Felix Salmon

The Origins and Severity of the Public Pension Crisis, by Dean Baker — CEPR

Nick Denton on Gawker redesign: “We got ahead of ourselves — and now we’re rowing back” — Poynter

When did American Express become a content farm? — Open Forum

An infographic about infographics — Think Brilliant

When a law blog turns trademark bully — Lawyerist

Is this a case of reality copying satire? A couple of weeks ago, Michael Lewis caricatured the dissenters from the FCIC report:

Financial Crisis Cause No. 3: The Chinese

And then today, in his defamation lawsuit against Lewis, Wing Chau seems to imply that’s what Lewis actually thinks:

Wing Chau and his immediate family are Chinese immigrants. His father, Muk Loong Chau, fled Chairman Mao’s China in 1953 to make a better life for his family in America—to pursue the American dream. Mr. Chau was born in Hong Kong, where the family was waylaid for many year while awaiting a visa. Eventually, the family immigrated to Rhode Island, where his father took various jobs at Chinese restaurants, usually working six days per week.

Why is this in the lawsuit? As Nitasha Tiku notes, it has nothing to do with the case, and can only be there to make Lewis seem prejudiced against the Chinese.

Meanwhile, there’s all manner of wonderful stuff in the suit designed to make us prejudiced against Lewis:

I’m particularly fond of the BA in Art History (I have one myself) and the “family compound” (sadly not).

There’s lots more where that came from in the suit, which is particularly adept at using information from Lewis’s book to cast aspersions on its central character and, ultimately, on the book itself.

All of which is enough to make you want to dismiss the lawsuit as a very silly and opportunistic, if it weren’t for the fact that hidden on pages 15-18 of the 37-page complaint seems to be a pretty colorable case against Lewis and his publisher. (Steve Eisman is also a defendant, which I’m not so sure about.)

Wing Chau certainly comes off very badly in the book — in my own review, I said that Lewis “sets up a hapless fund manager named Wing Chau as a major villain”. It’s very easy to see that the reputational damage he says that he suffered as a result of the book’s publication is real. So the next question is: does the book portray him accurately? Or does it stray into defamatory fiction?

The book states that Chau “controlled roughly $15 billion, invested in nothing but CDOs backed by the triple-B tranche of a mortgage bond”, and told Eisman all manner of things about himself which few fund managers would ever admit to a perfect stranger, even if they were true. Chau says that he was invested in A-rated bonds as well as corporate and other non-mortgage debt; I believe him, although the complaint never quantifies what proportion of Chau’s CDOs were anything but BBB-rated mortgages. I can also believe that some of what Eisman says that Chau said was made up — although Bloomberg did find a second source confirming that Chau thanked Eisman for shorting the market, thereby providing more raw material, in the form of credit default swaps, for him to write.

I’ve suspected since March 1 of last year that although The Big Short is a spectacular book and a superlative piece of narrative financial journalism, Lewis was all too willing to simply accept whatever he was told by Eisman without checking his facts particularly assiduously. In the grand scheme of things, that doesn’t matter. The specifics of the allegations about Goldman Sachs and Wing Chau might not be spot-on, but the bigger picture is. Lewis’s readers weren’t misled about the financial crisis in general, or Eisman’s story.

But if Wing Chau can persuade a jury that specific factual allegations against him caused him significant damages, this could be a hard case for Lewis to win.

Lewis’s best defense, I suspect, will be that the fall-off in Chau’s business was inevitable, after the crisis broke, and that his dismal performance as one of the largest managers of subprime CDOs would have left him with precious little “reputation in the business community” either way. It’s entirely possible that Chau’s friends, being nice to him, have told him that he’s not the reason no one wants to invest with him, it’s the book. But there’s a good chance that they’d come up with some other excuse had Lewis not written The Big Short.

I suspect this case won’t ever go to jury: Chau doesn’t want to go through discovery, and no one wants to spend enormous sums of money on lawyers. So maybe a well-crafted complaint could get some kind of a payout for Chau quite quickly. But if he wants to fight this case all the way, he end up subjected to some highly embarrassing cross-examination.

Rupert Murdoch is one of the most successful businessmen in the world. But his company is being buffetted hard by ethics scandals — phone hacking in the UK, and Roger Ailes allegedly suborning perjury in the US. It’s right and proper this should be the case: the allegations are extremely serious, and involve people very high up in the corporate structure. News Corp might still carry its founder’s aggressive and entrepreneurial DNA, but that’s no excuse, and in any case there are lots of aggressive entrepreneurs who never commit these kind of crimes.

