Al-Maliki's Mehdi ultimatum

CNN's Nic Robertson speaks with Iraqi Prime Minister Nuri al-Maliki about the Mehdi Army, Blackwater and other issues.

Luxury Week: de Grisogono

CNN's Monita Rajpal speaks with Fawaz Gruosi, the CEO of de Grisogono, about his new mechanical digital timepiece.

From bottles to carpet

A new breed of business is making both a profit and environmentally friendly goods. CNN's Miles O'Brien reports

The Daily Loper - April 3, 2008

Everything All Of The Time Edition

Todays links of interest:

• iTunes Overtakes Wal-Mart in Music Sales
  So. This is a good thing in that Apple is substantially less evil and more music-focused than Wal-Mart. It’s still a bad thing in that selling music really isn’t Apple’s primary goal. Also: enjoy it while you can, Apple, because Amazon’s potentially far more awesome music store is just gathering steam.
• What happened when I Googled For You
  When you set up a website for a fake company as an April Fools joke, one of two things happens: naturally, some people don’t get that it’s a joke and have negative reactions to the idea as it is presented to them. But other people get the joke and want to play along, just to see how far you’re willing to go to perpetuate it. Not that we’re experts or anything, but we don’t think that Manjoo should have admitted anything, certainly not this soon. Or ever.
• Radiohead Best Of Details Revealed
  In case you were wondering why Radiohead wanted to leave EMI in the first place. Expect slightly different repackagings of what will be essentially the same bunch of the songs every few years between now and the end of time.
• McCain Reacts to Heidi Montag Endorsement!
  They. Deserve. Each. Other.
• New York `Borat’ Lawsuit Is Dismissed
  Borat deemed to be "journalism", which makes sense if Lou Dobbs and Bill O’Reilly and Chris Matthews are allowed to claim they’re journalists…
• MySpace music venture to take on iTunes
  Stop us if you’ve heard this one before.
• Critics v bloggers - who’ll win?
  Why do we need a winner at all? Remember, it’s all about the either/and.
• MLB.TV strikes out with premium online video
  Opening day mostly sucked for MLB.TV subscribers. But have no fear, usage will likely drop off dramatically for the next 150 games or so, then pick up again as playoffs approach.

Soros Lambasts Paulson, Call for Intervention

George Soros, in today's Financial Times, joins a long list of critics of the Paulson financial services reform plan, although even to dignify its bureaucratic legerdemain with the label "reform" is singularly misleading.

Soros departs from his peers in sketching out where he thinks regulators went wrong and offers two specific proposals, I am particularly keen about his idea of moving credit default swaps to an exhange; as I've discussed before, that is one of the cleanest and most sensible options available, and it would be viable in a large, active market like CDS.

From the Financial Times:

The proposal from Hank Paulson, US Treasury secretary, for reorganising government regulation of financial institutions misses the point. We need new thinking, not a reshuffling of regulatory agencies. The Federal Reserve has long had authority to issue rules for the mortgage industry but failed to exercise it. For the past 25 years or so the financial authorities and institutions they regulate have been guided by market fundamentalism: the belief that markets tend towards equilibrium and that deviations from it occur in a random manner. All the innovations – risk management, trading techniques, the alphabet soup of derivatives and synthetic financial instruments – were based on that belief. The innovations remained unregulated because authorities believe markets are self-correcting.

Regulators ought to have known better because it was their intervention that prevented the financial system from unravelling on several occasions. Their success has reinforced the misconception that markets are self-correcting. That in turn allowed a bubble of excessive credit to develop, which extended through the entire financial system. When the subprime mortgage crisis erupted it revealed all the weak points. Authorities, caught unawares, responded to each new disruption only after it occurred. They lacked the ability to foresee them because they were in the thrall of the market fundamentalist fallacy. They need a new paradigm. Market participants cannot base their decisions on knowledge, or what economists call rational expectations. There is a two-way, reflexive interaction between the participants' biased views and misconceptions and the real state of affairs. Instead of random deviations, reflexivity may give rise to initially self-reinforcing but eventually self-defeating boom-bust sequences or bubbles.

Instead of reshuffling regulatory agencies, the authorities ought to prepare for the next shoes to drop. I shall mention only two. There is an esoteric financial instrument called credit default swaps. The notional amount of CDS contracts outstanding is roughly $45,000bn. To put it into perspective, that is about equal to half the total US household wealth and about five times the national debt. The market is totally unregulated and those who hold the contracts do not know whether their counterparties have adequately protected themselves. If and when defaults occur, some of the counterparties are likely to prove unable to fulfil their obligations. This prospect hangs over the financial markets like a sword of Damocles that is bound to fall, but only after some defaults have occurred. That must have played a role in the Fed's decision not to allow Bear Stearns to fail. One possible solution is to establish a clearing house or exchange with a sound capital structure and strict margin requirements to which all existing and future contracts would have to be submitted. That would do more good in clearing the air than a grand regulatory reorganisation.

