Felix Salmon

I can highly recommend Nick Dunbar’s new book on the financial crisis; I’ll have a full review of it soon, but for the time being let’s just say that for my money it’s the best crisis book so far. Fair, detailed, unsparing, and — most importantly — written by someone who was reporting on the structured-products market all the way through the boom, instead of just looking back after the bust and asking what happened.

There’s a lot of reporting in this book, too, and today Reuters has an excerpt of how the Federal Reserve in general, and the New York Fed in particular, failed in its job of overseeing Citigroup. When DC-based examiners started asking tough questions, they were met with stonewalling from the New York Fed, which behaved exactly as you would expect from an institution captured by its big-bank shareholders.

The market and liquidity risk team and others in the Federal Reserve Board supervision division had grown concerned that as large banks built up their trading businesses and accounting rules gravitated to fair value measurement, bank balance sheets were increasingly subject to short-term market moves that could lead to rapid falls in regulatory capital. A memo produced by the team pointed out the issues and risks involved in increased use of fair value and warned that a sudden freeze in certain markets might imperil bank solvency. But when the market and liquidity risk team tried to interest Dahlgren in their findings, she retorted, “I think our banks know how to manage to fair value,” ending the discussion.

In 2006, the market and liquidity risk team attended a Citigroup risk assessment presentation to a committee of Fed examiners. When asked for the rationale supporting the designated satisfactory rating for interest rate risk, the New York Fed team could not provide any information. At another Citi meeting the market and liquidity risk team attended, the New York Fed examiners had been asked to come up with a list of supervisory priorities for the bank. They identified approximately twenty items and patiently explained why each one was important. Near the end, Peters interrupted and told his staff to cut the number of priorities to five or six because twenty was “too many.” The Washington, D.C., team was stunned—twenty was too many things to check regarding the largest and most complex bank in the United States?

This is a perennial problem — and the only reason we know how bad things were is because one small group of examiners, in Washington, was marginally less bad at regulating banks than another group in New York. Most of the time, there’s only one group of bank examiners, and they never blow the whistle on themselves.

At the end of the passage, Dunbar reveals that even if the full list of 20 priorities had been implemented in full, Citi would still have blown up, since no examiners had a clue that Citi was hiding $43 billion of CDO exposure off its balance sheet and outside its value-at-risk calculations.

Dunbar reports one particularly vivid conversation, in the wake of a carbon-trading desk blowing up:

One person on the market and liquidity risk team vividly remembers a New York Fed bank examiner shrugging off the emission trading losses, arguing, “Don’t worry about that. We just have to respond to these things when they happen. We can’t get ahead of these problems. We don’t have enough people, and the bankers have a lot of smart people.”

The sad thing is that the New York Fed examiner is probably right. They couldn’t get ahead of these things. And they still can’t.

An ounce of prevention, we’re all taught at an early age, is worth a pound of cure. But central banks are really bad at the prevention side of things. Which is why they have to put so much effort into their attempted cures.

South Korea, by rights, should be an entrepreneurial paradise. It’s rich, and growing fast, and well-educated, and urban, and open, and has the best IT infrastructure in the world. But it’s also very conservative, as Max Chafkin reports:

Jiho Kang, who is chief technology officer of a start-up in California and CEO of another one in Seoul, says that when he started a company after high school, his father, a college professor, kicked him out of the house…

To many South Koreans, being an entrepreneur—that is to say, going against the system that made the country rich—is seen as rebellious or even deviant. “Let’s say you’re working at Samsung and one day you say, ‘This isn’t for me’ and start a company,” says Won-ki Lim, a reporter for the Korea Economic Daily. “I don’t know how Americans think about that, but in Korea, a lot of people will think you of you as a traitor.” …

The penalty for failure is even more onerous for female entrepreneurs. When Ji Young Park founded her first company, in 1998, her bank not only required her to personally guarantee the company’s loans—a typical request for a male founder—it also demanded guarantees from her husband, her parents, and her husband’s parents. Park persevered—her current business, Com2uS, is a $25 million developer of cell-phone games—but her case is extremely rare. According to the Global Entrepreneurship Monitor, South Korea has fewer female entrepreneurs, on a per-capita basis, than Saudi Arabia, Iran, or Pakistan.

Markets, however, tend to find a way around such obstacles. And in the case of Korea, it’s a very interesting one: Korea is, essentially, importing its entrepreneurs from the US. Ambitious Koreans who are born or educated in America are going back to Korea — where the opportunity space for entrepreneurs is much less crowded than it is here — and making large, swift fortunes.

In the grand scheme of things, this has to be positive: good for Korea, certainly, and good for the world. But is it good for America that many bright Koreans are setting up shop over there rather than over here? Chafkin hints that it isn’t — that Korea’s gain is America’s loss. But I’m willing to let this one slide, especially on a day when US immigration policy seems likely to become just a tiny bit more sensible.

The US has always been the biggest importer of entrepreneurs on the planet. It’s perfectly OK if we export some as well. After all, a strong and economically vibrant Korea is very much in the US national interest.

If six different central banks coordinate a big liquidity operation, you end up with six different press releases, from the Bank of Canada, the Bank of England, the Bank of Japan, the European Central Bank, the Swiss National Bank, and the Federal Reserve.

All of them start the same way, talking about how they’re coordinating action, cutting the interest rate on their liquidity operations by 50bp, and agreeing to provide such operations in each others’ currencies, in future, should that become necessary. Think of it as a holiday greetings card from the banks to the market.

And then, underneath the “happy holidays” boilerplate, each individual central bank adds a little personalized note about itself. Here’s how the ECB describes what it’s going to do:

The ECB will regularly conduct US dollar liquidity-providing operations with a maturity of approximately one week and three months at the new pricing…

In addition, the initial margin for three-month US dollar operations will be reduced from currently 20% to 12%.