James Altucher isn’t one of them. An admitted criminal, he posted “10 Confessions” yesterday, including these:

6) In a year I won’t specify but more than five years ago I had a surefire technique for breaking into just about anyone’s email. Anyone who was potentially a threat to my business at the time had their emails read by me. And if they were really disruptive to my business I would disrupt their emails enough that they never bothered me again.

8 ) I had a car accident when I was 18 years old. I ran a redlight and almost killed someone. In the court case the lawyer encouraged me to lie and say the brakes didn’t work. So I did.

9) When I was at HBO I was helping to decide which companies would do which websites within the company. I had started a company on the side that was making websites for entertainment companies. I hired my own company in almost every instance.

These crimes are just as serious as those being alleged at News Corp. Hacking email is worse than hacking voicemail: Altucher didn’t just read his rivals’ email but also “disrupted” it, whatever that means. Perjury is worse than suborning perjury. As for self-dealing, it turns out that Murdoch has been accused of that, too, again in a less egregious manner.

If I were ever found to have hacked someone else’s email in an attempt to gain an advantage over the competition, Reuters would quite rightly fire me on the spot. And my crime would in no way be absolved if Reuters found out through me confessing to such a thing in public. Someone who’s honest about his criminal behavior is still a criminal.

In the comments to his post, Altucher says that his crimes “helped me ultimately to look forward and be a better person,” whatever that’s supposed to mean. His readers are lapping it up: one of them writes that “Your blog has skyrocketed to among my top 10 within 3 weeks of subscribing. Mostly because of how insanely honest you are.” Altucher replies, without any visible sense of irony, “thanks. I’m afraid that honesty is a scarce quality in the financial community.”

Oh, and he helpfully informs another commenter what the statute of limitations is “for most federal crimes.”

It’s common to see people like Altucher fall back on the “everybody does it” argument in cases like this — Altucher’s basically saying that all entrepreneurs behave this way, and he’s just being more honest about it. I don’t believe him.

There’s also the “let he who is without sin” defense — essentially saying that no one can criticize what Altucher did unless they have never committed any kind of crime themselves. That’s just silly — but I do feel comfortable saying I’ve never done anything like this. Run a red light on my bike? Yes, I’ve done that from time to time. Lied under oath? Hacked into e-mail? No. Maybe that helps explain why I’ve never started a company, but I wouldn’t want to ever start a company if such flexible morals were in any way necessary.

The fact is that white-collar criminals are, in general, incredibly good at deluding themselves that they’re good people, even when they clearly aren’t. The classic example being Bernie Madoff:

He can’t bear the thought that people think he’s evil. “I’m not the kind of person I’m being portrayed as,” he told me…

He said to me, “I am a good person.” …

“Does anybody want to hear that I had a successful business and did all these wonderful things for the industry?” he continued. “And got all these awards? And so did my family? I did all of this during the legitimate years. No. You don’t read any of that.” …

He sees himself at this stage as a kind of truth-teller…

Bernie Madoff is still keeping his own moral ledger, adding things up in his own way, telling himself that someday, he’ll come out ahead.

The point here is that self-forgiveness is incredibly close to self-delusion. Altucher is currently basking in the attention of people who are reading his confessional blog entries in a fascinated manner, much as they might read a crime-filled memoir. But that doesn’t mean he’s forgiven.

In one of Altucher’s last FT columns, he wrote this:

My friend told me: “Sometimes you confuse friendships and business. You need to stop that.” Then he added: “Look into the mirror and ask yourself if you are a trustworthy person. If you can do that three days in a row then let me know and we’ll get together.”

We haven’t spoken since.

The obvious message here is that Altucher isn’t trustworthy. But the subtler message is that so long as you’re trustworthy in friendship, you don’t need to be trustworthy in business. I will never believe that to be true. And I certainly wouldn’t ever trust Altucher if he proposed doing business with me.

Update: Altucher responds in the comments. After calling this post “grossly inappropriate and unprofessional”, he adds:

All of these things I wrote about, mentioned in Felix’s article, are 15-35 years ago or more. Not sure where your anger is at, Felix. You would be hard-pressed to find anyone professionally or personally who has a single complaint against me.

Update 2: As a tipster reminds me, Altucher reckons that maybe insider trading should be legal. Which would be handy indeed for anybody with the ability to hack into others’ email accounts.

Update 3: Altucher has now taken the post down.

Update 4: Commenter Bill Andivey presents the James Altucher rap.

GM debt has been through a lot of late. In May 2009, car czar Steve Rattner made a bold and unexpected decision to nationalize the company rather than leave it with debt outstanding. That decision was followed by a CDS auction which valued GM’s defaulted debt at just 12.5 cents on the dollar — a valuation unthinkably low just a couple of years earlier. Clearly, when it comes to automaker debt, there’s a lot of uncertainty and volatility — and where there’s debt with uncertainty and volatility, there’s sure to be CDS trading.

