With the dramatic collapse of some huge financial institutions, unprecedented government interventions and an enormous increase in volatility all in the last couple of days, it's a great time to be an economics blogger! While there appears to be an ideological blogwar going on between the regulation hounds and the down-but-not-out libertarians, I'm not going to enlist. I am, however, in league with the libertarians on the short-sale ban. It's appalling. Skip the next three paragraphs if you know what short selling is (OK, read the next sentence if you want my only joke in this post)
In short (sorry), this is the practice of borrowing a share of stock that you don't own, selling it, and hoping the price goes down. If it does, you replace the share you borrowed with a cheaper one and keep the profit. If it goes up, the share you have to buy to close out your position costs more than you made, and you've just lost money. There are some more complicated ways to do these trades, but that's not pertinent right now.
Smart people are in agreement that short selling is, or at least can be, a good thing for market efficiency. If an asset is overvalued, the presence of short sellers will accelerate the price correction. The short sellers had better information than everyone else, and they profit deservedly. If the asset is undervalued, short sellers will lose money.
Short selling becomes unpopular when lots of assets that people pay attention to are overvalued, since it accelerates the correction that few people (including politicians) want to see. Of course, it's possible for some unsavory things to happen in the world of short sales. Like all investing, the act of short selling is (in itself) information, and can create a feedback loop. If investors see their colleagues taking short positions, and they suspect those people have good information, they may do the same. The collective effect might drive share prices far below what the market ultimately decides is an appropriate price. If that's true, the people who were late to the short-sell party will lose money. A more ominous concern is that short sellers may be disseminating bad information to cause an unfounded fall of the share price. That's fraud, and it's a legitimate fear.
I'm reminded of a case my sister worked on at the ACLU's Rhode Island affiliate. Community groups and authorities in Providence were becoming increasingly concerned that human traffickers were importing women and setting up unlicensed massage parlors that were really just exploitative brothels. Among other remedies, authorities proposed restrictions on the activities of massage parlors. As the ACLU successfully argued, these restrictions would only have affected legitimate businesses that were licensed and had already submitted to government oversight. The underground brothels would have no incentive to become legitimate. It was a clear case of confusing an illegal practice with a legitimate one, and regulating the latter.
What does this have to to with short selling? It's a legitimate practice, and it just got a blanket restriction.
If we assume that the SEC is not simply trying to manipulate stock prices upward (and i really hope that's not what this is about), then the concern - indeed, the only legitimate reason for this regulation - is that some short sellers are engaging in something malicious. Perhaps someone is spreading false information. Maybe the short sellers are actually terrorists! This has been put forward by respectable people, so i won't dismiss it. Whatever the problem was, it can't happen now that short selling is banned.
Here's my question: If you see this type of misconduct, can you target it specifically? Clearly it's preferable to locate and arrest anyone who is purposely spreading bad information. It goes without saying that we're better off apprehending terrorists than restricting their ability to make financial bets.
I'm hopeful that someone is trying to do those things. But what if you
can't find and arrest the evildoers? Or you think that will take too
long and the damage to markets will be done? Stop the feedback loop!
If an investor is spreading falsehoods - or betting based on falsehoods
- and you let the market know, the market is going to ignore the
information that it gleaned from that investor's transactions. If you
even present the compelling case that this is happening - without hard
evidence - the market will discount that investor's information. No more echo.
If you think that the market is in a feedback loop started by terrorists, tell everyone. The terrorist agenda (destruction of western civilization via financial collapse?) is substantially different from the typical investor agenda (profit maximization), and the market is unlikely to perpetuate that loop based on the idea that it's being driven by the person with the best information.
If the SEC has any concrete (or even not so concrete) evidence of misconduct among short sellers, it can achieve its agenda by simply publicizing that evidence. The echo chamber feasts off perceived information inferiority, and the SEC is well positioned to address that perception. But banning a legitimate practice because you suspect it's being exploited by evildoers is regulatory chemotherapy.
Just a couple weeks after the Economist pointed out the mission creep at the Fed, it looks like something startlingly similar is happening at the FDIC. Yesterday it announced a plan to modify mortgages issued by IndyMac (a bank that is now in its conservatorship) by lowering interest rates and extending payment terms for borrowers:
The [FDIC] plan announced Wednesday has two goals: keeping [IndyMac mortgage] borrowers in their homes -- a subject [FDIC Chairwoman Sheila] Bair has been outspoken on -- and increasing the value of IndyMac in the eyes of a potential buyer as the FDIC seeks to sell the bank and its assets. Materials provided by the FDIC make clear that the latter consideration will be paramount in their efforts to rework loans for struggling borrowers.
