Felix Salmon

ECRI says it’s a “done deal” that the US is going into a recession — WSJ Marketbeat

The CDS market views Morgan Stanley as being as risky as an Italian bank — Bloomberg

A guide to China CDS — FT Alphaville

Stephen Roach predicts a soft landing for China — Project Syndicate

Bank of America’s not the only one planning to charge for debit cards — Reuters

Find many more great links at Counterparties.com

Kodak shares fall 60% as its rumored to have hired restructuring lawyers — WSJ

Massive CEO severance packages are “rewarding failure” — NYT

S&P and Dow Jones are discussing merging their indices — FP (Reuters story)

And Michael Lewis rides bicycles around California with Arnold Schwarzenegger — Vanity Fair

The Clearing House has a new study complaining about the idea that the world’s biggest banks — the Too Big To Fail institutions — should have higher levels of capital than other banks. (The study is meant to be here, but the website isn’t working very well, so I’ve mirrored it here.pdf.) The main conclusion is that “if the Basel Committee’s G-SIB capital surcharge is implemented in the U.S., these banks would have to either increase the borrowing costs to their customers by 60 basis points” — an outcome so self-evidently horrific that the study doesn’t even bother to explain how harmful it would be.

But of course a closer look at the study shows that borrowing costs wouldn’t actually need to rise at all. Here’s the key headline in the presentation:

NIM here, is Net Interest Margin, which is then used to compute borrowing costs. And “NIX ratio” is non-interest expenses, known to many as “bankers’ bonuses”.

The calculations here are not mathematically unconvincing. According to The Clearing House, the cost of bank equity will go down under the new regime — by about 70 basis points. That won’t make up for the hit to shareholders from being less leveraged.

So yes, it’s entirely possible that there is indeed a non-negligible cost to implementing this surcharge. That cost is going to have to be borne by three different groups: borrowers, bankers, and bank shareholders.

But if you look at the report, it’s predicated on the idea that shareholders don’t bear any of the cost at all all: we have to “maintain shareholder returns”, for some unknown reason. This is silly, for reasons convincingly explained by Martin Wolf — the returns that banks are offering to their shareholders are far too high. Back in the 50s and 60s, banks had a return on equity around 7%; now they require more than double that. There’s no reason why we shouldn’t go back to the old returns.

If banks’ return on equity fell from about 15% to about 7%, then there wouldn’t be any increase at all in borrowing costs, and bankers could even keep their bonuses. But more likely, some combination of the three will happen: lower return on equity, lower bonuses, and slightly higher borrowing costs, to the tune of maybe a couple of tenths of a percentage point.

This is all good. Bankers’ bonuses should be lower. And borrowing from a big bank should cost more: it helps to incentivize borrowers to move their business to smaller, less systemically-dangerous institutions.

Besides, the problem right now isn’t that banks are lending at exorbitant rates: it’s that banks aren’t lending at all. I think many small businesses, especially, would be perfectly happy to pay an extra 0.6% if that meant they could get a loan rather than not get a loan.

And it’s undoubtedly true that the more capital banks hold, the less of a risk they pose to the financial system as a whole.

Right now, there are two huge risks which could result in trillion-dollar writedowns at the world’s too-big-to-fail banks. The first is real estate: prices are still falling in the US and around the world, and at some point mortgages can and should have their principal written down. And the second, of course, is developed-world sovereigns, especially on the European periphery. If they default, then there will be a lot of writing down to go around.

Higher capital levels can’t protect us fully against either of those risks, let alone both of them. But they would help. And if banks build up their capital to a healthy point, then maybe we’ll be able to orchestrate a market-friendly set of global writedowns which doesn’t bring the entire financial system to its knees.

Maybe that’s what the big banks really fear, here: that if they’re asked to build up their capital, that only means they’re going to be asked to write down that capital later. I can see why they wouldn’t be happy about doing such a thing. But for the other 99%, the idea frankly looks rather attractive.

By Mark Dow

Matthew Yglesias has an interesting new post on Hard Keynesianism. It was succinct enough for me to be able to read the whole thing in between my tactical trades this morning and write a brief response.

He makes the basic points that (1) symmetric countercyclical fiscal policy is at heart of true Keynesian thinking (as opposed to much of the faux and pseudo Keynesian characterizations that pass for public discourse these days) and (2) it is hard to do.

He also insinuates by way of the case of Chile that the courage to do this comes from the center-left (in this case, the Concertación coalition) that governed over the surplus years, only to fall apart in 2010 when the center right took over.

I don’t myself want to insinuate that Matthew Yglesias isn’t serious or smart. In my view, he is both. And I sympathize very much with the two basic points. But, as I like to say, the most dangerous place to be is in between someone and what they want to believe. And I think his desire to confer virtue onto the center left and vice on the center right misses two important idiosyncratic, Chilean features that have more to do with outcomes there than do politics.

First, Chile is a small open economy dominated by trade. Copper is its most prominent export. Its Copper Stabilization Fund, established in 1985, makes it much tougher to spend windfall proceeds from copper sales. And copper prices quadrupled in the 2004-2008 period. In fact, given this structure and that kind of rise in copper, it would have been next to impossible not to generate big surpluses in Chile.

Fine. Well than why the big fiscal deficit in 2010? Yes, center-right Sebastián Piñera was elected that year. But it was not Chile’s biggest event. The tragic 8.8 earthquake in February that hit Chile’s central coast was. The deficit corresponded to the massive amount of spending the government trotted out to counter its effects. It was not reflective of the difficulties of time-consistent fiscal policy.

Now, back to trading….