This isn’t some kind of hypothetical facility, it’s a very real injection of cheap liquidity into the European markets, and it is desperately needed.

Across the Channel in London, the Bank of England is saying essentially the same thing: the window’s open, fill yer boots!

The Bank will continue its weekly tenders of U.S. dollar funding at fixed interest rates each Wednesday until further notice, with counterparties able to borrow unlimited amounts against eligible collateral.

In Switzerland the SNB is a little more subdued, but in substance identical:

The SNB intends to continue conducting US dollar liquidity-providing repo operations at terms of one week and three months.

The other three central banks, by contrast, all fall over themselves to say that they’re just being good global citizens, here, and don’t really face any liquidity pressures at home. Yet. Here’s Japan:

Financial conditions in Japan have continued to ease and Japanese financial institutions do not face difficulty with funding in foreign currencies. There is, however, a possibility that Japan will be adversely affected, should conditions in global financial markets deteriorate further.

And here’s Canada, which goes further still and says that actually, its window is not open right now, but it might open it in future, should it be so inclined.

The Bank of Canada judges that it is not necessary for it to draw or offer operations on any of these swap facilities at this time, but that it is prudent to have these agreements in place. Should these facilities be drawn on, the details of the liquidity facilities provided would depend on the specific market circumstances at the time.

Finally, we have the Fed.

U.S. financial institutions currently do not face difficulty obtaining liquidity in short-term funding markets. However, were conditions to deteriorate, the Federal Reserve has a range of tools available to provide an effective liquidity backstop for such institutions and is prepared to use these tools as needed to support financial stability and to promote the extension of credit to U.S. households and businesses.

The way I read this, the Fed is not actually going to be providing liquidity to the market at the new rates. Europe might be facing a liquidity crunch right now, but the US isn’t, and so the Fed is keeping this particular bazooka in its closet for such a time as it becomes necessary to bring it out.

The difference between the ECB and the Fed is, I think, instructive. The Fed has always been willing to provide liquidity to the markets in extremis, and partly as a result banks have up until now been happy to lend to each other. The ECB’s status as lender of last resort is much more dubious, however, and so it needs to come out and actually do these things if the market’s going to believe that they’re real.

Needless to say, this is not a healthy state of affairs. Here’s how that Exane BNP Paribas note on liquidity explains it:

Today’s announcement strengthens and widens the liquidity channels from the central bank to individual commercial banks; it can’t in and of itself get those banks lending to each other again. And we won’t be out of the woods, in Europe, unless and until that happens.

Karl Smith made a funny point in response to my post about Apple’s falling p/e ratio: since Apple’s not returning any money to shareholders in the form of dividends or buybacks, he says, shareholders aren’t getting any return on their investment.

Unfortunately, Matt Yglesias didn’t seem to get the joke:

The crux of the matter, as I see it, is Apple’s ever-growing cash horde which went from $70 billion in liquid assets at the end of Q2 to $82 billion in liquid assets at the end of Q3. The company is earning huge profits, which is great, but since it seems determined to neither return those profits to shareholders nor to re-invest them in expanded operations it’s hard to see how investors aren’t going to discount the value of the enterprise.

This is trivially wrong. If Apple’s cash pile is growing, that will increase its p/e ratio, rather than decrease it. On April 20, Apple reported Q2 earnings of $6.40 per share, or $20.98 over the previous 12 months. It closed the following day at $350.70, which corresponds to a p/e of 16.7 on a TTM basis. On July 19, Apple reported Q3 earnings of $7.79 per share, or $25.26 over the previous 12 months. It closed the following day at $386.90, which is a p/e of 15.3 on a TTM basis. The earnings were up, the price was up, but the p/e ratio was down.

Now Apple has roughly 1 billion shares outstanding, so let’s say that its “cash horde” went from $70 per share to $82 per share over the course of the third quarter. That’s more than 20% of the share price, right there. Take the cash away, and the p/e ratio falls to just 12. Even if you value the cash horde at just 50 cents on the dollar, the p/e ratio still falls, to 13.7 from 15.3.

It’s possible that shareholders would like to receive the cash as a dividend payment — although if and when that ever happens, they will have to pay income tax on it. They might even value Apple more highly if they can see themselves getting a modest income from their Apple stock without having to sell any shares. But we’re talking very marginal effects here: there’s no real sense in which turning a dollar of cash into a dollar of dividend payment increases the value of a company. Indeed, once the dividend is paid, the stock price will go down, since it no longer reflects the value of that cash.

I suppose it’s theoretically possible that investors are valuing Apple’s cash at zero, on the grounds that they’re never going to see any of it. But even if they are valuing the cash at zero, that doesn’t change Apple’s p/e ratio, which is still falling. What makes no sense is Yglesias’s idea that Apple with zero cash would somehow be worth more than the same company with $82 billion in the bank.

Smith’s point is a bit more subtle, and is probably best expressed in terms of the theoretical idea that a company’s share price should equal the net present value of its future dividends. If it never pays a dividend, and will never pay a dividend (or get bought), then the value of the company is zero.

I’ve been critical of Berkshire Hathaway’s no-dividend policy, but largely because the company’s shares are so ludicrously expensive that you can’t raise cash by selling just a few of them. Anybody who started with a decent Apple shareholding and then rebalanced annually to keep Apple a certain percentage of their total portfolio would indeed have received very healthy cash dividends, over the years, from the proceeds of all the shares they sold. And meanwhile, Apple’s shareholders get to hold on to all of the company’s earnings tax-free. (In fact, insofar as those earnings are kept overseas, they’re saving on tax twice: first when Apple repatriates the money and pays corporate income tax on it, and secondly when they pay personal income tax on their dividend income.)