The WSJ, however, has decided to take a golly-gee approach to the whole thing, larded with a good sprinkling of demonization. I’m surprised to see veteran bond-market reporter Matt Wirz — a genuine expert when it comes to such things — with a byline on this:

Fresh from Wall Street’s alchemy labs: Credit derivatives tied to General Motors Co. debt. The rub is, no such debt exists…

Investors who bought “naked CDS” to bet on the likelihood of default, rather than to hedge risk from other investments, are credited with worsening the liquidity crisis that gripped financial powerhouses, prompting calls for tighter regulation of the industry.

First of all, there’s no alchemy here. You might not like credit default swaps in general, but they’ve been around a long time, and there’s nothing new or innovative about CDS on GM. Sure, the amount of GM debt outstanding is low, but it’s a bit weird to say that “no such debt exists,” given that there’s still $4.6 billion in bank debt outstanding.

The assertion about the nonexistence of GM debt is backed up with a single extremely vague sentence:

Banks, some of which have made loans to the car maker, have been buying the CDS even though it is unclear whether the contracts would cover their debts, according to people familiar with the matter.

Nowhere is it explained what this is supposed to mean; I’m guessing that there’s a question as to whether a default on GM’s bank loans would trigger the CDS. And then there’s also the question of what would be auctioned and delivered in any CDS auction:

When a company files for bankruptcy or fails to meet its interest payments, the market stages an auction to determine the value of the defaulted debt, and how to compensate the CDS holders.

The value assigned to the CDS relies on investors being able to buy and sell bonds in the open market, so it is problematic for the newly revived GM not to have any bonds outstanding.

This isn’t really true. CDS auction prices are emphatically not a function of the open-market secondary-market price for individual bonds: that’s why there’s an auction in the first place. Would bank loans not be eligible to be tendered as cheapest-to-deliver debt securities? The article doesn’t say. But whenever any company has $4.6 billion in bank loans outstanding, there’s a secondary-market price for those loans, so in principle it should be possible to find them and deliver them. If the number of loans outstanding is small, then that just creates a familiar problem in the CDS market, when the amount of CDS written is larger than the amount of debt outstanding. The CDS market has dealt with that problem many times, and it’s not really an issue any more.

In any event, it has long been common practice for banks to hedge their loan exposure in the CDS market — that’s one of the generally-accepted “legitimate”, or non-naked, forms of CDS trading. There’s a reason why they’re called credit default swaps rather than bond default swaps.

But more to the point, the WSJ seems to be willfully naive about what’s going on here. Why would you sell credit protection on GM debt? Because it currently has very little debt outstanding, because you don’t think it’s going to reach a remotely dangerous level of debt in the next five years, and because you get to cash a steady flow of CDS premiums in the interim. Essentially, exactly the same reasons that you would buy GM bonds, if any existed — only selling protection is much cheaper, so you get a higher internal rate of return.

And why would you buy credit protection on GM debt, if there’s no such debt outstanding? Maybe you intend to buy bonds when GM issues them, and you want to lock in protection now, while it’s cheap. Maybe you are a GM supplier, or you have exposure to one, or in some other way you have GM counterparty risk which is easy and cheap to hedge at the moment. Maybe you’re just taking the opposite side of the GM-Ford relative-value trade featured in the WSJ, betting that over the long term GM is going to continue to struggle in the face of steadily declining US market share. Or maybe you just reckon the price of credit protection on GM debt is going to go up rather than down.

Whatever the dynamics of GM CDS trading, however, this kind of extrapolation is a reach too far:

If the cost of protection on GM continues to trade below Ford, for example, GM should be able to sell bonds at lower yields than Ford.

It’s bizarre to see this at the end of a whole article dedicated to the weirdness of the market in GM CDS, and the fact that the price is largely a function of the fact that GM does not have any bonds outstanding. At some point, GM is going to start issuing new bonds, and at that point various different investment banks will start talking to the carmaker about the level at which they might be priced. I very much doubt that any such bank would tell GM that it could issue through Ford just because of where the two companies’ credit default swaps were trading.

For the time being, GM CDS are trading at a tight level precisely because no one’s expecting a bond issue any time soon. If GM starts making noises about raising money in the bond markets, expect those CDS spreads to widen out significantly. It’s still possible that GM bonds could trade through Ford, of course — after all, Ford would still be much more highly leveraged than GM. But let’s not take today’s CDS market as much of an indication of anything. It might not be financial alchemy. But that still doesn’t make it a particularly useful guide to future bond pricing.

