Google Wave Drips With Ambition. A New Communication Platform For A New Web.

Ca c'est autre chose que twitter... Comment font ils chez google pour rester aussi créatifs, et aussi constamment excellents ?? l'anti Microsoft en tous points.

 

 

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Google Wave Drips With Ambition. A New Communication Platform For A New Web.

via TechCrunch de MG Siegler le 28/05/09

Yesterday, during the Google I/O keynote, Google's VP of Engineering, Vic Gundotra, laid out a grand vision for the direction Google sees the web heading towards with the move to the HTML 5 standard. While we're not there yet, all the major browser players besides Microsoft are aligned and ready for the next phase, which will include such things as the ability to run 3D games and movies in the browser without additional plug-ins. But Google wants to take it one step further with a brand new method of communication for this new era. It's called Google Wave.

Everyone uses email and instant messaging on the web now, but imagine if you could tie those two forms of communication together and add a load of functionality on top of it. At its most fundamental form, that's essentially what Wave is. Developed by brothers Lars and Jens Rasmussen and Stephanie Hannon out of Google's Sydney, Australia offices, Wave was born out of the idea that email and instant messaging, as successful as they still are, were both created a very long time ago. We now have a much more robust web full of content and brimming with a desire to share stuff. Or as Lars Rasumussen put it, "Wave is what email would look like if it were invented today."

Having seen a lengthy demonstration, as ridiculous as it may sound, I have to agree. Wave offers a very sleek and easy way to navigate and participate in communication on the web that makes both email and instant messaging look stale. The much better comparison is coincidentally the company started by another group of (former) Googlers, FriendFeed. But Wave is a different product for a number of reasons, and seemingly has loftier goals — all of which I'll touch on below.

Features

During our demonstration, the Wave team kept reiterating that the product is still basically in its infancy. While it was born out of an idea Jens Rasmussen had in 2004, it was placed on the back-burner (while he and brother Lars got busy building what would eventually become Google Maps), only to be resurrected in 2007, and finally set free for internal testing only a few months ago. The reason Google kept reiterating this is because the feature set as it exists right now is just a sliver of what they intend it to be eventually. That said, there's already plenty to do.

Wave features a left-hand sidebar "Navigation" and a list of your contacts, from Google Contacts, below that. But the main part of the screen is your Wave inbox. This looks similar to what your Gmail inbox looks like except it feature the faces of your friends who are involved in each thread. There are also number indicators signifying if there is new content in that thread. This is an important distinction from Gmail — it isn't just about new messages, there can be any kind of new content in these waves.

Clicking on any of the wave threads will open another pane to the right of the inbox that shows that wave in its entirety. Let's say one wave is a message from a friend and you want to reply to it. If they're not currently online, you can do it below their message just as you may in Gmail. Except there's no bulky new message creator to pop open, you simply start typing below your friend's message. But perhaps you want to respond to a particular part of their message — well you can do that too simply by starting to type below the part you're replying to.

Maybe you want to add another friend to the wave. You can do that by going over to your contact box and dragging their picture into the wave. This is where things really start to get interesting. If that friend wants to get caught up on what everyone else in the wave has already been talking about, they can do so by using the "Playback" feature. This is sort of like rewinding the wave to see what has happened in the past and you can watch it progress through its changes.

But if two of the people involved in the wave are online at the same time, you can talk to each other in real time, all in the same wave. Simply start typing, and your friend will see words as you enter them, and vice versa. This is the element that's like instant messaging obviously, but the key is that it's just a small part of what potentially makes up a wave conversation. And if you don't like the idea of real-time communication where the other person can see what you are typing as you type, you can enter a "Draft" mode to hide your words until you're ready to send them.

And say there is one person in a multi-person thread that you want to message privately. You can easily break-off a private conversation in the wave. Obviously, only you and the other recipient would be able to see this message, but for the both of you it would remain in the flow of the wave itself, keeping it in context.