The FDIC is charged with seizing the assets of dangerously undercapitalized banks, paying out depositors (up to insured limits, in most cases $100k), and minimizing the cost to taxpayers by selling off the assets for as much as possible. People who hold stock in the closed bank get wiped out, as they lose claim to the bank's net assets (which were presumably nonexistent anyway).
Here's my problem: IndyMac is not the only entity with a whole lot of illiquid mortgage-backed assets on its balance sheet. I think it's safe to say that anyone who owns this stuff is looking for a way to maximize its value, and if foreclosures are happening, it's because mortgage-backed paper holders think foreclosing homes will allow them to recover more than loosening terms for borrowers who can't pay.
So the FDIC is hoping that it has stumbled on a plan that would help pretty much every bank in the US - but that nobody has thought of yet! Really, this seems like (at best) an experiment that could maybe increase the value of IndyMac's assets, and at worst a politically popular PR stunt (keep people in their homes!!) with the potential to further damage the real victims of IndyMac's closure.
This is mission creep at the FDIC - and it's potentially pretty frightening (though I'm admittedly easy to spook these days). There's a reason the FDIC is not in the habit of releasing a bank's borrowers when it takes over. Actually there are three reasons:
1. Writing down the assets is an extra cost to the FDIC and thus to taxpayers
2. That's money that could potentially have been paid to the bank's depositors
3. That's money that could potentially have been distributed to bank's shareholders
If the FDIC succeeds here, and loosening borrower terms is going to make all that mortgage-backed paper liquid and valuable and nice-smelling, then I'm just wrong. But either way, the FDIC looks like it's experimenting with house money - it's trying something out (that the private sector isn't trying) using funds that more appropriately belong to IndyMac's depositors and shareholders, while any potential losses will be covered by taxpayers. Keeping people in their homes is a feel-good goal, but it's not the FDIC's charge, and using the FDIC to test this out is an opaque and disingenuous way to do it. If it fails, the FDIC will damage its already strained balance sheet saving the borrowers of a bank that it already "saved."
From Financial Times:
Brian Hunter, the trader who was blamed for the collapse of $9bn hedge fund Amaranth Advisors two years ago, has taken advantage of last month's plunge in commodity prices to help propel the year-to-date return at the fund he now advises to 230 per cent.
WOW. To be sure, there is no way to generate that sort of return without having an investment thesis that is fantastically right. That said, a portfolio that is capable of such a return in 7 months is almost certainly 1) severely leveraged, and/or 2) drastically unhedged. I'm not sure that this is the vindication that Hunter may be hoping for ... if I were his investor, I'd be concerned he's playing the financial market equivalent of blackjack, where doubling/tripling/quadrupling up is entirely feasible, as is the commensurate downside. This is not the first time I've suspected that Hunter may be (quite rationally) exploiting the standard hedge fund compensation structure - management fees plus carried interest - that provide substantial gains to the manager for appreciation (whether driven by Beta, "Alpha", volatility or whatever) without corresponding downside for depreciation. Investors and fund managers, of course, say that a manager who loses his shirt feels the downside in that he won't be able to attract future capital, but I think that is neither sufficient nor true. But as long as his investors are OK with it, more power to Hunter!
It's hard to analyze this any more without knowing his positions, so I'll paste Alan Greenspan on the collapse of LTCM. His focus on "financial modeling" is not particularly relevant, as that was simply LTCM's alleged secret sauce (whereas Hunter's is apparently his macroeconomic intuition):
"How much dependence should be placed on financial modeling, which, for all its sophistication, can get too far ahead of human judgment? This decade is strewn with examples of bright people who thought they had built a better mousetrap that could consistently extract an abnormal return from financial markets. Some succeed for a time. But while there may occasionally be misconfigurations among market prices that allow abnormal returns, they do not persist. Indeed, efforts to take advantage of such misalignments force prices into better alignment and are soon emulated by competitors, further narrowing, or eliminating, any gaps. No matter how skillful the trading scheme, over the long haul, abnormal returns are sustained only through abnormal exposure to risk."
I'm impressed that Guy Kawasaki posted some of his blogging statistics from the past year. The numbers show that he's a phenomenally successful blogger. They also show that blogs are nowhere near replacing the traditional news media.