“It’s 50 cents on the dollar,” Madoff said. “These people probably would’ve lost all that money in the market.” — NYM

Larry Summers topless in the NYT, running on a treadmill — NYT

Even after James Altucher admits to being a criminal, financial types are still going to love him — Altucher

A survey of laid-off journalists. 70% are earning less than they were, but only 24% say their life is worse now — Atlantic

6,000 words on Charlie Sheen — GQ

Parking Requirements Force NYC Affordable Housing Project to Shrink — Streetsblog

Gibson Dunn sending nastygrams. Do they want to come off as privileged bullies? — Streetsblog

I wonder what’s appreciated more since 1985: Apple shares, or Warhol’s Apple ad — Artnet

Maybe it’s the Palo Alto drinking water? It’s got to be something like that, in any case — some kind of causal explanation of why so many people start fancying themselves experts on public policy the minute they become successful in Silicon Valley.

Often, this kind of thing manifests itself in hubristic runs for public office, as we remember all too well from the political ambitions of Carly Fiorina and Meg Whitman. Other times, it’s the likes of Vinod Khosla or Pierre Omidyar declaring that they’re going to save the planet by means of for-profit microfinance. This time, it’s Mary Meeker, freshly arrived in the Valley, taking it upon herself to publish a 466-page PowerPoint presentation, not to mention a BusinessWeek cover story, based on the conceit that you can analyze the US fiscal situation as though the country were a company.

The presentation will surprise no one who has been following the fiscal debate at all, except for in the stunning vagueness of its “potential policy solutions.” Actually, it’s worse than that: after more than a year of Meeker’s self-described “deep dive” into America’s finances, she declares with no boldness at all that “we do not take a view on preferred policy options.”

As for the BusinessWeek article, here are the companies mentioned, in order: Apple, Microsoft, Apple, Apple, Apple, Microsoft, Dell, Amazon, Google, eBay, Morgan Stanley, Kleiner Perkins, Morgan Stanley, Morgan Stanley, Kleiner Perkins, Harvard Business Review, Microsoft, Nokia, Nokia, Google, Apple, Microsoft, Nokia, Nokia, eBay, Facebook, Google, Yahoo, Apple, GM, GM, GM.

Well, at least she mentioned one genuinely industrial company, there, at the end. But it’s incredibly unclear what she’s advocating: first she says that GM’s restructuring “can serve as an example for the future,” but then she quickly backtracks, saying that “no one would recommend that USA Inc. follow a similar course of slashing, burning, and stiffing bondholders.”

The truth of the matter is that you can’t run the country like it’s a technology company, and you can’t analyze it that way either. And it’s impossible to know what to make of rhetoric like this:

Once you understand USA Inc.’s main problems, the solutions become almost self-evident…

There’s a lot that can be done to make USA Inc. operate like a well-run business. A corporate turnaround specialist would quickly hire an independent firm to conduct an audit of each business line…

I hope it’s clear by now that USA Inc. has a spending problem, not a revenue problem…

In 25 years of studying tech companies and working in financial services, I’ve discovered that people will sacrifice if they have a clear idea of what their sacrifices can accomplish. I think the same goes for USA Inc…

USA Inc. needs to prime itself for renewal—and prepare for brutal decisions that change how we do business.

Actually, the solutions aren’t self-evident. Try asking a “corporate turnaround specialist” to turn around a corporation run as a democracy, where every employee gets an equal vote. Auditing business lines isn’t going to help you much there. Besides, Meeker’s “spending problem” is in the future, and overwhelmingly in Medicare and Medicaid — her “negative net worth” number of $44 trillion for the USA includes $58.1 trillion in future Medicare and Medicaid liabilities. And her solutions on that front are all but nonexistent: “isolate and address the drivers of medical cost inflation” or “improve efficiency / productivity of healthcare system” are not an answers so much as just ways of restating the question.

There’s really no point in calling for “brutal decisions” while at the same point refusing to take any view on what those decisions should be. And it might come as a shock to Meeker, but you can’t really extrapolate from the rich and well-educated employees of technology and financial-services firms to Americans as a whole. Ask Wisconsin’s Scott Walker about Americans coming together to make sacrifices for the greater good of the whole.

The main conclusion I draw from this report, then, is that once again Silicon Valley has managed to produce someone who thinks that their success in the tech industry qualifies them to talk with great certainty about issues they don’t really understand. Washington is full of fiscal-policy wonks, and Meeker has spent a lot of effort recreating standard fiscal analyses. But at least the Washington types understand that fiscal policy is a political issue, rather than something which can be solved with consultants and PowerPoint. And that’s something which seems to have eluded Meeker entirely.