Ron Suskind thinks that equity holders are secured creditors — Economics of Contempt

Bernanke said that long-term unemployment is a “national crisis” — AP

Can a weakened Volcker rule stop rogue traders? — Pro Publica

Europe extends the short-selling ban, crushing the dreams of some traders — FT Alphaville

Charles Kenny takes a hammer to the icon that is small business as job engine — Businessweek

And CalPERS admits that it probably won’t meet its 7.75% return goal this year — Bloomberg

This year marks the 15^th anniversary of the Personal Responsibility and Work Opportunity Reconciliation Act (PRWORA), the Bill-Clinton- and Newt-Gingrich-led overhaul of cash assistance to poor families with children.* One of the major changes of that law was adding work requirements so that most cash assistance applicants (generally single mothers) couldn’t receive help without heading into the world of market-based work.** When the bill passed, and unemployment was below 5%, there was some concern about what would happen when the economy slowed and jobs weren’t as easy to come by.

We are now finding out. As this graph from the Center for Budget and Policy Priorities shows, as unemployment has sky-rocketed, and other social safety net program like SNAP (a.k.a. food stamps) have seen a surge in participation, Temporary Assistance for Needy Families (TANF) has barely budged.

Some policymakers see this as a sign of “success.” At least that was the word Robert Doar, the commissioner of New York City’s Human Resources Administration, used on Wednesday at this New York University event. Between December 2007 and December 2009, as the number of unemployed people in the state of New York increased by 91%, TANF cases increased by just 4%. Doar is proud of this.

Now, if we’d somehow solved the problem of poor children—the people for whom cash assistance is ultimately intended—then I might agree. But that’s hardly the case. According to the Census Bureau, in 2010, 22.0% of Americans under the age of 18 lived in poverty. In New York City, the figure is 30%.

That works against Doar’s hypothesis that one of the reasons TANF cases haven’t risen is that would-be recipients are getting along by tapping other social welfare programs, such as unemployment insurance. It also illustrates a major misconception about unemployment insurance, which only half of all unemployed workers get, and those coming from low-wage jobs—like the ones cash assistance recipients tend to move into—typically don’t.

A more likely explanation is that eligible people aren’t joining the program. In fact, that’s what the data shows, both in New York and nationally. Before PRWORA, more than 80% of eligible families participated. Today, about 40% do.  In many states, benefits have become much stingier, which might help account for the decreased interest—except that the same drop is also seen in states like New York, where the dollar-value of benefits has remained essentially the same since 1996.

What has changed considerably is the process for applying for cash assistance. As policy analyst and TANF expert Bich Ha Pham detailed at the NYU event, an applicant in New York City must now attend 45 days of a 9-to-5 job-search workshop before having an application considered. Aside from the fact that the best way to look for a job is probably not to sit in a room with a bunch of other unemployed people for a month-and-a-half, this structure completely ignores the chaotic reality of being a single mother in financial crisis. (As the Community Service Society has shown, it also ignores the needs of high-school drop-outs, who would probably get a lot more out of a GED program than resume advice.) Indeed, a large proportion of applicants wind up being “non-compliant” during this initial 45-day job search.

The point here is not to bash Doar or his agency.*** The point is to illustrate that we can’t really have a conversation about whether or not linking cash assistance to market-based employment is problematic in a time of high unemployment, because program structure itself is distorting the behavior of would-be cash assistance recipients.

Although, in a way, maybe that is an answer to the question.  As sociologist Kathryn Edin and social anthropologist Laura Lein illustrated in their 1997 book Making Ends Meet (and in this shorter paper), the problem never really was that cash assistance recipients didn’t want to work. Indeed, interviews with hundreds of women showed that, depending on the city, between a third and half were working, just not in the formal economy. (Other data show that many cash-assistance recipients face problems that make mainstream employment difficult—more than a quarter have work-limiting physical, mental, or emotional  problems, compared with less than 5% of the general population.)

So maybe what we’re learning—should we be able to put aside the overly simplified view of the “deserving” and “undeserving” poor—is that it’s time for another round of welfare reform. But this time what needs to be reformed is how the system goes about understanding the needs and limitations of single working mothers. As Edin and Lein documented, barriers to formal employment include not just balancing work schedules with lone parenting and the added costs of having a job outside of the home (such as day care), but also the realities of low-wage work. Those realities include income volatility, the lack of unemployment insurance should a job be lost, and the lack of benefits that middle-class parents often depend on—such as sick days and the ability to make phone calls from work to check on children.

At the NYU event, even political scientist and PRWORA booster Larry Mead agreed that there is a lot of room for improvement in how work requirements are implemented. Much low-wage work is high-turnover and dead-end. The system, he said, would be much better if it focused not just on job placement, but also on job retention and job progression.

In other words, on reality.

*We typically call this law “welfare reform,” although that’s a bit misleading, since it didn’t address other social welfare programs, such as disability and unemployment insurance, workers’ compensation, Medicare, food stamps, and disaster relief.

**This is a fantastic bit of historical turnabout, since, as Theda Skocpol documents in this book, cash assistance to single mothers originally required women to stay at home to raise their children and not work outside of the home.

***While Doar-bashing isn’t the point, it is tough to avoid, especially when he says things like he finds it “troubling” that an increasing number of food-stamp recipients are working. Troubling, that is, because it indicates people are bilking the system, not because it reflects fundamental breakdowns in the labor market such as the decoupling of productivity gains from wage growth and rampant underemployment.

Henry Blodget has a long and detailed response to Marco Arment, which is fascinating to anybody interested in the nuts and bolts behind a modern for-profit blog.

If you boil Blodget’s 4,000 words down to a single idea, it’s basically this: over-aggregation.