It’s very easy, of course, to run a discounted cashflow model on Apple: such things model earnings, not dividends. And although there are some mutual funds which only invest in stocks which pay a dividend, I don’t think their absence from Apple’s shareholder base explains any part of its low p/e ratio.

And in any case, the joke behind Smith’s post is just that even if the lack of a dividend can explain a depressed p/e ratio, it can’t explain a falling p/e ratio. No one expected Apple to pay any dividends two years ago, when the stock was trading on a p/e of 32. Why should they suddenly care about such things now?

Some of today’s many stories from Counterparties.com. Now with extra underlinks! Check it out.

“War games” – How companies are already contingency planning for a Euro breakup — Reuters

Ex-NOTW editor: “You have to be cleverer than the criminals” — Guardian

S&P cuts ratings for all “Big Six” banks — WSJ Marketbeat

RIM is apparently willing to have its customers use better phones made by competitors — WSJ

$200 million from MF Global’s customers turns up at British JP Morgan Chase — Dealbook

George Packer paints a great portrait of one occupier of Wall Street — New Yorker

John Heilemann: Is 2012 the same as 1968? — New York

Keith Gessen writes about his arrest in New York City — New Yorker

Thomas H. Lee is looking at buying out Yahoo’s US business — Reuters

And the Little Printer That Couldn’t Do Anything – BergCloud

A few ticketing datapoints from recent news coverage:

• The Leonardo show at the National Gallery in London is sold out through the end of its run, in February, with ticket prices at £16 ($25) apiece. Some sites are offering the tickets for resale at as much as £300, but the National Gallery says that if you have a resold ticket, you won’t get in.
• Christie’s is selling tickets at $30 apiece (plus tax) to see the collection of Elizabeth Taylor before it goes up for sale on December 13.
• Broadway shows are nearly all using variable pricing now, with tickets to see Hugh Jackman costing as much as $350 each, while tickets to The Book of Mormon are currently $477 apiece.
• Thanks partly to such tactics, Spider-Man set a new box-office weekly record for the Foxwoods Theater last week, bringing in $2,070,196. (Back in December, Catherine Rampell said that under a “best-case scenario”, the musical could gross $1,646,991 in a week.)

Rampell’s not wrong on an average basis: Spider-Man is typically grossing something less than $1.5 million a week. But what really interests me about this chart is its volatility:

If you want to maximize total revenues, this is the kind of chart you want to see: one where the box-office gross can rise past $2 million a week in a heavy week, but the show can still play to full houses at a lower gross at slower times of year.

What we’re seeing in London is the failure of the old model, where ticket prices were set in advance and never change. Set them too low, and you wind up with Leonardo-style fiascos, and ticket scalping. Set them too high, and you leave money on the table. And of course the prices are set long before the rave reviews come in, so you can’t be too optimistic or aggressive in pricing them.

What we’re seeing at Christie’s is an example of a company choosing a pretty sensible way of managing the inevitable crowds. Give people timed tickets, and the auction house won’t get mobbed by thousands of people wanting to just turn up and see celebrity schwag. And if you’re selling tickets anyway, you might as well sell them at a high price.

And what we’re seeing on Broadway is the perfection of the variable-pricing model which has long been used in the airline industry. When you don’t need to print tickets in advance with a face value on them, you can change prices dynamically according to supply and demand, and there’s really no limit to how much, in theory, you can charge.

The losers here are the ticket brokers, and no one’s crying for them. People have always paid hundreds of dollars per ticket to go see Broadway shows — they just haven’t paid the theater and the producers. It’s much better this way. I wish that the National Gallery was a bit more commercial in its ticket-selling: I’d pay good money to see the show when I’m in London next year, but I don’t have the ability to do that now.

The optics, though, are dreadful: a state-owned institution can’t go charging $100 per ticket to see a show of nine paintings. Only the rich could then afford to see the show, and the National Gallery is for everybody, not just for the rich.

But there has to be some way to make this work. Maybe market-rate tickets could be sold alongside a £5 option which involved a lot of waiting in line, something like that. Not all tickets need to be market-rate. But there’s no reason some shouldn’t be.

What on earth did Hank Paulson think his job was in the summer of 2008? As far as most of us were concerned, he was secretary of the US Treasury, answerable to the US people and to the president. But at the same time, in secret meetings, Paulson was hanging out with his old Goldman Sachs buddies, giving them invaluable information about what he was thinking in his new job.

The first news of this behavior came in October 2009, when Andrew Ross Sorkin revealed that Paulson had met with the entire board of Goldman Sachs in a Moscow hotel suite for an hour at the end of June 2008. He told them his views of the US and global economies, he previewed a market-moving speech he was about to give, and he even talked about the possibility that Lehman Brothers might blow up. Maybe it’s not so surprising that Goldman Sachs turned out to be so well positioned when Lehman did indeed do just that a few months later.

Today we learn that the Goldman meeting in Moscow was not some kind of aberration. A few weeks later, on July 28 2008, Paulson met with a who’s who of the hedge-fund world in the headquarters of Eton Park Capital Management — a fund founded by former Goldman superstar Eric Mindich.

The secretary, then 62, went on to describe a possible scenario for placing Fannie and Freddie into “conservatorship” — a government seizure designed to allow the firms to continue operations despite heavy losses in the mortgage markets…

Paulson explained that under this scenario, the common stock of the two government-sponsored enterprises, or GSEs, would be effectively wiped out…

The fund manager who described the meeting left after coffee and called his lawyer. The attorney’s quick conclusion: Paulson’s talk was material nonpublic information, and his client should immediately stop trading the shares of Washington- based Fannie and McLean, Virginia-based Freddie.