My colleague Peter Rudegeair asked me a good question last week: even if the number of stocks listed in the US is falling dramatically, what’s happening in the rest of the world? He even helped answer the question, finding data from the World Federation of Exchanges. Which I then played around with a bit in Excel to generate this:

The US is clearly the outlier here: everywhere else in the world is still seeing the number of listings rise. (And now maybe it’s a bit more obvious why Deutsche Börse is buying the NYSE, rather than the other way around.) At the end of 2009, there were more companies listed in the Americas outside the US than there were inside the US.

US listings now account for only about 10% of all listed companies globally — that’s significantly less than America’s share of global GDP, which is closer to 20%. Even as the US is moving from public to private, or at the very least from many public companies to fewer public companies, the rest of the world is still moving fast in the opposite direction.

Looking at this chart, it seems to me that anybody with the bulk of their equity holdings in US companies is clearly missing out on something important. Yes, US companies are active globally, and those US listings do include a smattering of foreign companies, in the form of ADRs. But it’s a big world out there, and if you’re looking for an everything bagel, it’s going to be hard to find it if you confine your search to US counters.

I can highly recommend the big Reuters report on Glencore, a company likely to go public some time in the second quarter at a valuation somewhere in the neighborhood of $60 billion.

Even before the IPO, there’s lots of speculation about what Glencore will do with the proceeds, which could be $16 billion or more. Top of the list is further growth — a merger with Xstrata alone would probably suffice to push the capitalization of the combined company over the $100 billion mark. The deal will also mean a huge uptick in the wealth of Glencore’s partners, who currently cash out at book value. Given that the company is likely to trade on a multiple of 3x book, no one’s going to be doing that any more.

Glencore has been a highly secretive operation from its earliest days under Marc Rich, and constitutionally hates the transparency involved in being public. So if even Glencore is capitulating, what does that say about my thesis that the stock market is increasingly irrelevant?

For one thing, I think it says that Glencore is run by highly-aggressive traders who judge themselves and others on how much money they have. Billionaire CEO Ivan Glasenberg is no philanthropist, and neither does he feel, as many Silicon Valley founders do, that what their companies do is more important than how much money they make. Far from mistrusting speculators, Glasenberg is one. So the only real reason to stay private is the question of privacy. But Glencore already gives enormous amounts of financial information to so thousands of people around the world — it told Reuters that “full financial disclosure is made to all of the company’s shareholders, bondholders, banks, rating agencies and other key stakeholders.” As a result, anybody important who wants to know details of Glencore’s finances can probably find out pretty easily.

Going public will certainly mean more press for Glencore — and given what the company does, more press necessarily means more bad press. It’s hard to position yourself as a major force for global good when your main businesses are mining and commodities speculation, and when you generate a lot of your edge by being willing to do deals with highly-corrupt politicians that other companies won’t touch. But Glencore’s bosses are hardly the first people to make the calculation that for hundreds of millions of dollars, they’re OK with being hated.

There’s also a sense of statistical inevitability about going public. You can stay private for decades, but the option of going public will always be there, and there will always be charming investment bankers telling you what a wonderful idea it is. A single moment of weakness, and it’s done. And once done, it’s more or less irreversible. A unified and single-minded family like the Cargills can stay resolute — but that’s an impressive feat, and if Glencore starts draining Cargill’s milkshake after it goes public, even the Cargills’ resolve might waver.

This part of the Reuters report stood out for me:

Glencore’s arrival in the FTSE would intensify the London exchange’s shift into natural resource firms. Fox says the increasing domination by a single sector is a “big headache” for smaller British investors who want a diversified portfolio. “It concerns me as much from a financial perspective as a moral perspective,” he says. “Customers will not expect that when they invest in a mainstream UK growth fund that a third of their money will end up in commodities.”

The point here is that the stock market, at least in the UK, is becoming a commodities play — much as the Russian and Brazilian stock markets have been for some time, not to mention Canada and Australia. Betting on commodities is all well and good, but it’s not the same as investing in the economic growth of a country. “While the stock market is certainly not a perfect reflection of corporate performance,” Ira Millstein tells me, “it is one measure.” That’s true — but it’s a measure of declining utility. The Glencore IPO only serves to underline how the stock market is more of a reflection of global asset values and of financial speculation than it is of underlying corporate performance in the real world.