But Wave is hardly just about traditional styles of messaging and replying that we've become accustomed to with email and IM. You can also edit things wiki-style with concurrent group collaboration. As anyone who has ever tried to group-edit a document on something like Google Docs knows, this can get tricky fast. But Wave offers a nice UI and real-time edit updates to ensure that even a few people editing something in a wave don't step all over each other. When someone is editing something, you see their name outlined by a brightly colored box next to the edits they are making in real-time. If you get confused, you can just use the Playback feature I described above to jump around and see the edits.

And from here we go much deeper. Say you want to share some recent photos on Wave, if you have a browser with Gears installed, all you have to do is drag and drop the pictures right into the Wave window. It's worth noting that this is the one Achilles heel keeping Wave from being fully functional with the "modern" web browsers (Firefox, Chrome, Safari and Opera) without any additional add-ons. ("Modern" is Google's passive aggressive way of calling out Microsoft's Internet Explorer.) Google says it would like to see such functionality added to the HTML 5 standards because it really simplifies this type of sharing.

And it's pretty damn cool. If you share pictures in a wave thread with several other people, from the moment after you drag the photos into the wave on your end, your friends can see the thumbnails of them on their screen. Everyone in the wave can collaborate to change the titles of the pictures, and you can view things like a slideshow of the images.

But pictures are just the beginning. Other example of things you can share in Wave include Google Maps (that you can edit), games, event invitations, and more. And those are just the examples the Wave team itself has thought of. Which brings us to the next point of Wave.

Wave As Web Communication

Google isn't just thinking of Wave as another web app that it creates and you use on one site — it wants you to be able to use it across all sites on the web. Say, for example, you have a blog. As a post, you could share a wave with the public and allow others to see what you and the other people in your wave are doing. And these visitors to your blog could even join in as well right from your blog, and all the information would be placed right into the original wave.

This could work a few ways. Either you could enable anonymous collaboration on the wave on your site, offer users the ability to sign-in with a certain method you already have on your site, like a comment user name, or they could sign in and interact with their Wave/Google name. We asked about using something like Facebook Connect as a method by which you could edit a wave, and though Lars Rasmussen said they hadn't yet worked on anything specifically for such functionality, they are very much thinking about it — though you can be sure that Google would prefer Friend Connect.

Waves can also be published as their own entities on the web. This would make them and their content indexable by Google's bots. But the Wave team is careful to note that if something is published to the public on the web, there's a big indicator of that within the wave that you may see in your main Wave pane.

And it's not just blogs that Google wants Wave on, it's pretty much any type of site you can imagine. And for a lot of different uses. For example, plenty of companies user some type of management system for communication beyond email or IM. We use Yammer, and when I was with VentureBeat, we used a FriendFeed private room. Yammer is good but it is just basically Twitter on your own system. The FriendFeed room is much more dynamic, but FriendFeed hosts that. Wave could offer the best of both worlds, and they're all for companies or even individuals hosting Waves on their own servers.

That's one of the keys to this entire idea. Google doesn't want Wave to be another one of its apps, it wants Wave to be a communication platform that it may have started, but flourishes all over the web in a bunch of different places. Which brings up the next point.

Developers, Developers, Developers

Gundotra, who used to work for Microsoft, cited Bill Gates' early insistence on having a robust developer community as one of the keys to the success of Windows. (And we all know what current CEO Steve Ballmer thinks about developers.) That same emphasis on developers is helping newer platforms like Android and the iPhone grow. And if Wave is to be successful, the entire team knows it will once again be because of developers.

While the Rasmussen brothers and Hannon, along with some 50 developers now working on the project at Google have built a very intriguing framework, it is just a taste of the potential of Wave if the development community embraces it. On Friday, Google will open Wave's APIs to developers to let them have at it. The hope is that in short order, there will be a ton of gadgets, extensions, mash-ups and interesting sites all built around the Wave concept.

The idea is to make the system as open for adoption as possible. The team wants to see Waves created by someone communicating with Waves created by someone else. "We want it to be an open system like email. We want other services to build Wave services even in competition with Google," Lars Rasmussen told us.