The other issue is rising foreclosures. About 40 per cent of the 6m subprime loans outstanding will default in the next two years. The defaults of option-adjustable-rate mortgages and other mortgages subject to rate reset will be of the same order of magnitude but occur over a longer period. With single family home sales running at an annual rate of 600,000, foreclosures will overwhelm the market and cause prices to overshoot on the downside. This will swell the number of homeowners with negative equity who may be tempted to turn in their keys. The fall in house prices will become practically bottomless until the government intervenes. Cutting foreclosures should be a priority but the measures so far are public relations exercises.

The Bush administration has resisted using taxpayers' money because of its market fundamentalist ideology. Apart from a bipartisan fiscal stimulus, it has left the conduct of policy largely to the Fed. Yet taxpayers' money will be needed to reduce foreclosures. Two proposals by Democrats in Congress strike a balance between the right to foreclosure and discouraging the exercise of that right. One would modify the bankruptcy laws allowing judges to modify the terms of mortgages on principal residences. Another would provide Federal Housing Administration guarantees that would enable mortgage holders to be paid off at 85 per cent of the current appraised value. These proposals will not solve the housing crisis, but go to the heart of the issue. They should be given serious consideration.

Orwell Watch: Wal-Mart CEO Wants Business to Influence Health Policy

How dare the CEO of Wal-Mart, the company that makes such a studied practice of paying workers so badly that taxpayers subsidize its prices, say he and big business should influence health care policy? The US has the most costly healthcare in the world while failing to produce materially better results than countries with varying degrees of so-called socialized medicine. Large corporations are the most powerful buyers in the health care system, yet their efforts to improve delivery and lower costs have been singularly unproductive. So why should a crowd that has consistently failed have any say in reform?

And Wal-Mart promoting this line is particularly heinous. The Bentonville giant is known for keeping workers just below the number of hours to qualify them as full-time, precisely to avoid giving benefits such as health care. Thus if workers are single or married to spouses who similarly lack coverage, the likelihood is high that they will upon occasion turn to emergency rooms for health care, which is an extraordinarily high cost delivery system that comes out of the collective purse.

And listen to this from CEO Lee Scott, quoted in the Financial Times:

I think government is going to be engaged after this election regardless of who wins, and I think business should be more involved in the discussion. I think it has long-term ramifications for our global competitiveness.

Hhhm. Most (read all) of our advanced economy trade partners have more generous public payment for health care. They also have lower current account deficits than we do. While correlation is not causation, tell me why I should believe the reverse is true, that a single payer system would be bad for competitiveness? There seems to be a dearth of evidence to support this view.

New Wall Street Gimmick: "Ring Fencing" Dead Assets

Several alert readers caught the Financial Times story, "Wall St banks seek to ring-fence bad assets," and I held off from posting on the assumption it would merit coverage in the Wall Street Journal or the New York Times. Not so.

The Financial Times article says that investment banks are seeking to put dodgy assets in a separate subsidiary, with the hopes of offloading it to over-eager bottom-fishing chumps investors. Or if that doesn't work, to taxpayers:

According to people familiar with the matter, banks are discussing a joint proposal to regulators to set up a fund, which would absorb US subprime assets and other troubled securities, as a way of restoring confidence in the banking system and ending the pressure to recognise mark-to-market losses.

I don't give this proposal any hope of seeing the light of day, at least in this form, although a huge number of permutations later, something that might have germinated with this idea could come to life.

The biggest obstacle is the idea that this facility would be organized by the industry and all would participate on the same terms. As we found with the stillborn SIV rescue plan and the "bail out the monolines" firedrill, getting consensus among a large number of disparate players is well-nigh impossible.

This effort is likely to founder over the same issue that killed the MLEC, the hoped-for SIV garbage dump, which is how to value the assets going into the new vehicle. Prices need to be set for the instruments that will be moved out of a bank; this stuff by definition doesn't trade so how to price it is legitimately subject to debate. But that's assuming it even got that far. For participants to have a down-and-dirty discussion, they'd wind up shedding light, if in a general way, on their exposures and how much they had marked them down. I doubt that the involved parties would risk revealing that much.

The FT points to problems along these lines:

However, bankers say the prospect of a co-ordinated solution remain remote because of the difficulties in getting banks to agree on the terms and the scope of a common fund.