How can Buddy Fletcher’s tax returns show income of $1.5m from 2007-9 when he was paid $13.5m in dividends alone? — NYT

Google fires the first shot against Demand Media — Google

The cost of the Madoff investigation is equal to the annual budget of the SEC — NYT

Don’t Believe Everything You Read: The Real Skinny on Servicer Settlement Talks — American Banker

In Anti-Bike Lane Case, Gibson Dunn Strays From Pro Bono Standards — Streetsblog

“Avoid the guy who offers his clients ‘a very special opportunity’ to invest in anything. He has a problem with cocaine” — CNBC

Bill Black on Finance’s Five Fatal Flaws — Ritholtz

Amazing interactive health map of America — Measure of America (Check out the other maps too!)

The crazy corporate maneuvering behind the Smile Train-Operation Smile Merger — NYT

Sometimes, financial innovations seem like a good idea at the time, and it’s only later, after everything has gone pear-shaped, that it becomes clear we would have been much better off without them. Other times, financial innovations are clearly a bad idea from the get-go:

Factor Advisors, a New York-based asset management firm, announced today the launch of FactorShares, the first family of spread exchange traded funds (ETFs) that allow sophisticated investors to simultaneously hold both a bull and a bear position in one leveraged ETF…

FactorShares ETFs are capital efficient, targeting a daily leverage ratio of 4:1… FactorShares ETFs seek investment results for a single day only, not for longer periods.

Some investments, in things like hedge funds or private-equity funds, are considered so risky that you need to be qualified to buy them. Other investments — public stocks listed on the NYSE are a good example — can be bought by just about anybody. FactorShares, incredibly, are in the second category.

Needless to say, no one with an ounce of common sense should go anywhere near these things. Even if you’re convinced that bonds are going to outperform stocks, you should never touch FSA, the fund which gives you a 2x leveraged long position in Treasury bonds combined with a 2x leveraged short position in the S&P 500.

Just look at the official FactorShares FAQ if you want some of the reasons: the funds certainly should never be held overnight, and “may experience tracking error intra-day”; there’s “a compounding effect and tracking error”; the leverage fluctuates and “could be higher or lower than an approximately 4:1 leverage ratio”; there’s the inevitable Management Fee, of 0.75%; “other fees apply including brokerage commissions”; the shares “are not mutual funds or any other type of investment company within the meaning of the Investment Company Act of 1940, as amended, and are not subject to regulation thereunder”; the Managing Owner has been a member of the National Futures Association only since December 2009; the shares “may be adversely or favorably impacted by contango or backwardated markets”; you have to deal with a K-1 form for tax purposes at year-end; and I’m sure there’s lots of other stuff in the various prospectuses.

What confuses me is why the SEC, the NYSE, and other institutions who consider themselves to be protecting individual investors would ever allow these things to trade openly on the stock exchange in this manner. This isn’t a company raising equity capital so that it can invest in the real economy and grow and thrive. Instead, it’s a pointless, parasitical, negative-sum financial monstrosity which will probably make a modest sum for its sponsor and lose money, on average, for anybody who invests in it. It doesn’t even serve any legitimate hedging purpose.

ETFs looked like a good idea when they started replacing index funds. But the more that this kind of thing happens, the more of a bad name they’ll have. Let’s hope regulators wake up and shut this scheme down, and lots of similar ones too. People who buy these things aren’t “sophisticated investors”; they’re really not investors at all. If they want to gamble, there’s always Vegas.

Who is responsible for turning New Jersey governor Chris Christie from an uninspiring and inchoate peddler of conservative platitudes into the major anti-union force that he is today? Step up, Mr Squid:

Christie won by about four points on Election Night in 2009, with little notion of what he was going to do next. When I asked him if there was any one moment of clarity that put him on the path from cautious candidate to union-bashing conservative hero, Christie pointed to a meeting about a month into the transition, when his aides came to him brandishing an analysis of the state’s cash flow produced by Goldman Sachs.

Goldman Sachs, of course, is the company where the CEO recently said of his employees that “If we could do it, we would have their bonus be 100 percent of their comp” — in other words, no salary whatsoever, no job security, give all the power to management and give the workers no rights at all.

All of which makes Christie’s improbable victory over former Goldman chairman Jon Corzine so much more ironic. Only someone who has beaten a squid himself, it seems, is capable of taking Goldman’s advice to its logical conclusions.

On February 14, 2008, John Lyons, the examiner in charge of large bank supervision at the OCC, sent Citigroup and its auditors a scorcher of a valentine. In a nutshell, it said that Citigroup had no idea what it owned and had no idea how to value it. “Risk management had insufficient authority,” it said, the board “had no effective oversight role,” and “matters requiring attention” ranged from corporate governance and risk management in general and CDO valuation in particular.

Eight days later, on February 22, Citi unveiled its annual report to shareholders. In that report, Vikram Pandit personally attested that Citi had full control over its finances and that its valuations were reliable; the auditor, KPMG, said exactly the same thing.