And with that in mind, Google plans to open source Wave. This will be the third phase of Google Wave. The first is Google Wave, the product, which Google creates, works on and eventually releases to the public as a web app. The second is Google Wave, the platform, which we outlined above as a system in place for developers to get involved in and create things for. But the third aspect is Google Wave, the protocol, which is its existence as a web communication platform. Find out more at the Waveprotocol.org site.

Because it will be open sourced (as Google gets it ready for a public release), it won't be just Google that is in charge of what it becomes. As it has been doing with Android, it will largely be the development community that dictates where it goes. Or, at least, that's the hope.

A New Web

So, if you've read this far, you're probably thinking that Wave either sounds great or you're confused as to what it exactly is. It really is one of those products that you have to see in action to understand. Unfortunately, unless you're a developer, you're not going to be able to see it right away. As we noted at the beginning, Wave is still in its early stages, but Google sees enough promise in it that it wants to get the developer community involved as early as possible — and that's why we're seeing it launch at Google I/O.

It's also important to note that Wave is very much centered around the key fundamentals Google is focusing on with HTML 5: The canvas element, the video element, geolocation, App Cache and Database and Web Workers. You can read more about those on O'Reilly Radar or in our live coverage from yesterday, but one of the keys for Wave will be the Web Workers. This capability allows you to run background processes outside of the browser so it doesn't slow to a crawl which running very rich apps — which Wave is.

Web Workers helps turns the browser into a more full-fledged launch pad for the next generation of web apps. That was the main point of yesterday's keynote and today's provides the best example thus far of one of these new-style apps in Wave.

It's a really interesting concept, one that you really do need to see in action. It's ambitious as hell — which we love — but that also leaves it open to the possibility of it falling on its face. But that's how great products are born. And the potential reward is huge if Google has its way as the ringleader of the complete transition to our digital lives on the web.

Update: We're sitting in the day 2 Google I/O keynote where the team is showing off Google Wave. There are a number of impressive features that we didn't even go into (yes, there's that much to this). One of my favorites is that not only is search real-time in Wave, but it's really live. For example, if you remove an 'e' from "Here" it will disappear from the results for that word. Likewise, if you add the "e" back on, it will pop up again — instantaneously.

Another great feature is the advanced spell checker that not only looks through a dictionary for spelling, but looks for context in your sentence. It's crazy to think that this could work, but it does as they're showing it off.

And yes, Wave will work with Twitter. The team itself created a gadget for it that they call "Twave" that brings in tweets from your stream, complete with your contacts' Twitter icons. You can respond to these tweets from within Wave and they will go back to your Twitter stream. But the best feature is Twave's search feature which scans Twitter in real time and updates live when new results come in. You can use this to track anything you want in real-time.

Now the team is showing off a wave that can translate to other languages in real-time. Again, impressive.

The demo at Google I/O has just ended to huge standing ovation. If today is any indication, this is going to be big.

Update 2: And here's an interview we recorded with the creators of Google Wave. Hear them explain the product in their own words.

Update 3: And here's our coverage of the post-keynote press Q&A session.

Update 4: And finally, here's a video of the full demo from I/O today. You'll want to watch this if you're interested in Wave.

CrunchBase Information

Google Wave

Lars Rasmussen

Jens Rasmussen

Stephanie Hannon

Information provided by CrunchBase

Crunch Network: CrunchBase the free database of technology companies, people, and investors

 

 

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Zipf’s Law

 

 

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Zipf’s Law

via Economist's View de Mark Thoma le 20/05/09

<p>HTML clipboard</p>

Sizing up cities:

Math and the City, by Steven Strogatz: ...The mathematics of cities was launched in 1949 when George Zipf, a linguist working at Harvard,... noticed that if you tabulate the biggest cities in a given country and rank them according to their populations, the largest city is always about twice as big as the second largest, and three times as big as the third largest, and so on. In other words, the population of a city is, to a good approximation, inversely proportional to its rank. Why this should be true, no one knows. ...

Given the different social conditions from country to country, the different patterns of migration a century ago and many other variables that you'd think would make a difference, the generality of Zipf's law is astonishing.