Now the concept of over-aggregation is not well defined, and means different things to different people. To Ryan McCarthy, who used to work at the Huffington Post and is acutely attuned to such things, over-aggregation is what happens when Outlet A writes a story and then Outlet B basically rewrites or copies the story so that there’s no reason to click through to A any more. HuffPo and Business Insider have both been accused of this, as have sites like Newser.

But that’s clearly not what was happening with Marco’s posts, so let’s put that kind of over-aggregation to one side for the moment. The dispute between Marco and Business Insider relates to something different — which is what happens when TBI links out directly to other people’s blog posts.

Now I’m a great believer in linking out directly to other people’s blog posts: I’ve built an entire website which does nothing else. And Counterparties.com doesn’t just have external links, either: each link also comes with a dedicated permalink, like this one.

But here’s the thing: we build Counterparties.com by hand, we write every headline on the site, we add a tag to it, and so on. What you see on Counterparties is our unique content. It links to other sites, but it doesn’t copy anything from those sites. And we link out maybe 20 or 30 times a day, tops. This is not some kind of copy-and-linking robot algorithm, it’s a hand-built list of artfully curated links.

At TBI, by contrast, the areas of the site with nothing but external links work very differently. There are two such areas: one’s a column called “Read Me” which appears on the right hand side of the page if you scroll down a bit, and the other is a dedicated section called “The Tape“. For readers navigating the site, both of them work as they should: you see the headline, you click on the link, you go straight to the other website.

But behind each of those links is a huge CMS (content management system) architecture, whereby every external link is generated from a dedicated permalink page which people navigating the website are never supposed to see.

If you go to Yahoo Site Explorer, it’ll tell you that TBI has — get this — 465,825 separate pages. Now the likes of Henry Blodget and Joe Weisenthal are undeniably prolific, but there’s no way you get to 465,825 pages manually. TBI is about four years old, if you go back to its first incarnation as Silicon Valley Alley Insider; 465,825 stories over four years works out at well over 300 stories per day.

So most of those pages, it turns out, were generated by robots without any human input at all: they look like this, or like this, and they’re just pages which copy-and-paste the headline, the author, and some of the content from third-party websites.

According to Blodget, this huge mass of robo-pages at TBI has an entirely innocent explanation. “To put something into the ReadMe box,” says Blodget, “we need to have a page with the headline and sub-head and author on our site, even if the page will never be seen by our readers.” It’s just a technical necessity! Nothing nefarious about it!

To be honest, it’s not a technical necessity. Other sites which link out a lot — Drudge, say — don’t have millions of hidden permalink pages generating every link on the home page. And Blodget protests a bit too much, I think, when he says he gets no googlejuice from these pages:

In the past, these pages have been indexed by Google, but because they include a link back to the originating site and page, they do not generate much (if any) SEO value for us. They exist only because it was easier for our developers to use the existing post-headline-author metaphor in our publishing system than to create the Tape entirely from scratch…

We always include a link to the original post on this stub page, so Google won’t conclude that we produced the original story.

I don’t think that Blodget is trying to get Google to link prominently to his stub permalink pages; nor is he trying to fool Google that those pages constitute original TBI content.

But those pages can do wonders for his googlejuice even if Google never links to them at all. The main reason is that because those pages are being created every minute of the day, Google is forced to spider TBI on a real-time basis, just to keep up with all that new content. Google likes those kind of sites, because it considers them to have lots of very fresh content — the more frequently you update your site, the higher your PageRank.

And of course since Google is spidering TBI on a real-time basis, it picks up TBI’s home-made stories the minute they appear. So if TBI writes a story about Fred Bloggs, and then someone searches Google for Fred Bloggs one minute later, the TBI story will come up at the top of the search results. Conversely, if I put a story about Fred Bloggs up on felixsalmon.com, which is almost never updated, it could take days to appear on Google. Having lots of robo-pages, then, helps boost the search prominence of TBI’s non-robo-pages.

Blodget does seem to have taken this criticism to heart:

We’re going to see if we can add “no follow” links to the stub pages to make sure that Google doesn’t index them. If we can’t do that, we’ll eventually redesign The Tape, so it doesn’t create stub pages at all.

I suspect that “no follow” links aren’t the best way to do this: I’d suggest instead that Henry put all the stub permalinks on a separate subdomain like articles.businessinsider.com, and then use the robots.txt file to tell Google not to index anything on that subdomain.

But more conceptually, the TBI over-aggregation problem will still exist, in the form of The Tape running huge numbers of other site’s headlines on an indiscriminate basis. (I think that ReadMe, at least, is more curated, although I’m not sure about that.) Henry says that “we created the Tape because we didn’t want to bother with RSS readers anymore”, but the fact is that The Tape is a really bad RSS reader. Building a good web-based RSS reader is hard: just ask Nick Denton, who put a huge amount of effort into building Kinja before abandoning it as a consumer product.

Instead, I think that the driving impetus behind The Tape was the more-is-more approach to web publishing: it has been clearly demonstrated again and again that the more content you put up, and the more frequently you update, the more pageviews and unique visitors you end up getting. That explains not only The Tape, of course, but also the large number of one- and two-paragraph stories on TBI. It’s good for business, but it’s not necessarily good for readers who want less sensationalism and more insight.

