John At The Center

Roger Ehrenberg has a much-linked-to piece about how Wall Street banks might revamp the way they pay their traders: basically, he says, turn them into fund managers, with a large ownership stake in their virtual funds.

The main problem with this, that I see, is that a Wall Street investment bank has lots of very good traders, and they never all have big bets on at the same time. When one desk wants to put on a big trade, it generally needs to make a case for putting at risk a large amount of the bank’s capital. But the capital doesn’t then belong to that desk in perpetuity: it lasts only as long as the trade does. So capital is always flowing to where it can best be put to use. That’s how a bank’s prop traders, as a group, can often make much more money than any given trader or desk could on their own.

via Felix Salmon » Blog Archive » Revamping traders’ pay Blogs .

However, I am sick and tired of the “sanctity of contract” theme as far as outsized bonuses from “dead other than by the grace of the US taxpayer” organizations are concerned, and Ehrenberg lobbed in a vote firmly in the “sanctity of contract” camp. And while he does argue for changes in what he calls the Wall Street trader compensation model, the record does not give much reason to think his suggested remedies will actually change behavior all that much.

My beefs about Hall’s pay are not the level per se but the structure. He appears to have a firm within a firm, an arrangement that often leads to bad ends (Mike Milken at Drexel and the AIG Financial Products Group are the poster children, but I have seen smaller scale variants that also wound up causing trouble for the organizations housing them). He refused to comply with efforts to integrate his unit into the asset management group, which presumably would have been better for the bank, so he clearly wants to have his cake and eat it too: enjoy the advantages of Citi’s cheap borrowing costs (an important advantage in his business) and infrastructure (he is relieved of much of the hassle of running a business) and can focus on a year long horizon rather that worrying about Sharpe ratios and monthly NAVs. And his deal appears extraordinarily rich, with the cut for his group below but presumably not much below 30%, well above hedge fund norms.

via naked capitalism: On The Sanctity of Wall Street Pay.

First, what the Census Bureau and HUD actually said was that sales were up “11.0 percent (±13.2%)*.” Follow the asterisk to the footnote and you get this clarifying bit of information: “90% confidence interval includes zero. The Census Bureau does not have sufficient statistical evidence to conclude that the actual change is different from zero.” So it’s probably a good idea to ignore the size of the reported gain and to at most consider the direction the data is headed, which a chart captures better than a single data point.

Second, what a great chart. It’s not the first time Calculated Risk has put it out, and I hope it’s not the last. That area they’re calling the “Distressing Gap” exists because distressed sales (of super-cheap foreclosures) make up such a large chunk of existing-home sales. The sales activity reflected in the blue line isn’t healthy as much as it is desperate. Well, unless you consider getting rid of excess inventory and debt overhang as healthy—which I guess I do.

via New and exsiting home sales data tell two different stories – The Curious Capitalist – TIME.com.

The people borrowing and lending the money had far more financial interconnections than we noticed or knew about – there was a lot of borrowing and lending among them that was hidden or ignored – and when the higher than expected number of borrowers defaulted, that meant some of the people expecting payments from the lenders were forced into default as well.

So a key thing I missed was the degree to which these markets are interconnected, and that may explain why I’ve emphasized finding better measures of interconnectedness, and then insulating markets against it as part of the reform process (and leverage is a key factor driving the interconnections).

via Economist’s View: Interconnectedness and the Distribution of Default Risk.

I agree, but I’m thinking (hoping) the flash trading issue is what’s upseting folks:

I’ve resisted writing a piece about high frequency trading lately. Although I have a very good understanding of the subject, I see it as a kinda lost cause to try to educate people about – uninformed people want to believe that computers are front running them, stealing their money and manipulating the markets. People who understand equity trading know that this is just the culmination of technology advancement and competition for spreads, which has resulted in equity bid/ask spreads being narrowed to their lowest levels ever. There has never been a better time for the individual stock trader to execute orders: our bid ask spreads are narrower than ever. A high frequency trader may have a computer program trying to scalp a penny or a fraction of a penny from you – but this is better than it’s even been – better than the days of specialists scalping 1/8ths and more.

via Kid Dynamite’s World: We Fear What We Don’t Understand.

Great analogy for CDS:

Zucker started a business enticing people to pay $1 to take a swing at a golf ball. The prize for a hole in one from 150 yards: $1 million. He rented space from a driving range and persuaded an insurance company to allow him to pay a premium for a million-dollar policy.

via They’re drinking it up in New York (page 2) – Los Angeles Times.

South Korean consumer confidence rose to the highest in almost seven years in July as government stimulus policies and record interest-rate cuts began leading the economy toward recovery from the global recession.

The sentiment index rose to 109 from 106 in June, the Bank of Korea said in Seoul today. That’s the highest level since the third quarter of 2002, when the bank published its confidence survey on a quarterly basis. A score of more than 100 indicates optimists outnumber pessimists.

via South Korean Consumer Confidence Rises to a Seven-Year High – Bloomberg.com.

After MySQL became a Sun property, the quality of MySQL started to suffer, including releasing a version of MySQL that had serious known bugs. This had never happened before and sent a clear signal that not all was well with MySQL. And the community had a lot of frustrations with Sun as Sun slowed or stopped accepting patches. Even important companies like Google had serious patches to MySQL ignored. Clearly the process had broken down.

via OSCON: The saga of MySQL – O’Reilly Radar.

The Cleveland Fed’s Yuliya Demyanyk says “most popular explanations for the subprime crisis turn out to be myths.” I disagree on Myth 8, perhaps the crisis wasn’t “totally” 100% unexpected, but it was generally unexpected and very few people got this right. As for Myth 10, I don’t think anyone still believes that the “subprime mortgage market was too small to cause big problems,” though that was believed at one time. Also, I’m not completely convinced that Myth 4 that “Declines in mortgage underwriting standards triggered the subprime crisis” is a myth, though that seems to be partly acknowledged in the discussion:

via Economist’s View: “Ten Myths about the Subprime Crisis”.

A study by the Boston Fed came to the credulity-straining conclusion that securitization was not a culprit in the noteworthy dearth of loan mods on residential mortgages, Lew Ranieri remarked back in 2008 at the Milken Conference that he was appalled by what was going on, that servicers used to do mods (as in no one worried about offending the tender sensibilities of investors in the pools), I have heard similar things from old real estate hands, that in the stone ages when banks owned paper, they greatly preferred to keep the borrower in the home if he was at all viable. So the change seems to have everything to do with servicer behavior, which in turn reflects their economics (as in they get paid to foreclose, which they are set up to do, and they have so streamlined and automated their operations that they find it cumbersome and costly to do mods. And they lack the know how or desire to do them well).

via naked capitalism: “Does Securitization Affect Loan Modifications?”.