When we found out about the Moscow meeting, I asked how on earth Paulson thought such behavior was OK. But now I think he was downright pathological in giving inside information to his old Wall Street buddies. And the crazy thing is that we have no idea how many of these meetings there were, or how long they went on for — the only way that we ever find out about them is when reporters like Sorkin or Bloomberg’s Richard Teitelbaum manage to find a source who was in the meeting and is willing to talk about what happened.

Given that it’s taken two years since the release of Sorkin’s book for the Eton Park meeting to be made public, it’s fair to assume that there were other meetings, too — possibly many others. Paulson was giving inside tips to Wall Street in general, and to Goldman types in particular: exactly the kind of behavior that “Government Sachs” conspiracy theorists have been speculating about for years. Turns out, they were right.

Paulson, says Teitelbaum, “is now a distinguished senior fellow at the University of Chicago, where he’s starting the Paulson Institute, a think tank focused on U.S.-Chinese relations”. I’d take issue with the “distinguished” bit. Unless it means “distinguished by an astonishing black hole where his ethics ought to be”.

Is it cheaper for Germany to bail out EU countries rather than leave the euro? — Washington Post

Weisenthal and Platt question the importance of debt-to-GDP ratios. It’s possible they didn’t read all of This Time Is Different — Business Insider

James Surowiecki argues that Italy and Spain are still saveable — The New Yorker

While Wolfgang Munchau says the euro zone could be only days from collapse — DeLong

Daniel Kahneman: “Emergent weirdness is a good bet” — Freakonomics

“Fitch slams US indecisiveness, delays AAA rating decision” — FT Alphaville

Krugman gleefully quotes Greenspan getting everything wrong in 2005 — NYT

3 Connecticut Gold Coast money managers win $254 million from the lottery — Greenwich Time

The Silicon Valley startup that built the “matrix” behind the War on Terror — BusinessWeek

And a long, controversial, intriguing piece on the mysteries of l’affaire DSK — NYRB

Jed Rakoff’s decision to block the proposed $285 settlement between the SEC and Citigroup is very welcome, but also raises all manner of questions about what might happen next.

The ruling is worth reading — as are all Rakoff’s judgments — but at heart it’s pretty simple.

The clever part of the ruling comes at the beginning, where Rakoff notes that the SEC’s complaint against Citigroup employee Brian Stoker includes language about Citigroup which is not included in the complaint against Citigroup itself. According to the complaint against Stoker, Citigroup “knew” that it couldn’t place the synthetic CDO with investors if it had made full disclosures about how it had been put together. But that knowledge of Citigroup’s never made it into the complaint against Citigroup.

That’s important, because the SEC’s stated reason for letting Citi off more lightly than Goldman Sachs is that Goldman had knowing and fraudulent intent (or “scienter”, as it’s known in legal jargon), while Citigroup didn’t. The SEC says that “Goldman Sachs was charged with scienter-based violations of the securities laws”, that “scienter-based violations are worthy of a more significant sanction”, and that Citigroup, by contrast, was guilty only of negligently operating as a fraud.

The most powerful part of Rakoff’s ruling, then, is where he basically demolishes that argument. He shows that the Citi fraud (as alleged by the SEC) was worse than the Goldman fraud, because in this case Citi was itself the beneficiary. (In Goldman’s case, John Paulson was the beneficiary.) And, as he says in footnote 7 (Rakoff loves saving his best stuff for footnotes), the SEC’s “logic is circular”, and nowhere does the SEC “explain how Goldman’s actions were more culpable or scienter-based than Citigroup’s actions here”. On top of that, the SEC extracted admissions from Goldman which it didn’t get from Citi, and also got cooperation from Goldman while “Citigroup has not agreed to cooperate with the SEC in any cognizable respect”.

The problem with Rakoff’s ruling, however, is that he doesn’t — and probably can’t — simply say that Citigroup’s getting off more lightly than Goldman, and strike down the settlement on those grounds alone. So he uses instead a different basis for his decision — that Citigroup is refusing to admit that it did anything wrong.

Indeed, here’s Citi’s statement today, in response to Rakoff’s judgment:

We respectfully disagree with the Court’s ruling. We believe the proposed settlement is a fair and reasonable resolution to the SEC’s allegation of negligence, which relates to a five-year-old transaction. We also believe the settlement fully complies with long-established legal standards. In the event the case is tried, we would present substantial factual and legal defenses to the charges.

In English, this says “we’d like to put this whole sorry story behind us, but if you force us to either admit or deny the allegations, we’re going to deny them”. As Rakoff notes, this is far from being the de facto admission of guilt that the SEC is painting the settlement as. And it’s certainly not a de jure admission of guilt, as Rakoff explains:

To be sure, at oral argument, the S.E.C. reaffirmed its long standing purported support for private civil actions designed to recoup investors’ losses. But in actuality, the combination of charging Citigroup only with negligence and then permitting Citigroup to settle without either admitting or denying the allegations deals a double blow to any assistance the defrauded investors might seek to derive from the S.E.C. litigation in attempting to recoup their losses through private litigation, since private investors not only cannot bring securities claims based on negligence, but also cannot derive any collateral estoppel assistance from Citigroup’s non admission/non­ denial of the S.E.C.’s allegations.

Rakoff says, with great forcefulness, that if the facts of the case are not known, the public interest is not being served. His prose here is worth quoting at length:

The Court is forced to conclude that a proposed Consent Judgment that asks the Court to impose substantial injunctive relief, enforced by the Court’s own contempt power, on the basis of allegations unsupported by any proven or acknowledged facts whatsoever, is neither reasonable, nor fair, nor adequate, nor in the public interest.