The EU is proposing a $77 billion financial transaction (quasi-Tobin) tax — AP

The German Finance Minister think the U.S. rescue fund plan is “stupid” — Telegraph

Martin Feldstein on why Germany and France are trying to delay the inevitable Greek default — Project Syndicate

Health insurance premiums jumped 9% last year — Kaiser Family Foundation

What slowing productivity says about our economic growth — NY Fed

Junk bond returns have turned negative — IFR

The vultures are circling Paulson’s assets — WSJ

The CDS market: actually pretty important — FT Alphaville

The SEC is suing NIR’s Corey Ribotsky for allegedly bilking a chintzy $1 million from clients — Bloomberg

Zynga’s virtual farms and tractors are depreciating faster — WSJ

Does Peter Orszag really want less democracy? Daily, he grows more Hamiltonian — TNR

Case-Shiller: Last month’s home prices are down 4.1% year-over-year — S&P

Goldman’s $1.2 billion in cuts includes smaller drinking cups — Dealbook

SEC charges RBC with selling shoddy CDOs to Wisconsin schools — SEC

Zynga profits are down 95% — Gamepro

The Wall Street protesters have a striking diversity of complaints — NY Observer

Perhaps out of boredom, Google made some ridiculous bids for the Nortel patents — Reuters

Martin Wolf: Banks are over-promising, and will fail to deliver –  Blogs.ft.com

It’s one of the oldest tricks in the retail-banking book: if you order your customers’ transactions from biggest to smallest, rather than in the order they’re received, then you’ll maximize your overdraft income. Every banker in the country knows this — to get the most overdraft fees, you have to push your customers into the overdraft zone as quickly as possible, by prioritizing their largest payments.

This truism is so blindingly obvious that it’s known even to management consultants like CAST, who were giving advice to Union Bank of California. In an insight typical of their kind, CAST told Union Bank that its fee income would rise if it ordered transactions from biggest to smallest.

But CAST didn’t stop there. To become a really successful management consultant, you need chutzpah:

Bank documents turned over to plaintiff attorneys during discovery indicate Union Bank agreed that CAST would receive 20% of any extra overdraft charges generated under its high-to-low system.

I can see why Union Bank would implement this system. I can even see why they might hire CAST to tell them to do it, so that they could blame The Consultants rather than take responsibility for their own actions. But paying CAST 20% of the extra fee income? That’s completely insane. And it’s a lot of money, too:

A system of putting through the transactions in whatever order maximized fees would in the first year boost Union Bank’s overdraft revenue by $18 million, or nearly 25%, CAST estimated…

In the summer of 2003, Union Bank established a “High to Low Implementation Team” in cooperation with CAST. In the first year, overdraft revenue jumped far more than expected — by $33 million to a total of $125 million.

So, CAST didn’t even get its math right! But at least it was lavishly rewarded for being wrong: 20% of $33 million is a very nice fee to pocket for telling a bank what it already knows. And the system stayed in place for six years — so that’s a good $40 million or so that CAST stands to have made from this advice. Nice work if you can get it!

If I were a Union Bank shareholder, I’d be angry about the horrible overdraft system. But I’d be furious that a large chunk of the extra fees were going to CAST for no good reason. Who agreed to this on behalf of Union Bank? And why? It makes no sense to me at all.

By Mark Dow
The opinions expressed are his own.

European policymakers came to the IMF meetings in Washington in a defensive mode; some defiant, some with their tails between their legs. Once in Washington, it only got worse. Policymakers from around the world and investors of all stripes lined up to administer verbal beatings. Warnings of cascading default, global depression and bank runs echoed throughout the meeting rooms. Thankfully, by the weekend’s end, the message sank in, and Europe emerged with the beginnings of an agreed plan.

The news is not so much the nature of the plan. The broad lines of a likely structure had been anticipated by various analysts and market participants in the run up to the meetings. What was new was the recognition on the part of the EU leaders that several specific steps — steps heretofore publicly dismissed by the broad swath of European leaders — were now necessary. The three elements are:

• A serious and confidence-building European bank recapitalization process
• A far deeper restructuring of Greek debt
• A larger, leveraged war chest with which to finance the bank recap and build a firewall to protect Italy, Spain and France

This represents a significant step forward. It is good for markets, good for Europe, and, indeed, good for the rest of the world. It addresses many of the urgent issues, and would also allow Europe to focus on the important, longer-term ones.

However, a lot a work remains to be done, and this plan, even if perfectly carried out, does not solve several critical issues. Here are the risks:

Implementation risk. National governments have to pass the European Financial Stability Facility implementing legislation, and the Frankenstein of a financial structure that is being contemplated needs to avoid constitutional challenges, downgrades, and other logistical roadblocks. If it can be credibly argued that the plan stays within the confines of the Treaty, it will go a long way toward assuaging punctilious German concerns.

Size. The eventual leveraged fund has to been seen by the market as having a de facto unlimited balance sheet. Markets like finite numbers and will be quick to start the countdown of remaining resources as soon as the new entity starts buying Italian and Spanish bonds. The numbers being floated (~EUR 2 trillion) look on the low side. I think a number north of EUR 3 trillion would more likely achieve the famous “bazooka effect”. The more you have, the less you need. I may be underestimating EU creativity, but to do this I think IMF NAB resources may be needed as a second loss tranche, along the lines of what I suggested last week and Raghuram Rajan mooted yesterday in the Financial Times.

Optimal-degree-of-crisis syndrome. This is another form of implementation risk. The modus operandi in Europe has been minimalist, instrumentalist, and reactive. They have responded once their pain thresholds were reached, only to relax efforts once the sense of crisis subsides. This has led people to underestimate the fundamental resolve of EU leaders. But, the structural coordination issues in Europe are very serious, and policymakers will have to work very hard to avoid falling again into this trap in the coming months.

