for the foreseeable future; Shanghai is just the most extreme example.

FAA, 2007-date: “Nothing can be stowed in the seat pockets except magazines and passenger information cards.”

Cerberus implodes: “The real surprise is that 29% of their investors haven’t asked for their money back.”

TED expends 1,684 words on fisking a pro-forma to-be-sure clause in a WSJ blog entry. I love blogs.

Never mind if your hotel’s on fire, how clean is it?

The amazing Netflix presentation, if you haven’t seen it

Lehman shares surge!

Flying into LHR, I looked down and saw a 13-acre park in prime central-London real estate. I had no idea what it was.

Never mind losing $17.3 billion on the stock. At least you made $350 million on the rights issue!

James Murdoch is slightly younger than I am, but that doesn’t stop large chunks of his MacTaggart lecture from sounding as though they’re emanating from a veritable dinosaur. In an age where pretty much everybody agrees on the importance of increased regulation in the financial sector, it seems trite at best for him to equate any such impulses with creationism:

The consensus appears to be that creationism – the belief in a managed process with an omniscient authority – is the only way to achieve successful outcomes. There is general agreement that the natural operation of the market is inadequate, and that a better outcome can be achieved through the wisdom and activity of governments and regulators.

This creationist approach is similar to the industrial planning which went out of fashion in other sectors in the 1970s. It failed then. It’s failing now.

Actually, I can’t remember a time when there was less faith in the ability of the unfettered market to create successful outcomes, either in finance, where largely-unregulated financial institutions ended up needing hundreds of billions of dollars in state bailouts, or in journalism, where media outlets in general, and newspapers in particular, are dropping like flies, helpless in the face of the onrushing digital era.

While it’s pretty obvious that in a competitive marketplace, the cost of any good will fall towards its marginal cost — which in a digital world is free — Murdoch still feels happy proclaiming, against both evidence and common sense, that “it is essential for the future of independent digital journalism that a fair price can be charged for news to people who value it”. Does he really think that if the BBC went away, that would open up the door to charging for digital journalism online?

James should cross the Atlantic a bit more often. The dream of being able to charge a fee for digital journalism is one which should by rights have died long ago, but it’s being kept alive by dint of the sheer desperation of those, like James Murdoch’s father Rupert, who have convinced themselves that it’s the only way that their media properties are going to be able to continue to make enormous amounts of money.

Weirdly, all of this silliness comes in the context of what’s actually a really sharp and perspicacious lecture. James is quite right that state-sponsored meddling in the media universe is likely to do more harm than good, especially when the state’s market share exceeds 50%. The BBC is too big, and the Corporation really is overstretching, especially when it does things like buy Lonely Planet. And the regulators, in many ways, are even worse.

On the other hand, Murdoch himself has a monopoly on pay-TV service in the UK at least as strong as the BBC has on free TV, and the existence of any monopolist is prima facie evidence of the need for a strong regulator. Yes, the BBC should be smaller. But then again, so should Sky.

Via Chris Addy, a Dilbert cartoon from January 2000:

The scary thing is this is actually true, when it comes to things like the Renaissance Medallion Fund. If it wasn’t for current and former employees only, it would have no difficulty raising many billions of dollars at 5-and-44. The only way it can keep the suckers at bay is by closing the fund to all outside investors.

Paul Kedrosky finds this chart in a Bloomberg story: it’s the kind of thing which really reinforces one’s belief in the wonders of data-fitting.

The story isn’t actually particularly clear on exactly what the graph is showing, and specifically what “adjusted for currencies” means:

The Nikkei doubled between October 1998 and April 2000 in dollar terms, as the chart illustrates. The S&P 500 has risen 34 percent since March when the Dollar Index, a measure of the dollar against currencies in six major U.S. trading partners, is factored in.

So it seems that the BofA analysts who came up with this chart first converted the Nikkei to dollars, only to then convert the S&P 500, which was in dollars all along, out of dollars. Hm. And they chose pretty random start points: what makes 1980 in Japan analagous to 1990 in the US?

But the most breathtaking claim of all is right there in the Bloomberg headline: “S&P 500 May Surge 40% in Duplication of Japan”.

In other words, the people who came up with this chart are not saying that the US is going basically nowhere over the long term. Instead, they’re saying that there could be a big further rally in the S&P 500 over the short term. On the basis of the fact that the Nikkei rose sharply, in dollar terms, at the tail end of the last decade.