It is not reasonable, because how can it ever be reasonable to impose substantial relief on the basis of mere allegations? It is not fair, because, despite Citigroup’s nominal consent, the potential for abuse in imposing penalties on the basis of facts that are neither proven nor acknowledged is patent. It is not adequate, because, in the absence of any facts, the Court lacks a framework for determining adequacy. And, most obviously, the proposed Consent Judgment does not serve the public interest, because it asks the Court to employ its power and assert its authority when it does not know the facts.

An application of judicial power that does not rest on facts is worse than mindless, it is inherently dangerous. The injunctive power of the judiciary is not a free roving remedy to be invoked at the whim of a regulatory agency, even with the consent of the regulated. If its deployment does not rest on facts — cold, hard, solid facts, established either by admissions or by trials – it serves no lawful or moral purpose and is simply an engine of oppression.

Finally, in any case like this that touches on the transparency of financial markets whose gyrations have so depressed our economy and debilitated our lives, there is an overriding public interest in knowing the truth. In much of the world, propaganda reigns, and truth is confined to secretive, fearful whispers. Even in our nation, apologists for suppressing or obscuring the truth may always be found. But the S.E.C., of all agencies, has a duty, inherent in its statutory mission, to see that the truth emerges; and if fails to do so, this Court must not, in the name of deference or convenience, grant judicial enforcement to the agency’s contrivances.

One wants to stand up and applaud loudly at this point. But at the same time, one also wonders whether Rakoff hasn’t painted himself into a corner here. In the past, as when the SEC came to an agreement with Bank of America with respect to its takeover of Merrill Lynch, Rakoff rejected a proposed settlement and then finally approved a bigger one. And as far as I can tell, the base-case scenario in this case, too, would normally be that the SEC and Citigroup go off into a corner, come up with something more acceptable to Rakoff, and then get him to accept it.

But Rakoff has drawn a line in the sand, here, and said that nothing will be acceptable to him, if it includes the standard refusal by Citigroup to admit guilt in the matter. The Goldman settlement would fail Rakoff’s test just as much as the Citi one did today. And so it’s not clear what happens next.

One option is that the SEC appeals Rakoff’s decision, and gets it overturned by a higher court. After all, the problem with the decision is that it’s so broadly written that if it were allowed to set some kind of precedent, pretty much every SEC settlement would get thrown out of court. Another option is that, as Rakoff ordered today, the SEC vs Citigroup case goes to trial, where the facts of the matter are determined for the record. That would be a bloody fight, and there’s a decent chance the SEC could lose. Or possibly the SEC and Citi will come to a second agreement, which Rakoff will find acceptable while conveniently forgetting his high-flown rhetoric today.

Rakoff makes a good point that in Citi’s proposed consent to the settlement, its promise “not to take any action or to make or permit to be made any public statement denying, directly or indirectly, any allegation in the complaint or creating the impression that the complaint is without factual basis” arguably violates Citi’s First Amendment rights. (I’m trying to find a full copy of the consent; the only version I have is missing that page, but I’m pretty sure that’s the language in it.) But in hinting that the settlement might be downright unconstitutional, Rakoff has raised the stakes so high that it’s far from clear that he can ever lower them again. Even if the SEC comes back with a settlement where Citi offers to pay billions of dollars in damages and fines.

Andy Zaky at Bullish Cross has a great post on Apple’s valuation, showing the astonishing degree to which the market is discounting the value of a dollar of Apple’s earnings today, compared to just two years ago. Back then, it was worth $32; now, it’s worth just $13. In the eyes of the market, Apple earnings are worth less than those of Cisco, Comcast, IBM, or AT&T, and are worth just 13% of the earnings of Amazon.

All of which raises the obvious question: why is Apple trading at such a seemingly depressed level? I have a few ideas, none of which are particularly compelling.

1. It’s run out of buyers. The Apple bull run has been going on for so long, at this point, that anybody who wanted to buy it has bought it already. And they’ve done pretty well by doing so. If they want to rebalance so that they keep their Apple holdings constant as a percentage of their total portfolio, they’re more likely to be selling than they are to be buying.
2. We’re all long Apple already. Apple is now firmly ensconced in its position as one of the two most valuable companies on the US stock market, in a world where ETFs and index funds are only getting more popular. As a result, if you’re long the S&P 500, you’re long Apple in quite a big way. And a large amount of the trade in Apple is going to be index-arbitrage trading. This is inevitably going to increase the correlation between Apple and the S&P 500. And when the S&P 500 has much lower earnings growth than Apple, that’s going to act as a drag on Apple’s share-price growth.
3. The headline share price is high. This shouldn’t matter, but it does. Small investors feel a bit weird about spending $2,500 on Apple stock and getting the grand total of seven shares in return. And the high share price sends a message to bigger investors, too: it says that Apple isn’t in the business of managing its share price, and is not about to engage in shenanigans like stock buybacks. Indeed, the market shouldn’t even expect a dividend any time in the foreseeable future, despite the fact that Apple clearly has more cash than it knows what to do with.
4. The headline market capitalization is high. When a company is worth $340 billion, a 10% rise in the share price means that the stock market has created $34 billion of new wealth. Which is harder than creating $3 billion of new wealth.
5. The appeal of the mean-reversion hypothesis. Apple can’t go on increasing its rate of earnings growth forever; indeed, it can’t even sustain its current level of earnings growth very long. It’s so big, and has come so far, and is making so much money, that at some point the only way to go is down. This is true on a conceptual level, but I don’t think it’s true on a practical level: Apple’s market share is still pretty small in the US, and positively tiny in the rest of the world. There’s a lot of growth potential left in this company, as smartphones increase their global penetration and as more people move from Windows to Macintosh.
6. Steve Jobs is dead. Apple’s p/e ratios started shrinking at about the same time that Jobs did, and all the hagiographic attention on how unique Jobs was only serves to remind us that he’s not around any more. If the next generation of Apple products is a success, people will still give Jobs the credit, and worry that Tim Cook won’t be able to replicate Jobs’s achievements. It’s going to take a long time before Cook can truly own the company and come out from Jobs’s shadow; in the meantime, investors are naturally going to worry that the glory years are over.
7. Apple’s earnings come from the frothiest, most disposable part of consumer income, which is the first part of consumer spending to go away if and when the economy heads south. As such, Apple’s more vulnerable to an economic downturn than most of its peers.
8. There isn’t a real bear case for Apple: the closest thing I can find is all technical-analysis astrology. And the way that markets work, stocks are much more likely to rise when people are bearish than when they’re bullish. No one seems to think that Apple is actually overvalued; indeed, analysts are ratcheting up their earnings forecasts at an astonishing pace. Here’s a table from Bill Maurer:

Estimates are up 12% over the past 90 days for the first quarter of 2012, and they’re up 7.5% over the past 90 days for the full year. This also helps explain the compression in forward p/e ratios.

What’s certain here is that the market simply isn’t rewarding Apple for its astonishing level of earnings growth of late. Which is weird, since that kind of earnings growth really wasn’t priced in a couple of years ago. Zaky’s convinced we’re seeing a market failure here, and I’m not convinced he’s wrong. But I’d be happier if someone could persuade me that there’s actually a good reason why Apple earnings seem to be worth so much less than so many of Apple’s less-successful peers.

Ladies and Gentlemen, this is what a lender of last resort looks like. What you’re looking at here are three lines. The black line is Morgan Stanley’s market capitalization, which tends to hover in the $40 billion range but which fell as low as $9.8 billion in November 2008. The orange line is the amount that Morgan Stanley owed to the Federal Reserve on any given day — an amount which peaked at $107 billion on September 29, 2008. And the red line is the ratio between the two: Morgan Stanley’s debt to the Federal Reserve, expressed as a percentage of its market value. That ratio, it turns out, peaked at some point in October, at somewhere north of 750%.

Many congratulations are due to Bloomberg, for extracting this information from the Fed after a long and arduous fight. It couldn’t have come at a timelier moment: if the ECB wants to avert a liquidity crisis, charts like this give a sobering indication of just how far it might have to go, and how quickly it might have to act.

On September 16, 2008, Morgan Stanley owed $21.5 billion to the Fed. The next day, that number doubled, to $40.5 billion. And eight working days later, on the 29th, the bank’s total borrowings from the Fed reached $107 billion. The Fed didn’t blink: it kept on lending, as much as it could, to any bank which needed the money, because, in a crisis, that’s its job.

The Fed likes to say that it wasn’t taking much if any credit risk here: that all its lending was fully collateralized, etc etc. But it’s really hard to look at that red line and have a huge amount of confidence that the Fed was always certain to get its money back. Still, this is what lenders of last resort do. And this is what the ECB is most emphatically not doing. I find it very hard to imagine the ECB lending some random European investment bank €100 billion just for the sake of keeping liquidity flowing.

And it’s frankly ridiculous that it’s taken this long for this information to be made public. We’re now fully ten months past the point at which the Financial Crisis Inquiry Commission’s final report was published; this data would have been extremely useful to them and to all of the rest of us trying to get a grip on what was going on at the height of the crisis. The Fed’s argument against publishing the data was that it “would create a stigma”, and make it less likely that banks would tap similar facilities in future. But I can assure you that at the height of the crisis, the last thing on Morgan Stanley’s mind was the worry that its borrowings might be made public three years later. When you need the money, and the Fed is throwing its windows wide open, you don’t look that kind of gift horse in the mouth.

Every time the Fed fights tooth and nail to prevent certain information from being made public, and loses, there’s a certain feeling of anticlimax: we get the information, and ask what on earth is so dangerous about normal people knowing it. The Fed is one of the most vital and least trusted institutions in America, and there’s a reason why a book called End the Fed is still riding high in the Amazon charts, more than two years after it was published. If the Fed wants to get Americans back on its side — and it needs to get Americans back on its side — then it will have to stop fighting these silly battles against transparency. Especially since the release of this data has a lot to teach the Fed’s counterparts in Frankfurt.

David Kocieniewski has a long article about Ronald Lauder as sophisticated consumer of tax-avoidance advice, who has managed to become worth somewhere north of $3 billion even as he’s given away hundreds of millions of dollars to charitable causes. (In 1988 he was worth less than $250 million; he inherited a lot of money from his mother in 2004, but today his stake in Estee Lauder constitutes only about one fifth of his net worth.)

Kocieniewski’s article raises a salient question: should the tax deduction for charitable contributions be abolished, capped, or otherwise profoundly reworked? President Obama’s jobs bill includes an idea he’s been unsuccessfully pushing ever since he became president: that the deduction for charitable giving be capped at 28%, even if your top marginal tax rate is 35%. According to a recent paper from the Center on Philanthropy at Indiana University, this modest tweak to the tax code would produce about $20 billion per year for the public fisc, while reducing total charitable giving by about $2 billion per year. That seems like a great idea to me, whether or not the government uses some of the proceeds to support the worthy charities which lose out.

Among those worthy charities, however, I would not include the Neue Galerie. It seems that Lauder has not actually donated his $135 million portrait of Adele Bloch-Bauer to the gallery; if and when he does, however, he’ll be able to deduct the full amount from his taxes at the top marginal rate of 35%, and thereby reduce his tax bill by more than $47 million. (If he can persuade the IRS that the painting has risen in value since he bought it, the deduction would be worth more still.)