Portugal (and maybe Ireland). Two things that stood out from the weekend in Washington were (1) how clear the consensus was around a deeper restructuring for Greece and (2) how far policymakers were from considering a solvency solution for Portugal (or Ireland). The reasons are political, not economic. The implication for Europe is if Portugal — a country most careful analysts believe is insolvent and highly uncompetitive — ends up on the protected side of the firewall, markets will be skeptical that this is a definitive solution. And, if any part of the solution is deemed to lack credibility, the credibility of the entire plan will be called into question. The same can be said for Ireland, even though its insolvency is more ambiguous and its competitive position is much better than that of Portugal or Greece.

Fundamental design flaw. The biggest issue is one of design. Europe does not meet — and never has met — any of the main criteria for an optimal currency area. So, even if the urgent financial issues of the EU were to be solved by this latest initiative, it will not — for both structural and cyclical reasons — bring about growth. The single currency, for all its virtues, represents handcuffs for the peripheral countries. With nothing but fiscal adjustment and structural reform (which in the initial years is contractionary) on the horizon as far as the eye can see, the feedback into the debt sustainability equation is likely to be persistently negative. In the long term this will be a very serious problem — perhaps an unsustainable one — for not just Greece and Portugal, but also for Italy, Spain, and possibly France.

For now, however, the Europeans are coalescing around a financial plan. After much denial, they seem to have taken on board the psychological dimension of the battle they are in. It is important that the world now steps up to provide its full support. It may not be a growth plan, and it contains short term risks and longer term design flaws, but given the fragile state of the global economic landscape, once again, plan beats no plan.

There’s one big reason why the current economic weakness in the US has come as such a shock. It’s not the only reason, but it’s an important one, and it hasn’t gotten nearly the attention it deserves: the state of macroeconomic data-gathering in the US is pretty weak.

In particular, the data coming out of the Bureau of Economic Analysis at the beginning of 2009 was way off. Here’s Cardiff Garcia, introducing an interview with Fed economist Jeremy Nalewaik:

The initial GDP estimate for the fourth quarter of 2008 showed that the economy contracted by 3.8 per cent. It was released on January 30, 2009 — about three weeks before Obama’s first stimulus bill passed. That number was continually adjust down in later revisions, and in July of this year the BEA revised it all the way down to a contraction of 8.9 per cent.

The BEA is happy to try to explain what happened here — but whatever the explanation, the original 3.8% figure was a massive and extremely expensive fail. It was bad enough to be able to get a $700 billion stimulus plan through Congress, but if Congress and the Obama Administration had known the gruesome truth — that the economy was contracting at a rate of well over $1 trillion per year — then more could and would have been done, both at the time and over subsequent months and years. Larry Summers warned at the time that the risks of doing too little were much greater than the risks of doing too much; only now do we know just how right he was on that front. (And even he didn’t push for a stimulus of more than $700 billion.)

So what’s being done to beef up the state of America’s macroeconomic statistics so that this kind of monster error doesn’t happen again? The BEA is doing the best it can, but it’s constrained both in terms of its budget and in terms of the quality of economists it can attract.

Here’s how Cardiff ended his interview:

FT Alphaville was recently having a broader discussion about the status of macroeconomic data-gathering in the US with a fellow blogger, Felix Salmon, and he made the point to us that it’s been in secular decline for the last few decades. Do you agree? Is this something that’s come up in your work on output measures?

Some evidence suggests that the measurement errors in GDP growth have become worse in recent years. This may have to do with the increasing importance of services in the economy in recent decades, a sector where the GDP source data has historically been spotty. This is because, historically, the U.S. Census bureau has not collected spending data for many types of services on a regular basis.

Despite budget constraints, the statistical agencies have mounted a major effort to improve their measurement of services GDP. However, even as they make progress, it is important to keep in mind that there will always be measurement errors of some kind or another in the GDP and GDI source data, so taking some sort of weighted average, as I proposed in the Brookings paper, would be the soundest approach.

Frankly, this just isn’t good enough. Moving to a weighted average of GDP and GDI doesn’t improve the quality of our statistics one bit; it’s just an attempt to cope with the fact that neither of them is particularly reliable. As the economy becomes increasingly complex and service-based rather than goods-based, it’s crucial that our statistical architecture keeps pace — and it clearly isn’t doing so.

When I told Cardiff that the status of macroeconomic data-gathering has been declining for decades, I was making two separate statements — first that the quality of statistics has been declining, and secondly that the status of economists collating such statistics has been declining as well. Once upon a time, extremely well-regarded statisticians put lots of effort into building a system which could measure the economy in real time. Today, I can tell you exactly how many hot young economists dream of working for the BEA on tweaks to the GDP-measurement apparatus: zero.

I’m pessimistic that this is going to change. Putting together macroeconomic statistics is not a prestigious part of the economics profession any more, and government payscales are pretty meager compared to what good economists earn elsewhere.

Increasingly the economists in the government who craft the policy responses to macroeconomic developments are working on a GIGO (garbage in, garbage out) basis. That, in turn, means more bad responses, more bubbles, more recessions, and in general more macroeconomic volatility. The world is getting messier — and we don’t even have a good basis for measuring just how messy it is, any more.

If you look at his blog, his Twitter account, and his interview with Forbes, not to mention his notorious BBC interview, it’s pretty clear that Alessio Rastani is, at least in part, who he says he is. The Yes Men do set up elaborate hoaxes, but they do so with respect to large institutions: they wouldn’t put this much effort into inventing “Alessio Rastani” out of whole cloth. Mostly because there are lots of genuine traders like Alessio Rastani floating around the internet already. They trade their own money, they sometimes win and they sometimes lose, and they aspire to getting famous on the internet and selling their own trading advice.

That said, however, the resemblance to “Jude Finisterra” from the Yes Men is startling. Which raises the question: is it possible that Rastani is both a trader and a member of the Yes Men? And the answer there, I think, is absolutely yes.