John Thain had said of the vastly simpler (and still unsuccessful) mononline effort that it would not work on a group basis, but institution by institution. So let's consider that case:

Under UBS's scheme, the bad assets will remain on the bank's balance sheet because the Swiss bank will initially retain full ownership of the new fund. However, UBS is expected to sell all or part of it to outside investors, or to spin it off, according to people familiar with its plan.

Um, this works only if the price to which you have marked the assets is lower than a third party is willing to pay. Otherwise, you wind up worse off. Simple example: you've written this garbage barge down to 25 cents on the dollar, convinced that that it extraordinarily cheap. But then you try getting bids, and all you get is 20 cents on the dollar, You'd have to take another 5 cents on the dollar loss to sell it, which is another hit to equity, which is precisely what you were trying to avoid.

Or just as bad, word gets out that you shopped your little nuclear waste subsidiary, but didn't like the offers. Now guess what that will do to your stock price, your counterparties' confidence, and CDS prices on your debt. You were better off having everyone believe, or pretend they believed, that your write-offs put all your problems behind you.

So this does not appear a bona fide notion to unload this stuff onto third parties, despite chatter of hedge funds and distressed investors out buying MBS and mortgages (that stuff is a walk in the park compared the complexity of some of these structures). And the volume that would be on offer is certain to swamp demand.

This effort, then, despite the brave talk (and perhaps a bit of self-delusion), is preparation to somehow dump these toxic assets on the laps of the Powers That Be. But the Resolution Trust Corporation created good banks and bad banks out of failed banks. It's an amazing bit if hubris if the industry thinks it can shove these assets onto taxpayers and carry on unimpeded.

There is also a lack of historical memory. The RTC was extremely controversial; Congress was not happy about funding its sizeable working capital requirements. And in contrast with 1990-1991, there are calls for relief from a lot more quarters. Wall Street may find it tougher than it thought to get its hoped-for rescue operation.

Quelle Surprise! Home Ownership Restricts Mobility, Particularly If You Can't Sell

Louis Uchitelle, in "Unsold Homes Tie Down Would-Be Transplants," points out that being unable to sell a house can keep people from taking jobs that require them to move. That problem is obviously now more acute given the moribund state of the housing market in many parts of the county. However, Uchitelle implies that the negative-labor-market impact of home ownership is strictly the result of a lousy real estate market.

That isn't accurate. As we pointed a year ago in "Is Owning Your House Bad for You?" we took as a point of departure an article by Tim Harford in Slate:

Even when we look only at internal migration, the barriers are formidable. Wherever people seem particularly keen to own their own homes—as in the United Kingdom, Spain, and some U.S. states—employment suffers as a result. English economist Andrew Oswald has shown that across European countries, and across U.S. states, high levels of home ownership are correlated with high levels of unemployment. More conventional factors such as generous welfare benefits or high levels of unionization don't explain unemployment nearly as well as the tendency to own houses. Renting your home and staying flexible do wonders for your chances of always finding an interesting job to do.

Recent research in the Economic Journal suggests that people who own their own homes form denser local networks, which help unearth local jobs. Still, the jobs tend to be less well-matched and commuting distances are longer. So, professor Oswald is right to argue that we should do everything possible to free up impediments to renting or to selling a house and buying a new one. It would be handy if we were allowed to build houses near Manhattan, too.

Even if we did all this, economists Ed Glaeser and Joe Gyourko argue that one serious barrier remains: Houses do not walk. No matter how bad things get in Detroit or Treorchy, the houses will still be there, and if they are cheap enough, people will want to live in them. The likely result is a gloomy sort of segregation: Those who feel that they can find a good job in the boom cities will move there and pay the higher rents. Those who are less confident of that would rather have no job in a cheap house than no job in an expensive house. Detroit will have residents for a long time to come.

My comments:

It's an interesting thesis, and likely some truth in it too, but there is one huge hole: the data isn't adjusted for age. Older people are more likely to own homes. And unemployed people over 40 (in some fields, over 35) find it much harder to find a job. It's age discrimination, in part, but also the reality that most organizations are pyramid shaped. There are more jobs at the bottom and the middle. Employers don't like hiring people who are overqualified (the subordinate might know more than the boss, or might get bored and quit). And for corporate and professional roles, employers also vastly prefer poaching someone from another company to hiring someone who is out of work, even if through no fault of their own.

But the demands of the workplace are at odds with home ownership and rootedness. I know of someone over 40 who did lose his job. His old employer was in Boston. His new employer is in exurban Philadelphia. He doesn't want to take his kids out of school, so he has a brutal commute. How many people are willing to do that?