Context: Michael Arrington of Techcrunch (#4 on the Technorati 100) is pretty much the world's greatest blog evangelist, to the point of annoying people. He certainly did that at an Online News Association conference in October, where he sat on a panel and said, among other things, that the New York Times should "dissolve itself and return what's left to the shareholders," and that mid-level journalists at mainstream publications should "leave their jobs for blogging where they could easily triple their income."
Arrington has been enormously successful with Techcrunch but Guy's stats shows how wrong Arrington is. Guy gets 6,200 page views a day and has 21,000 RSS subscribers. He's #45 on the Technorati 100 - not quite Techcrunch territory, but still in the very top echelon of all blogs. But he only made $3,350 from his blog in 2006. That's $1.39 per thousand page views, or $12.78 per post. His blog has made about one tenth of what even the lowest-level journalists need to make in a year.
I haven't seen a prominent blogger give us numbers like this before. Guy is clearly secure in doing this because he's a bestselling author, highly coveted speaker and venture capitalist. We know he has income outside the blog and he doesn't have too vested an interest making blogging seem more lucrative than it is. Granted, he may not be monetizing his blog as aggressively as he could, but he's still off by the factor of ten.
Blogs provide a hobby and an outlet for their writers. They're fun to write. They can be influential if done well, and they can be career-enhancing platforms if done really well. However, they're clearly not yet a good way to make a living. There is only a tiny set of blogs (or blog groups like Gawker) that make enough money to employ a few writers (these operations look a lot like magazines without the paper, not citizen media). Blogs have given us a forum of millions of voices, but they aren't going to democratize our news. Until the top 1000 blogs can do what only the top 10 do now, aspiring journalists should still try to get a gig at the Times.
I was really excited when I saw that San Francisco had finally cut a
deal with Earthlink and Google to provide free wireless internet
throughout the city. For reasons I don't entirely understand, I can't
stand paying Comcast over $40 a month for internet. I don't care about
paying for cable, my cell phone, my MUNI pass, the gym membership I never use, or any of my other monthly expenses. But I don't want to
pay for internet. I can't really explain.
After I read the AP article though, I was a bit less excited for a few reasons:
There's a bigger question here: should wireless internet be a government-provided free service? Economically speaking, we need government to provide us with goods and services that are non-rival and non-excludable. Non-rival means that my consumption of the good does not reduce the amount of the good available for you to consume. Non-excludable means that once the good exists, nobody can reasonably be prevented from benefiting from it. Examples are things like roads, street lights, police and national defense. A free market would under-produce these goods because the people who produce them cannot be properly compensated by people who consume them.
Wireless internet is actually perfectly excludable. The provider of this service can grant access to those who pay and deny access to those who don't - unlike, say, a sidewalk. Wireless is a club good, not a public good. At least in theory, the free market will produce wireless internet efficiently.
I agree with the moral appeal of free wireless - to prevent a "digital divide" in which only the wealthy can benefit from the internet. I think there's probably a better way to do this than to build a city-wide network and deploy lots of hardware that will obsolesce quickly. EV-DO and/or WIMAX will take over soon, and market forces are going to bring down their prices rapidly. What about vouchers for the most needy? That would allow very low-income people to get free wireless through whatever fast, current technology that the market ultimately chooses. And I would need to get comfortable with paying for internet...
Actually, let's see how this free Wi-Fi thing works!
Quick background: Antoine Walker used to be one of my favorite
basketball players when he starred on the Celtics. Then I picked him
for my first-ever fantasy basketball team four years ago. At that point
I actually started paying attention to him and realized that he was
overweight, lazy, uncoordinated and turnover-prone. He was also one of
the highest-volume shooters in the NBA, despite the fact that he had
shockingly low shooting percentages (this year he's making an
astonishing 38% of his free throws - League average is about 75%).
He basically did for my fantasy team what George W. Bush has done for Iraq. I vowed to never again put him on my fantasy team, and let's just say it hasn't taken much will power.
Well Antoine's current team, the Miami Heat, just suspended him for failing to meet a team-imposed body fat requirement. It looks like he'll be suspended until he can get his body fat below 8%.
I hope the Heat know what they're doing - either they stop enforcing this rule, or Antoine has played his last game! This is a shame - I think this season he had a chance to be the first player with a higher body fat percentage than free throw percentage. What a way to go.