Independent traders are, well, independent — and you don’t need to spend very much time hanging around the comments section (or even many of the posts) at Zero Hedge to discern a strong nihilistic and even anti-capitalist strain to much of the thinking in that community. Independent traders are often men in their 20s and 30s who inherited a substantial sum of money and who for whatever reason don’t have a more attractive opportunity in the regular workforce. They work from home, they tend to have a strong contrarian streak, and they have a lot of time on their hands.

All of which is entirely consistent with the profile of the kind of people who might join or become the Yes Men.

If you look at the two videos side by side (here, for instance), two things are pretty clear. One is that Rastani and Finisterra look and sound very similar to each other. But the other is that Finisterra is much less convincing, while Rastani is much more genuine: he seems to know what he’s talking about — stumbling over his words as he tries to explain trading to a broad audience — and believe what he’s saying.

I have no idea, then, whether Alessio Rastani is his real name, or whether he’s a member of the Yes Men. But here’s the thing: even if Rastani were a member of the Yes Men, that wouldn’t necessarily make his interview a hoax. Indeed, a trader who is hoping for a big stock-market crash is exactly the kind of person who might well put time and effort into undermining large corporations like Dow Chemical. Remember that the authors at Zero Hedge call themselves Tyler Durden, after the anarcho-nihilist character in Fight Club who wants to blow up the world.

It’s a common misconception that all traders are die-hard capitalists. But in fact many of them are quite the opposite. They still want to make money, of course. But that doesn’t mean they want the stock market to go up.

Treasuries due in 10 years or more have returned 28% this year — Bloomberg

China’s economy is still growing, but social unrest is way up — WSJ

Meanwhile, in the U.S., property crime has decreased in proportion to GDP losses — Economist

A booming North Dakota town has 3,000 unfilled jobs and parking spots that go for $1,200 — NPR

Dan Ariely says to be as vague as possible when hiring people — BusinessWeek

Alphaville has UBS’s Gruebel’s goodbye memo — FT Alphaville

Tumblr lands $85 million in new funding — NYT Bits

Netflix cuts a streaming deal with Dreamworks, but it doesn’t come cheap — NYT

Berkshire Hathaway is buying back shares, paying a premium of up to 110% — Bloomberg

And five banks account for 96% of the $250 trillion in outstanding derivative exposure — ZeroHedge

I’m in Sofia today, where I gave a talk on Groupon at the DigitalK conference. This post isn’t the speech that I gave, which was much shorter and more conversational; the slides I used are here.pdf. There’s not much new in this post, for those who have been following what I’ve written on Groupon over the past few months; I basically wrote it to get a feel for how I wanted my speech to flow. But here you go anyway.

It’s almost universally known, among people who live or work anywhere near the intersection of technology and finance, that Groupon is the fastest-growing company the world has ever seen. Technology companies are often fast-growing, of course, but Groupon’s growth rate is astonishing even by tech standards. Check out this chart:

Starting at zero, Groupon got within shouting distance of $1 billion in revenues within a single year. It took Zynga two years to get to that point, it took Amazon three years, and it took Facebook four years. eBay hadn’t even got there after five years. This isn’t entirely or even mostly a function of Groupon’s business model; much more important is the massively increased willingness of people to buy things online now than when the likes of eBay, Yahoo, and Amazon launched in the 1990s.

And it’s possible to quibble over terminology here, too: in its latest filing, Groupon now calls this number “billings”, with “revenues” being about half of what we see here. But whatever you call it, it’s a monster stream of cash which is flowing into the company, and you can add to these revenues some $1.1 billion in new equity capital, which is also helping to fuel expansion. Groupon isn’t just growing fast: it’s also raising money at a rate that no other company has ever dreamed of.

Importantly, the stream of cash flowing out of the company is even bigger. Half of Groupon’s billings go to merchants, usually small local businesses. Much of the rest goes towards Groupon’s rapidly-growing payroll, and to fund expansion into new cities and countries. And then there’s more than $900 million which has been used to cash out early investors in the company, including CEO Andrew Mason — a man who is now extremely wealthy even if Groupon stock goes to zero tomorrow.

Groupon is a very innovative company, and this is one of its most important innovations — the idea that the founder can and even should be able to cash out to the tune of millions of dollars very early on in the company’s lifecycle, while it is still raising new VC funds.

The argument here makes a certain amount of theoretical sense. VC investors are looking for home runs, and they’re willing to see a reasonably large percentage of their portfolio investments fail to achieve that end. Essentially, they want the CEOs they’re backing to take on as much risk as possible.

But there’s a problem with this model: CEOs are human, and humans are naturally risk-averse. When Andrew Mason first saw that he’d built Groupon into an inherently highly-profitable Chicago company, he could have decided to fund further expansion only out of the company’s profits, while keeping some portion of those profits for himself and his investors. Groupon would have grown at a much more normal pace, and would certainly never have generated eye-popping charts like this one.

Over the course of one year, from the first quarter of 2010 to the first quarter of 2011, Groupon’s subscriber base increased 24-fold; its revenue increased 14-fold; its sales rate increased 15-fold; and it swung from a profit of $8 million to a loss of $146 million.

These are the kind of figures which make eyes go wide — with greed, if you’re a VC, and with fear, if you’re an businessman trying to build a company which can deliver a reliable long-term profit stream. By cashing out a significant portion of the CEO’s stock, his backers essentially turned him from businessman to VC — they aligned his incentives with theirs. He won’t want for money ever again, so he’s no longer the type of person who would look at a company making $8 million a quarter and think that was pretty good. Instead, he wants to take risks, grow at a breakneck pace, and create a company which is likely to go public, later this year, at a valuation somewhere in the neighborhood of $15 billion. He wants to change the world.