The demands of labor mobility are increasingly in conflict with community life of any form. A McKinsey partner requisitioned a study by Yankelovich about 8 years ago, which reported (among other things) that college graduates would work for 11 employers before they retired. More recently, the Bureau of Labor Statistics predicts that current college graduates will have 13 jobs by the time they are 38 (note it is not clear whether this includes promotions). That kind of instability makes home ownership a risky move. It's not just the possible need to relocate, but the uncertainty over income that would get in the way.
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Yet Uchitelle fails to acknowledge that home ownership has been discussed in the economic literature and found to inhibit labor mobility even in good times. Guess we can't question that American dream.

From the New York Times:

The rapid decline in housing prices is distorting the normal workings of the American labor market. Mobility opens up job opportunities, allowing workers to go where they are most needed. When housing is not an obstacle, more than five million men and women, nearly 4 percent of the nation's work force, move annually from one place to another — to a new job after a layoff, or to higher-paying work, or to the next rung in a career, often the goal of a corporate transfer. Or people seek, as in Dr. Morgan's case, an escape from harsh northern winters.

Now that mobility is increasingly restricted. Unable to sell their homes easily and move on, tens of thousands of people ... are making the labor force less flexible just as a weakening economy puts pressure on workers to move to wherever companies are still hiring....

With homes changing hands easily in a booming market, interstate migration reached 2.2 million people in 2006, excluding the effects of Hurricane Katrina. As the economy and home prices began to unravel in 2007, however, interstate migration plunged to 1.6 million people....Worker mobility — or rather immobility — is making a big contribution to this decline....

Corporate transfers contribute significantly to worker mobility, and employers often cover at least some of the cost of selling a home in the old location and buying one in the new. That practice can backfire, says Richard Shaw, a vice president of Applied Industrial Technologies....

Out of 3,500 employees in the United States, Applied normally transfers 25 to 30 each year from one center to another... Despite the opportunity, transfers have fallen by half, Mr. Shaw said. That is mainly because transferred employees too often find themselves owning two homes — one in the old location and one in the new — and paying two mortgages.

Applied tries to minimize the problem by paying one of the two mortgages for up to six months, the expectation being that the old home will sell by then. Increasingly, that does not happen...

He tells of one transferred executive "who ended up owning two homes for more than six months and, finding himself paying two mortgages, opted to move back to his original city, surrendering his new house to the bank."

Bond Prices Imply Corporate Defaults at 2X Rate Forecast by Agencies

In an amusing bit of irony, Standard & Poors chief, in an interview, acknowledged that the bond markets are anticipating that corporate defaults will run at twice the rate foreseen by the rating agencies.

Recall that roughly half the big business debt outstanding is junk, and nearly all of that was issued in connection with LBOs.

The credit markets for some time have operated on the assumption that the financial system is under severe stress (which is confirmed almost daily in the press) and recession, likely a deep one, is in the offing.

Even if that view seems a bit dour, would you side with the rating agencies given their track record?

From Bloomberg:

Investors are pricing in defaults on corporate bonds twice as high as projected by rating companies, said Deven Sharma, Standard & Poor's president.

The rating assessor said on March 31 the default rate for non-investment grade U.S. corporate bonds may rise to as much as 5.7 percent and at least 3.4 percent by February next year, as companies are hurt by rising funding costs and a slowing economy. The rate was 1.09 percent in January.

``The markets are pricing in a default rate of nine or 10 percent for high-yield corporate debt, which is a lot higher than we're forecasting,'' Sharma said in an interview with Bloomberg TV. ``There is a recession and the recovery will be somewhat slower than we anticipated.''

The number of companies at risk of having their credit ratings downgraded rose by three to a record 703 in March amid a slowdown in housing and consumer spending that has pushed the economy closer to recession, S&P said on April 1. The number of potential downgrades is 90 more than reported a year ago and 68 more than the 2007 average.

Almost 76 percent of negative ratings changes have been among high-yield, high-risk companies, the rating assessor said...

``There is a fundamental change of behavior by consumers,'' he said. ``For many years, going back to the Great Depression, consumers always first paid their mortgage and if they default, they would default on their credit cards. For the first time, in 2005, we started to see the line being crossed, where consumers are willing to walk away from their mortgages.''

New home foreclosures in the U.S. rose to a record high in the fourth quarter as borrowers with adjustable-rate loans walked away from properties before their payments increased, the Mortgage Bankers Association said in a March 6 report. Late payments, or delinquencies, were the highest in 23 years, the bankers' group said.

Um, doesn't it occur to her that the change in consumer behavior might have been triggered by the new bankruptcy law? If you are above median income in your state (meaning ineligible for Chapter 7), it is easier to walk from your mortgage than your credit card debt. Another example of unintended consequences...