I feel quite safe in saying that of all the years to compare 2009-2010 to, 1999-2000 are probably not the most useful. And looking at what Japanese stocks did ten years ago will tell us absolutely nothing whatsoever about what US stocks are going to do now. No matter how many clever charts you come up with, or ridiculous justifications for the conclusions of your silly exercise in data-fitting:

“Even in economies overcoming credit booms, rallies can be powerful and last much longer than you think,” Bank of America’s Sadiq Currimbhoy, Arik Reiss and Jacky Tang wrote.

Well yes, if you’re caught up in the exuberant tail-end of a global stock-market bubble, maybe. But that spike in the yellow line that BofA thinks we might repeat on our orange line? Was basically a function of excesses like Softbank having a market capitalization of $200 billion. If you want to bet on that kind of thing happening in the US over the next year or two, feel free. But I’ll happily bet against you.

Update: Henry Blodget has the original Merrill report; it seems to admit how tortured the numbers it’s using are, and doesn’t go so far as to actually predict a 40% rally from these levels.

Aditya Chakrabortty has a UK perspective on financial reform:

The first chapter of Alistair Darling’s July white paper on banking reform was devoted to explaining just how important the City is to the UK economy. The Treasury’s ledger of revenues from financial services did not include a debit column that listed the amount lost on institutional bailouts and tax avoidance – of course it didn’t. Put to one side, if you can, the watchdogs’ manifold failings in the run-up to the banking crisis. In the debate over reforming the City there has been none of the regulatory capture that economists usually fret about – where the regulators forget about the public interest, and rig the rules to suit the very sector they’re meant to be supervising. There is, however, plenty of evidence of political capture. This isn’t just a New Labour problem; it applies also to David Cameron and George Osborne, whose policies are nowhere near as tough as their rhetoric – and to Barack Obama’s administration, which, on everything from regulating bonuses to handing out taxpayer money, appears to have turned into an unglamorous subsidiary of Goldman Sachs. A cast like this means the prospects for real reform at next month’s G20 summit of major economies in Pittsburgh are depressingly slim.

I think that making the distinction, as Aditya does here, between “manifold failings” and “regulatory capture” is a very useful thing to do. A regulator who failed is not necessarily a captured regulator.

Aditya’s also right that the real problem here is that regulators are appointed by politicians, and it’s the politicians who are captured. The banks don’t need to capture their own regulators: all they need to do is capture the politicians who appoint them. If you’ve got Phil Gramm deciding who gets appointed, you’ve won your battle before it’s even fought.

This is one more reason why consolidating regulatory power in the central bank is a good idea: even if the central bank isn’t totally independent, it’s more independent than any other regulatory agency is ever going to be, and therefore less likely to become filled with political hacks. Say what you like about the Fed, you’re not going to see it demonstrate the kind of premeditated spinelessness that the SEC commissioners showed over most of the past 10 years. If we want effective regulation, we’re going to have to remove power from politicians, many if not most of whom receive enormous campaign donations from precisely the companies they would regulate.

Peter Thal Larsen notes that the former CEO of JP Morgan Cazenove is now admitting that investment banks overcharge. This jibes with my experience in Switzerland: at one dinner I sat next to the former CEO of a large Swiss bank, who was very happy to admit that private banks gouge their clients by charging a low 1% management fee but then stuffing their clients’ accounts with own-brand structured products, all of which come with enormous fees and commissions attached. Could it be that one silver lining to the financial crisis is an outbreak of honesty among former bank executives?

Rolfe Winkler has a good, detailed snapshot of what’s going on at the FDIC. But I’m not nearly as worried about the state of the US deposit-insurance fund as he is. As I’ve said before, the FDIC can’t run out of money. Conceptually, it has simply been faced with a choice up until now — do you raise money from banks, in deposit insurance premiums, before banks start going bust and need an FDIC bailout, or after? Congress made the decision that is should be the latter, when they barred the FDIC from charging such premiums between 1996 and 2006.

That’s really not much of a problem. As Rolfe shows, now that banks are failing in large numbers, the FDIC is charging insurance premiums again, and will certainly continue to do so until any money it borrows from Treasury is paid back. Its credit line, of up to $500 billion, is more than enough to cope with the bank failures coming down the pike, which means that the only real question is how much of that credit line it will have to draw down, and how long it will take to pay it back.

Rolfe is right that “the deposit insurance fund is tiny compared with the total amount of deposits that are insured” — but it doesn’t need to be anything but tiny, because if push comes to shove, there’s essentially unlimited liquidity just sitting there for the asking. It’s the government which is insuring deposits: the FDIC is simply the entity created by the government to administer the deposit-insurance program, and the size of the fund is a way of keeping score and making sure that over the long term the US banking system pays at least as much in insurance premiums as the FDIC spends in bailing out failed banks.