Put another way, the government will spend $47 million so that Ronald Lauder can transfer a painting from his own ownership to that of a museum he controls. The painting doesn’t even need to be moved into the museum: it’s there already, and has been there since the day the museum opened. As far as the public and the art world are concerned, nothing will have changed — but as far as Lauder is concerned, he has a “reduce your tax bill by $47 million any time you need to” card just sitting in his back pocket.

There is very little public policy served by giving Lauder such a card. At the margin, does it make him more likely to open up a lovely museum of early 20th Century German and Austrian art in a Fifth Avenue mansion? Possibly. But the connection is tenuous enough that it’s hard to have any conviction in. And two things are undeniable: no one but Ronald Lauder will ever donate a $100 million painting to the Neue Galerie; and Ronald Lauder will never donate his portrait of Adele Bloch-Bauer to anybody else. No matter what happens to the tax code.

What we have right now is a situation where non-profit organizations, especially cultural ones like art galleries and museums, get very little direct government support — and when they do get direct government support, the Republican party in particular loves to rail against such expenditure as being fiscally irresponsible. On the other hand, private museums like the Neue Gallerie are the annual beneficiary of millions of dollars in federal tax expenditures which no one ever seems to question.

There are however hints that the tax-deduction sacred cow might finally be showing the first signs of weakness. Exhibit A: a curious column by Stephen Carter, in Bloomberg View, rattling off the parade of horribles that might happen if the deduction is eliminated.

Carter talks about — without citing or linking to any examples of — “the rising mania among politicians on both sides of the aisle to adopt a policy long popular within academic circles — either eliminating or severely restricting the charitable deduction, at least in the upper-income brackets”. Without any citations or links, it’s hard to know what he’s talking about, but I assume he’s not talking about the Obama proposal: reducing a deduction from 35% to 28% is not my idea of “severely restricting” anything, and if he was talking about an on-the-table presidential policy proposal, I’m sure his editors would have forced him to come out and say so.

In any case, color me enthusiastic about this idea, if indeed there is a “rising mania” for it. There are lots of public policy reasons why the federal government should encourage charitable giving — but I can’t think of any good reasons why that encouragement should be targeted especially at higher-income taxpayers. Generalizing wildly, the poor give to churches and the needy; the rich are much more likely to give to museums or concert halls or their own bespoke charitable trusts.

Carter is absolutely right that the funds donated to charity each year go to a very different set of places than the funds which are spent by the federal government, despite the fact that both are designed “to promote the general welfare”. In that sense, government can never replace charity.

But of course people wouldn’t stop giving to charity if the tax deduction went away — indeed, 70% of Americans don’t itemize their taxes at all. And there will still be plenty of millionaires and billionaires who want to save lives and/or put their names on hospital wings, or support their beloved local opera house, or help keep Central Park beautiful. The only important numbers here are the deltas: if the tax deduction went away, how much would charitable giving go down? And which charities would be hardest hit?

It’s hard to answer the first question with any specificity. But the second is easier to answer. Take a look at the $360,000 salary for the director of the Neue Galerie — or, for that matter, the $1.5 million paid to the general manager of the Metropolitan Opera, or the other seven-figure salaries paid at non-profit hospitals, universities, and foundations. There’s a rich-people money-go-round here: Jeff Raikes of the Gates Foundation doesn’t need his million-dollar salary, but the foundation is paying it anyway, as a matter of principle, presumably to encourage other foundations to start paying similar sums. These 1% salaries aren’t being paid out of small-dollar donations from the masses; they’re being paid out of large-dollar donations from other members of the 1%. And there’s no good reason for the US tax code to encourage such things.

Richard Thaler has a smart take on all this:

Having decided that charitable giving is a worthy cause, the government subsidizes charitable gifts from certain households, and for those chosen to be part of the plan, every dollar donated to a charity is increased by a specified percentage. To qualify, taxpayers must have a substantial home mortgage; the subsidy rate increases with taxable income. Low-income taxpayers receive no subsidy, but donations from qualified high-income taxpayers are subsidized by as much as 40 percent — or more…

The tax subsidy rate should be the same for everyone. This means that rather than being a deduction from income, the subsidy should take the form of a tax credit, so that if you contribute $1,000 and the subsidy rate is 15 percent, your taxes would be reduced by $150. (Ideally this credit should be “refundable,” so it is payable even if your tax bill is zero or negative.)

Carter’s response to Thaler is to say that it’s “a solution that would, of course, ‘cost’ the government more” than it’s spending right now in tax expenditures on the charitable deduction. But again, he doesn’t explain why this should be the case; it’s certainly not self-evident. A universal, refundable 15% tax credit would be a lot more democratic than the current deduction, and allow all Americans to take advantage of it, rather than only the minority who itemize their taxes. And if it did indeed end up costing more than the current system, with its deductions of 35% or more, that would only go to prove how badly skewed towards the rich the current system is.

We’re getting nowhere with respect to deep reform of the tax code, but it’s back on the table, as it is during every presidential election campaign. If we’re serious about it, then we should start taking an ax not only to the mortgage-interest deduction but also to the charitable-donation deduction. Because every time I see reports of a family charitable trust which carefully makes only the minimum outlays each year, I wonder just how charitable a lot of these donations are.

And of course Bloomberg View has a very large dog in this fight: it’s based in the headquarters of the Bloomberg Foundation offices on 78th Street, which are by some margin the most lavish offices I’ve ever seen in my life. Mike Bloomberg has every right to spend as much money as he likes on his foundation. But there’s absolutely no reason why the rest of us should subsidize those expenditures.