That’s the idea, anyway; we’ll see how it works out. Historically, VC rounds have been about providing capital to companies which need it; in Groupon’s case, they’re more about finding a way to cash out early investors. And so a lot of people who own Groupon stock today didn’t really put money into the company, so much as they simply bought pre-IPO stock on the secondary market. If they end up making a fortune in the IPO, then other companies will certainly start looking at the Groupon model as something maybe worth emulating.

What’s sure, however, is that the kind of growth and ambition exhibited by Groupon is catnip to journalists looking to puncture something which looks very much like a bubble. Going public before you’ve achieved sustainable profitability? Using seemingly made-up measures like Adjusted Consolidated Segment Operating Income instead of generally-accepted accounting principles? Becoming a billionaire before the age of 30, while refusing to play according to the spoken and unspoken rules of both Wall Street and Fleet Street? It’s a recipe for getting the press to turn on you.

But in fact the conventional wisdom on Groupon is narrow-minded, a little bit silly, and largely based on journalists kidding themselves that “everybody” thinks Groupon is a huge success, and that therefore it falls to them to debunk the myth. In reality, the huge-success meme was extremely short-lived, and stems largely from the fact that Google attempted to buy Groupon for $6 billion at the end of 2010. Ever since Groupon turned Google down, there’s been a steady drip of stories saying that they were idiotic to do so and that valuations of Groupon in the $15 billion to $25 billion range are utterly ridiculous.

Now, I’m not going to take a position on how much Groupon is worth; I’m neither an investment banker nor an equity analyst. But what I’d like to do is run down a few reasons why a stratospheric valuation could conceivably be justified, and then look at a few of the potential potholes which face Groupon in its attempt to justify that valuation.

First of all, Groupon has cracked local, in a way that pretty much nobody else has been able to do. We spend most of our disposable income at merchants located within easy striking distance of where we live — but until Groupon came along, those merchants had no good way to reach us online. Everybody’s interested in what’s going on locally, and Groupon worked out that a steady stream of daily emails, each one touting a great local deal, would be hugely attractive to millions of people. This is advertising you want to get.

Second, Groupon has created advertising that is guaranteed to work. By setting a minimum number of people who need to sign up for a deal before it’s activated, merchants can be sure that the needle will be moved and their effort won’t be wasted. This is something of a holy grail in advertising and marketing circles, and it absolutely helps to explain Groupon’s spectacular growth. Merchants hate to spend money on marketing because they fear they’re being swindled by fast-talking sales reps. With Groupon, they know exactly what they’re signing up for, and they won’t end up spending huge amounts of money on nothing.

Indeed, those merchants are not spending any money at all: they’re being paid. This is another great Groupon innovation: create a form of advertising which merchants not only pay nothing for up front, but which they actually get paid. Yes, there’s a cost to providing their goods or services, and in many cases that cost is greater than the amount of money they’re getting from Groupon. Merchants who get too greedy for a big up-front paycheck can end up ruining themselves when those coupons get redeemed. But anybody who’s ever run a small business knows that the promise of money in hand is always going to be incredibly attractive when compared to advertising or marketing which has to be paid for.

In fact, Groupon gives advertising away for free. It has an astonishingly valuable email list, and many merchants would pay good money to be able to send out wittily-written ads to local Groupon subscribers. But they don’t need to do that. Groupon makes its money from the tiny minority of customers who actually pay for a deal. But that leaves millions of people every day who read ad copy which is targeted directly at them. That targeted advertising is extremely valuable, and Groupon isn’t charging a penny for it. Because it has an alternative source of income, Groupon doesn’t need to charge merchants for the privilege of being included in its emails. And so a merchant who values that exposure is well ahead of the game as soon as the email goes out.

But another Groupon innovation goes one further than that — it’s the Groupon commitment device. A commitment device is the way the people force themselves to do something which they know they want to do, for fear that for some reason or other human weakness might otherwise mean they wouldn’t do it. The classic commitment device is marriage: it helps people stay together when otherwise they might drift apart. A mortgage is also a commitment device, which forces you to spend a large sum of money every month slowly building equity in your home, until after 30 years you own it outright. A Groupon, of course, is nowhere near as important as marriage or a mortgage. But it has a similar effect. I see a Groupon in my email — let’s say it gives me $50 off a meal at a restaurant I’ve been meaning to try down the street. By buying the Groupon with a click of my mouse, I force myself to go to that restaurant — something I might well never have got around to, otherwise.

Groupon forces its customers to buy its products using something which isn’t very innovative at all — the hurry-it-won’t-last-long sales pitch. By making sure that offers can only be bought for a day or two, Groupon forces people to make a decision now as to whether they want to do this thing. And that non-innovative part of the Groupon model is one of its big potential weaknesses, as I’ll come to in a minute. But first of all there are some potential strengths to Groupon.

What we’ve seen up until now is the way that Groupon has worked and grown to date. But looking forwards, optimists see lots of other great promise in the company. I don’t want to dwell on these, because forecasting the future of any tech company is always a mug’s game. Some of them are likely to work, others will probably fail. There’s Groupon Now, and the mobile applications which are nascent but growing fast. There’s the move from services into products. There’s the Getaways travel product. And there’s targeting — the crucial way in which Groupon promises to be able to target customers according to their purchasing preferences and a myriad of other factors, rather than just going on what city they live in. It hasn’t happened yet, but I suspect that over the medium term, Groupon will succeed or fail based on whether it manages to crack the targeting nut. Having a huge subscriber base is a necessary condition for targeting, but it’s far from sufficient.