What’s more, even if the 2006-7 vintage of loans will continue to underperform for years, that doesn’t mean, as Rolfe seems to think it means, that there will be a large number of FDIC bank bailouts for years as well. Banks are inherently profitable institutions, and with interest rates at zero they’re inherently very profitable institutions. Loan losses can and will to a large degree be covered by operating profits, and/or the raising of new capital. Remember that depositors are at the very top of the capital structure: not just stockholders but bondholders too need to be wiped out before the FDIC takes any losses. Look at the recent rally in the prices of both bank stocks and bank bonds: it means (a) that the market is pricing in a much lower risk of failure at such institutions, and (b) that it’s much easier for those banks to raise new money if they need to.

So yes, the FDIC insurance fund might go for a little while with a negative balance. But that’s nothing to lose any sleep over. The FDIC deficit, unlike the national debt, is sure to be paid off, in full, over time. And insofar as the government needs to loan money to the FDIC, it will end up making a small profit on that loan. If only the same could be said for most other government spending!

Simon Johnson and James Kwak have an important article on financial innovation in the latest issue of Democracy. The broad thrust of the article I agree with — as you might expect, given that after listening to my last debate on the subject, James Kwak came to the conclusion that “obviously I agree most with Salmon”. (Thanks, James!)

That said, there are significant chunks of the Johnson and Kwak article that I disagree with, and I feel that it’s probably long past time that the “financial innovation: good or bad?” debate allow itself to make some nicer distinctions than have generally been made until now. So with the clear proviso that I’m on the “financial innovation: bad” side of the broader debate, here’s where I take issue with Johnson and Kwak.

First, they address securitization:

Securitization—the transformation of large, chunky loans into small pieces that can be easily distributed among many investors—was a beneficial innovation, because it expanded the pool of money available for lending. And securitization on its own, before the new products of the late 1990s and 2000s, did not produce the colossal boom and bust we have just lived through.

Sure, nothing, on its own, produced the colossal boom and bust we’ve just lived through. But securitization is as much to blame as anything else, if not more so. Securitization absolved lenders from sensible underwriting, since they knew they were just going on onsell that debt anyway. And it made bond investors comfortable with the idea of buying structured products tested only by models, as opposed to actual analyzable liabilities of real-world entities. You can’t phone up the CFO of a special-purpose entity and ask him how things are going. And lending in general works when there’s a relationship between the borrower and the lender. Securitization severs that relationship, which is harmful.

I’d also take issue with the idea that anything which expands the pool of money available for lending is, ipso facto, a good thing. To the contrary, things which expand the pool of money available for lending can serve only to inflate credit bubbles. In general, lending shouldn’t be easy to come by; and it should in principle always be just as easy to issue equity as it is to issue debt. We’re nowhere near that point right now, and securitization only serves to drag us further away from it.

Johnson and Kwak then attack the credit default swap:

Another paradigmatic product was the credit default swap, which insured a security (like a CDO) against the risk of default. But by underpricing that risk, it essentially tricked investors into buying securities that they would not otherwise have bought. The losses were borne by the companies that underpriced the credit default swaps, such as A.I.G., and by the government, which had to bail out A.I.G.—leading to the misallocation of capital to value-destroying investments.

The CDS, pace financial innovation, did not in and of itself underprice credit risk: it was simply a measure of credit risk. And indeed for most of the history of the CDS market, the basis on CDS was positive: as you’d intuitively expect, the cost of insuring a certain credit against default was higher than the spread on that credit’s bonds. You couldn’t lock in a risk-free return by simply buying a security and insuring it against default. So if the CDS market was underpricing risk, the bond market was underpricing risk even more. It was only after the credit market imploded that the negative-basis trade started becoming possible. So you can’t really blame a negative CDS basis for any part of the crisis.

Yes, it’s clear, in hindsight, that AIG, in particular, was underpricing credit risk. But that has nothing to do with the structure of the CDS market more generally. Instead, the problems with AIG surrounded the fact that it only ever sold credit protection, and never bought it; and that once it had sold protection, it used its triple-A credit rating to avoid having to put up any collateral against those positions or otherwise be forced to protect itself against loss. AIG in general, and AIG Financial Products in particular, did a lot of things wrong. But that’s not the fault of the CDS market.

Johnson and Kwak are right that regulators should be inherently suspicious of financial innovation; they’re possibly too polite to mention that this is largely because most financial innovation comprises, at its heart, some kind of regulatory arbitrage. (Securitization being no exception.) I agree also with the idea of standardizing CDS documentation, although it should be said that that is already happening to a large extent. I’m not at all sure, however, that standardized CDS will be much easier to regulate than the customized CDS of old. It’s not the customization which is the problem, it’s trying to get a grip on net positions, in a market which is constantly in flux. The way to solve that problem is to simply let the market continue down the road of the past six months, where CDS are increasingly being shunned as an asset class in favor of good old-fashioned bonds.