The FCIC should have asked questions about this — after all, the OCC letter comes from its own archives. But it doesn’t seem to have done so, which means that it has fallen to Jonathan Weil to do the digging and to construct a timeline and to ask awkward questions. The problem is that Weil, as excellent as he is, doesn’t have nearly the power that the FCIC had. So he can get stonewalled easily:

Pandit, Crittenden and O’Mara didn’t return phone calls. A KPMG spokesman, George Ledwith, declined to comment, as did an OCC spokesman, Kevin Mukri. A Citigroup spokeswoman, Shannon Bell, declined to discuss the OCC’s findings.

It’s now certain that Citi and its auditors were well aware of the problems the bank had in valuing its assets — those problems were clearly spelled out to the bank in a formal letter from its regulator. And yet, as Weil writes:

Somehow KPMG and Citigroup’s management decided they didn’t need to mention any of those weaknesses or deficiencies. Maybe in their minds it was all just a difference of opinion. Whatever their rationale, nine months later Citigroup had taken a $45 billion taxpayer bailout, still sporting a balance sheet that made it seem healthy.

Both Pandit and KPMG are still in place; their la-la-la-la-we-can’t-hear-you approach to disclosure seems to have worked perfectly. But the SEC should look into this. It’s the formal disclosures in the 10K which now look deceptive at best and downright fraudulent at worst. I know it’s fun to chase hedge funds for insider trading. But we’re still waiting for the crisis-related prosecutions to begin, and this would seem to be a fruitful place to start — especially given Pandit’s newfound hero status.

Update: Shannon Bell emails with the full official statement from Citi:

“Citi maintains rigorous disclosure controls and procedures to support its CEO and CFO certifications.  These controls and procedures were followed in connection with the filing of the 10k in February 2008, and Citi’s certifications were entirely appropriate.”

(Cross-posted at CJR)

At the end of 2008, the loan market was in stunningly bad shape. There was almost no bid for loans in general, and cov-lite leveraged loans in particular were treated like they were radioactive. If you looked at the prices they were trading at, the market was clearly expecting a huge wave of defaults in the very near future, along with very low recoveries.

Two years later, the picture could hardly be any different. High-yield bonds are being issued within 40bp of the state of Illinois. Cov-lite loans are being churned out at bubble-era pace: the $8.8 billion so far this year is 25% of all loans year-to-date, already tops the 2010 total, and works out to an annualized pace of something in the region of $65 billion. The defaults that everybody was expecting generally failed to occur, and the few defaults that did happen had surprisingly high recoveries.

The WSJ‘s Mike Spector is at pains to point out that “creditors aren’t guaranteed to lock in these better recoveries. Distressed-debt exchanges, while giving good recoveries in the short-term, could later prove a mirage should firms falter again.” This is true broadly, but false narrowly: if creditors want to lock in their recoveries they can do so very easily by selling their shiny new bonds and loans in this frothy market at very high prices.

When I started blogging full-time in 2006, I formulated a principle — that the market is the best pundit. Sometimes the market is wrong and some specific pundit is right, as I’m sure my boss at the time, Nouriel Roubini, would love to remind you. But the expectations priced in to the market are a more reliable base case than any other forecast you might use.

That principle didn’t work out well for me in the case of mortgage bonds. Or just about anything else: the market took it upon itself to go completely bonkers, with a level of volatility bespeaking zero reliability whatsoever when it came to priced-in expectations. Even so, in the midst of a massive recession it did seem reasonable that crazy cov-lite loans would start defaulting en masse — no matter what the Fed did in terms of monetary policy.

But something interesting happened: it turned out that these bonds and loans were big enough to concentrate the minds of the creditors. Banks and investors worked hard to avoid realizing losses, in a manner which has most emphatically never happened in the mortgage market or with small business loans. You can call it “extend and pretend” or “delay and pray” if you like, but it seems to have worked, with a lot of help from the Fed. That was unexpected, and because it was unexpected it had a huge effect on prices, which outperformed massively in 2009 and 2010.

So when the market seemed unreasonably sanguine, in early 2007, it was wrong. And when the market seemed reasonable in its pessimism, in late 2008, it was also wrong. Right now we’re back to unreasonably sanguine again — Bethany McLean says, sensibly enough, that the recent uptick in cov-lite issuance is “a sign that some kind of reckoning is in store.” But the one thing I’ve learned over the past three years is that the market just isn’t a sensible or rational place.