Mohamed El-Erian is calling for massive recapitalization of the banking system:

The global financial system is being refined “day in and day out,” El-Erian said, and as a result the balance between public and private is shifting and regulation is altering. “This is not being done according to some master plan,” but in reaction to a series of crisis management interventions.

None of these piecemeal policy moves restored confidence in the markets, he said. What is needed is a coordinated and simultaneous set of policy actions globally in four areas: restoration of credit markets, elimination of deteriorating assets from balance sheets, injecting capital quickly into the banking system, and regulatory forbearance.

Oh, wait, that was El-Erian back in October 2008. But he’s saying something very similar now:

In addition to specifying higher prudential capital ratios, governments must now bully banks to act immediately. Where private funding is not forthcoming, which should now be the presumption for a growing number of banks, recapitalization must be imposed, in return for fundamental changes in the way financial institutions operate and burdens are shared.

The main difference, here, is the move from “regulatory forbearance” the first time around, to governments forcing “fundamental changes in the way financial institutions operate” today. But either way, this is basically, the bank-nationalization debate all over again.

In the U.S., we didn’t nationalize in 2009. We ended up taking only modest stakes in banks, and getting through the crisis through the massive application of liquidity by the Fed. If the central bank, as lender of last resort, ensures that banks will always be funded, then you don’t need nationalization. It’s a bailout by monetary rather than fiscal means, and it’s a lot friendlier to bank shareholders than nationalization is.

But the problem in Europe is that the ECB is displaying neither the willingness nor the ability to act as a lender of last resort — and in that situation, the only policy action left is for governments to step in and try to backstop the banking system directly. This is a very dangerous road to travel down: it’s basically what Ireland did when it guaranteed the liabilities of the entire Irish banking system, thereby consigning itself to a national fiscal nightmare for the foreseeable future.

So color me unconvinced that the solution to a liquidity crisis is an injection of capital. At best it’s insufficient; at worst it’s unnecessary, and only serves to exacerbate the painful process of deleveraging in a pretty drastic manner. After all, liquidity problems can hit anybody, no matter how solvent they are — just ask the German government. The Bund auction failed in large part because the European liquidity-go-round is utterly broken right now, and it’s hard to see how things would improve if Europe’s sovereigns, including Germany, started getting into the banking business.

The idea behind sovereign recapitalizations is our old friend Anstaltslast — the idea that if a bank is owned by the state, then there’s an implicit government guarantee on its liabilities. If Europe’s sovereigns started taking substantial equity stakes in their own banks, then there would be fewer worries over bank solvency: it’s almost impossible for a bank to go bust if the sovereign really doesn’t want it to. But in the context of serious worries over sovereign solvency, this tack doesn’t make a lot of sense. Once you’ve nationalized, there’s no real end to the degree to which you might end up being on the hook for the banks you now own: you can’t credibly claim that the banks you own are now so well capitalized that they’ll never need any more money. And in this case, of course, the worries over European bank solvency are worries over European sovereign solvency. You can’t tie these two rocks together, through nationalization, and expect them to float.

El-Erian is very good at explaining the problem which needs solving:

Europe must still stabilize its sovereign debt situation. But this is now far from sufficient. Policymakers must also move quickly to contain banking sector frailties, and do so using a more coherent approach to the trio of capital, asset quality and liquidity.

It seems to me, though, that sequencing matters here. Liquidity is — always — more important than capital/solvency. Give an insolvent bank enough liquidity, and it can live indefinitely. Remove liquidity from a bank, and it dies immediately, no matter how solvent it might be or how high its capital ratios are. And as for asset quality, we’re pretty much talking a zero-sum game here: when the banks’ dubious assets are the sovereign’s liabilities, the real solution is inflation, not nationalization.

And as for banks’ non-sovereign assets, good luck with selling those. The shadow banking sector knows exactly what happens to asset prices when sellers put €5 trillion of those assets on the market at once, and there’s literally no one out there who would dream of buying such things at or near par.

In every crisis there’s a point of no return — if you don’t do XYZ in time, it’s too late, and the crisis is certain to get out of anybody’s control. I’m increasingly convinced we’ve already passed that point of no return in Europe. The banks won’t lend to each other, the Germans won’t do Eurobonds, and the ECB won’t act as a lender of last resort. The confidence fairy has left the continent, and she isn’t about to return. Which means, as we used to say in 2008, that things are going to get worse before they get worse.

A really good overview on Angela Merkel saying “nein” to euro bonds — Spiegel

John Muellbauer: The solution to Europe’s crisis? Conditional euro bonds — Vox EU

European banks still have trillions of dollars of bad loans they’re unable to sell — IFRE

Is Canada’s current housing market frothier than pre-crash America? — The Economist

Why MF Global’s auditors could rubber stamp risk at Goldman, JP Morgan — Bloomberg

The AT&T / T-Mobile deal looks pretty unlikely to be approved — NYT

The Rise and Fall of Bitcoin — Wired

And Dan Primack argues that the internet bubble 2.0 may not have burst yet — Fortune

Izzy Kaminska has an intriguing post on what happened with today’s bund auction — FT Alphaville

European banks are avoiding regulations with “false deleveraging” — Bloomberg

Hungary has asked for a “precautionary credit” from the IMF — Telegraph

The “darker side” of US GDP has some bad news for us — WSJ Real Time Economics

America faces two big “fiscal cliffs” in the next 14 months — The Economist Free Exchange

The big rumored mortgage settlement might not include California — Reuters

“How to steal money from Manhattan, with Columbia’s pro-biz think thank” — The Awl

And Tyler Cowen has a great idea for how to handle the NBA strike — Marginal Revolution

Many more links are available at Counterparties.com. Have a great Thanksgiving, if you’re in a country where that’s done.