Johnson and Kwak then finish with a list of good financial innovations we might encourage: banking the underserved (a no-brainer), reforming health insurance (yes, but let’s not debate that here), and finally this:

We need innovation in financial education. A large part of our regulatory system relies on consumers being able to make intelligent choices when faced by an ever increasing and ever more complex set of financial choices. The recent crisis has shown that even large and supposedly sophisticated investors, such as municipalities and pension funds, did not fully understand the products they were buying. Economist Robert Shiller has proposed government-subsidized financial advice; this may not be a sufficient solution, but it is a start. Obama’s proposed Consumer Financial Protection Agency (first proposed by Elizabeth Warren in Democracy, Issue #5, “Unsafe At Any Rate”) could also go far in improving consumers’ understanding of their financial options.

This I’m much less sure about. You can be sure that no matter how good the financial education provided, the consumers of that education won’t end up being better educated about financial affairs than large and supposedly sophisticated investors, such as municipalities and pension funds. The problem with investors who made bad choices during the boom wasn’t that they were insufficiently educated: it was rather that they were educated too much. Financial education breeds overconfidence, and overconfidence was a much more important cause of the crisis than insufficient education was. If a strong CFPA prevents truly harmful products being sold to consumers, that’s the best we can hope for: a mass education program isn’t practicable and wouldn’t work even if it were implemented. The last thing I want is Robert Shiller being unleashed on the public, telling them that they can hedge the value of the equity in their houses by buying derivatives on house prices.

So thank you, Simon and James, for fighting the good fight. But this clearly isn’t the last word on the subject.

Pockets has a spectacularly good comment on my blog entry about the charitable status of private schools which would more than deserve elevation as an entry of its own were it not for the fact that (s)he has gone into even more detail here and here. The main insight is that the “top” schools tend to advertise themselves and compete on the basis of how well their pupils do in exams, what universities they get into, that kind of thing. And that they can boost those numbers substantially by giving scholarships and bursaries to super-smart poorer kids:

UK private schools are among the best schools on the planet, and I was lucky enough to attend one. Saying that they maximise profits isn’t saying that they’re manipulative or evil or bad (I wonder if this is what’s annoying people?). They’re staffed with many lovely, caring individuals (like lots of other profit-maximising companies!), and through scholarships/bursaries they offer a great trade to smart poor kids – we’ll give you an amazing education, if you allow us to charge other kids to sit next to you.

Given that the schools would do this even if they didn’t have charitable status, it’s not clear why we’re giving it to them. As Pockets writes:

If you wanted to convince me of a private school which is acting charitably, not profit-maximising, then you’d have to describe a system where pupils take the entrance exam – and then the low-scoring poor children are offered bursaries. That’s a school which is gambling on its ability to raise standards among disadvantaged kids. But no private school does that, and with excellent reason: the cost could be lower league table results for the school.

Matt Yglesias also makes a point about private schools which I should have made initially:

They’re certainly not charities. And as best one can tell, their main impact on the common weal is negative, drawing parents with resources and social capital out of the public school system and contributing to its neglect.

You’d have to believe that New York City’s public schools would be both better funded and free of this kind of nonsense if a larger portion of the city’s elite were sending their kids to them.

There’s an analogy here to the studies showing the beneficial effects of homeownership. The problem is that two effects get mixed up: on the one hand, people who own their own homes do tend to live better lives. But on the other hand, those are the kind of people who would probably live better lives anyway, and by moving away from rental neighborhoods they effectively ghettoize those left behind. Similarly with private schools, especially in areas where a high percentage of local kids gets educated privately (like where I grew up, in Dulwich): the local public schools can be very bad indeed, despite the huge number of rich and highly-educated parents in their catchment area. To put it in economist-speak, private schools inflict a negative externality on the quality of education in the neighboring state-run schools.

Incidentally, pace another comment in the original thread, Greenpeace is not a registered charity in the UK — at least the headline organization which most people think of when they think of Greenpeace, Greenpeace Ltd, is not a charity. Not everybody in the non-profit space is a charity, and there’s no particularly good reason why all private schools should be charities, either.

Market Folly has the 24-page second-quarter letter from Elliott Associates, while the 16-page memo from Howard Marks of Oaktree is here. Both have moments of brilliance, and are better financial writing than anything you’ll read in a newspaper or magazine this month. Of course, they’re openly talking their book. But you guys are smart enough to discount for that, and come away with some pretty sharp insights.