If you’re being logical about such things, stocks look incredibly frothy right now, just as bonds do, both in terms of valuation and in terms of psychology. But this market has a way of making everybody look foolish, no matter how logical they are. Which is ultimately just another reason to spend as little time as possible paying any attention at all to the market. It’ll just drive you mad.

Back in November, Michael Barr told me that by the end of the first quarter this year, the government should be in serious discussions with banks about how they’re going to fix their broken mortgage operations. Those discussions seem to have started up, on an informal basis, as the government has cobbled together a not-quite-ready-for-prime-time settlement proposal which it will at some point formally present to the banks.

The most interesting part of the proposal, as it’s described in the WSJ, is that it looks as though the banks are going to be encouraged to do principal reductions on mortgages in lieu of paying fines:

If a unified settlement can be reached, some state attorneys general and federal agencies are pushing for banks to pay more than $20 billion in civil fines or to fund a comparable amount of loan modifications for distressed borrowers.

I’m cautiously optimistic about this. There are risks of the banks ultimately getting off very lightly: a fine is a punishment for doing something wrong, while principal reduction, by contrast, can actually benefit banks if they do it right. But in this case it seems that most of the benefit might go to homeowners and bondholders rather than banks.

The one thing I’m sure about is that the final settlement, if and when it arrives, is going to be extremely complicated, and will be presented with great fanfare and a huge headline dollar amount. But the settlement will in reality mark the beginning, not the end, of the process, and the proof of the pudding will be in the execution.

“You should hold us to whether things get better or worse,” said Barr in November. “If a year from now nothing has changed, that would be a reasonable criticism.” There’s still a lot of time to go, on that front. But amid all the noise surrounding the settlement, let’s keep our eyes on the ultimate prize, which is meaningful help for homeowners. Both government and the banks have made lots of promises on that front in the past, none of which have turned out to be worth very much. The settlement will constitute yet another high-profile promise. And we won’t know until much later this year whether it’s done any good at all.

Russell Carollo, of Mark Cuban’s JunketSleuth, has a great post up today about the way in which the FDIC aggressively rebuffs FOIA requests that other government agencies are happy to comply with. The FDIC has long been a hugely powerful and unaccountable arm of the government, and its letters to Carollo stink of arrogance and entitlement.

The FDIC repeatedly refused to provide any information on travel by its employees, claiming, among other things, that it has no central database, that Junketsleuth’s requests were too broad and that even if they had the information, the public wouldn’t have a right to see it…

Although the FDIC has rejected all of JunketSleuth’s Freedom of Information Act requests, more than 20 other agencies that got identically worded letters turned over their travel databases, which contain hundreds of thousands of records…

In addition, more than 30 agencies have provided JunketSleuth with other types of records. Those include hotel bills, airline receipts and other documents related to travel by top agency officials and other government employees, or to travel to specific destinations that we asked about.

But the FDIC provided nothing.

In response to JunketSleuth’s initial request for data, the FDIC claimed that our request – again, worded identically to those that yielded voluminous records from many other agencies – did not “reasonably describe” the information being sought.

The FDIC also said that we did not specify a time frame for the records we sought, suggesting that our request for data could be interpreted to mean all travel-related information compiled since the agency was created in 1933.

The FDIC seems perfectly happy to send responses to FOIA requests saying that it will provide no information at all on the grounds that the FOIA “could be construed to include” some impractically massive amount of information. It’s a textbook example of bad faith: what’s clearly happening here is that the FDIC has first decided that it’s not going to provide anything at all, and then instructed its lawyers to find some colorable reason why the request is being denied.

Why is it that the FDIC is being so willfully obstructive even as other agencies, including the Department of Defense and the FDA, are much more cooperative? The answer is surely the culture of secrecy and of we-know-best that pervades the financial sector generally, including the areas where it seeps into government. The Fed, of course, is just as bad, if not worse — it has a habit of dismissing FOIA requests out of hand, on the grounds that it’s not a government agency. (Technically, it’s a privately-owned corporation.)

Whenever information has emerged which Treasury or the Fed initially wanted to keep secret, the deleterious effects have been invisible — once again, the risk of something bad happening as a result of disclosure is an excuse used to justify a blanket decision not to disclose anything, rather than the reason for that decision. It’s worth remembering here that immediately before he was Treasury secretary, Tim Geithner ran the hugely secretive New York Fed, and did nothing to improve its transparency.

Government is, by its nature, a massive bureaucracy, and it’s very hard if not impossible to change an ingrained culture in such places. But a bit of top-down pressure could only help. Perhaps the White House could appoint an “openness czar” or similar to whom anybody getting serially rebuffed could appeal. Because this secrecy is ultimately self-defeating, not to mention politically damaging.

(Cross-posted at CJR)