I have no idea what any of these businesses might be worth, or what kind of probability to apply to them succeeding. But looking down this list, and looking at the kind of money which Groupon is bringing in without these businesses, it’s definitely possible to see how this could be a $20 billion company, potentially.

But.

There are also risks to the Groupon model, and we’re already seeing some of them materialize.

One risk is that merchants stop wanting to play ball. Maybe they move their business to to a Groupon clone which offers them a bigger cut of the proceeds. Maybe they don’t return to Groupon because it turns out that too many Groupon buyers are only coming because they bought the Groupon, and don’t become valuable repeat customers. Or, conversely, maybe it turns out that too many Groupon buyers are people who would have come anyway, and so the merchant is simply taking a big haircut on their normal revenues. Or perhaps — as we’ve seen happen a few times, according to press anecdote — merchants simply get overwhelmed by Groupon traffic, and thereby alienate their existing customers.

If you look at the established market of Boston, the trend here is not good. As markets mature, they won’t be as white-hot as they were in their youth. But one big problem for investors is that none of them really have a clue what kind of revenue per merchant is necessary for profitability.

The other big risk is that consumers stop wanting to play ball. The novelty wears off, they find too many Groupons sitting unused in their desk drawer, they get burned one too many times by a deal which seemed really good in the email but which turned out in real life to be disappointing.

Already we’re seeing signs that this is happening: according to a guy called Sam Hamadeh, Groupon’s revenue per customer has fallen from $15 per month to $3 per month. Now the number of customers is still growing fast, but clearly profits are going to be hurt if those customers don’t spend nearly as much as they used to. Here are the numbers for Boston, again:

And there are other risks, too, including big possible legal risks. There are lots of laws governing coupons, in all 50 states and around the world, and Groupon seems to be happily violating dozens of them, while doing its utmost to fob legal responsibility off onto merchants who can’t possibly know what the law says.

But the biggest risk of all, which pretty much encompasses all of the other ones, is simply that Groupon will develop a bad reputation. If people don’t trust Groupon, then it’s all over.

In the beginning, Groupon got away with a lot, thanks partly to how innovative it was and partly because of the jocular tone to its emails. But at this point everybody knows what the model is, and the humor is hardy surprising any more. And increasingly consumers and merchants are asking just how good Groupon’s deals are, really. Not in terms of save $X if you spend $Y, but in terms of the intrinsic quality of the merchants being featured.

It seems to me that if Groupon wants the Yipit charts to start going up and to the right, if it wants to delight consumers, and if it doesn’t want to become shorthand for desperate-and-crappy merchants resorting to a last-ditch effort to get people into their otherwise-empty stores, then it’s going to have to start imposing more editorial control over its sales team.

In the long run, people will buy coupons only from those sites they trust to send them to great merchants. Groupon has first-mover advantage, but consumers are fickle, and will happily switch their allegiance to smaller companies they think are cooler, if Groupon makes them feel a bit unwashed every time they buy into an offer.

How can Groupon ensure that it features only merchants its email list will love? I haven’t a clue. But that’s the single biggest task facing the company. If it wins at that, it’ll be fine. If it fails, I fear it will slowly wither away.

Last week, the California legislature sent the governor a bill that would ban most employers from running credit checks on job applicants. If the governor signs the bill into law (which this web site tells us he’s likely to), California will become the biggest get yet for those pushing for such laws around the nation. Is this just what a country full of unemployed people with wrecked credit needs? Or is it, as HR managers have been hollering, a way of hindering them from finding good, upstanding workers?

The back story is as follows. A decade ago, about a third of employers ran credit checks on job applicants; today, some 60% do. HR types (and, of course, the Big Three credit bureaus) argue that credit checks help firms find reliable employees who are unlikely to steal from company coffers. Civil liberties types argue that pre-employment credit checks have a disparate impact on groups that tend to have lower credit scores, like minorities.

The Great Recession is what makes this back-and-forth particularly interesting. Losing a job is one of the fastest ways to wreck your credit. Now, it seems, that same bad credit may hinder you from regaining a steady paycheck and mending your finances. Quite the vicious cycle.

But you’ve also got to feel a little bad for firms. The labor market is full of asymmetric information and while employers often have the upper hand (they know how much other workers get paid, what employees actually contribute to the bottom line, etc.), it can be a very scary thing to go out into the world and pick a person to let into your business.

So who should win the debate? Should firms be banned from using credit checks in the hiring process?

Let’s look at the evidence.

There is a lot of reason to believe that using credit reports to judge candidates will lead to unfair outcomes. Consider, for instance, a case the Department of Labor won against Bank of America which revealed that by using credit checks in its application process for entry-level jobs, Bank of America excluded 11.5% of African-American applicants, but only 6.6% of white applicants. Who else might reliance on credit reports work to exclude? Well, the major causes of bad credit are things like divorce, large medical bills, and unemployment. So, maybe divorcees, the uninsured, and the currently jobless?

Now, one might argue that while such a situation is unfortunate, it is nonetheless part of a bigger picture. By judging job candidates on debt-to-income ratio, accounts in collection, foreclosures, bankruptcies, and education and medical debt (all things firms report will make them less likely to hire a candidate), employers are helping to ensure that they wind up with good workers.

The only problem is, there isn’t any evidence that credit is an indicator of how reliable a worker will be, or the likelihood that he will embezzle or otherwise steal. As a lobbyist for TransUnion testified in front of Oregon legislators last year: “At this point we don’t have any research to show any statistical correlation between what’s in somebody’s credit report and their job performance or their likelihood to commit fraud.” The state of Oregon has since banned job candidate credit checks.

So have Connecticut, Maryland, and Illinois, joining first-movers Washington and Hawaii. It looks like California will be next. And that’s almost certainly a good thing.