Keep in mind that this pattern emerged on its own. ... Many inventive theorists working in disciplines ranging from economics to physics have taken a whack at explaining Zipf's law, but no one has completely solved it. Paul Krugman ... wryly noted that "the usual complaint about economic theory is that our models are oversimplified — that they offer excessively neat views of complex, messy reality. [In the case of Zipf's law] the reverse is true: we have complex, messy models, yet reality is startlingly neat and simple." ...

Around 2006, scientists started discovering new mathematical laws about cities that are nearly as stunning as Zipf's. ... For instance,... populous ... cities have more gas stations than smaller ones (of course), but not nearly in direct proportion to their size. The number of gas stations grows only in proportion to the 0.77 power of population. The crucial thing is that 0.77 is less than 1. This implies that ... bigger cities enjoy economies of scale. In this sense, bigger is greener.

The same pattern holds for other measures of infrastructure. Whether you measure miles of roadway or length of electrical cables, you find that all ... show an exponent between 0.7 and 0.9. Now comes the spooky part. The same law is true for living things. That is, if you mentally replace cities by organisms and city size by body weight, the mathematical pattern remains the same.

For example, suppose you measure how many calories a mouse burns per day, compared to an elephant. ... The relevant law of metabolism, called Kleiber's law, states that the metabolic needs of a mammal grow in proportion to its body weight raised to the 0.74 power.

This 0.74 power is uncannily close to the 0.77 observed for the law governing gas stations in cities. Coincidence? Maybe, but probably not. There are theoretical grounds to expect a power close to 3/4. Geoffrey West of the Santa Fe Institute and his colleagues Jim Brown and Brian Enquist have argued that a 3/4-power law is exactly what you'd expect if natural selection has evolved a transport system for conveying energy and nutrients as efficiently and rapidly as possible to all points of a three-dimensional body, using a fractal network built from a series of branching tubes — precisely the architecture seen in the circulatory system and the airways of the lung, and not too different from the roads and cables and pipes that keep a city alive.

These numerical coincidences seem to be telling us something profound. It appears that Aristotle's metaphor of a city as a living thing is more than merely poetic. There may be deep laws of collective organization at work here, the same laws for aggregates of people and cells. ...

[For more on city size, see: Why Has Globalization Led to Bigger Cities?, by Edward Glaeser.]

 

 

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Martin Wolf on the Need to Rein in Finance

MW a été brillant depuis le tout début de la crise, avec d'autant plus de mérite qu'il y parvient tout en étant à la fois britannique et éditorialiste au FT. Ces deux qualités ne sont a priori pas compatibles avec un examen critique du capitalisme financier de ces dernières années...

 

 

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Martin Wolf on the Need to Rein in Finance

via naked capitalism de Yves Smith le 21/05/09

I always enjoy reading the Financial Times' editor, Martin Wolf, but I sometime forget how refreshing and pointed he can be when he decides to let loose at a deserving target. Today's lesson is the almost ludicrous efforts of the financial services industry to explain why the debacle that they just foisted on all of us isn't sufficient cause to put it on a choke chain.

Wolf pillories a report produced by some leading lights of the UK's banking industry. Its main failing, as Wolf points out, is that the industry has already captured Alistair Darling, chancellor of the exchequer, who sponsored the effort and sat on the committee. The verdict was pre-deetermined: "to examine the competitiveness of financial services globally and to develop a framework on which to base policy and initiatives to keep UK financial services competitive".

Ulp. Darling lives in a parallel universe, preoccupied with saving the perps who took down the economy with their recklessness. But he is hardly alone in how badly he has been captured by the industry.

Wolf has a remarkably straightforward recommendation.. The industry produces extenalities, like polluters, so tax it. I've long been a fan of Tobin taxes without being able to prove my pet suspicion, that too much ease of trading benefits intermediaries more than the principals, by encouraging more speculation than is needed to lubricate markets. Wolf provides another rationale. And he dismisses the notion that innovation is ever and always good (radiation tonics were innovative too, and killed people) and that determined regulators cannot restrain big financial players.

From the Financial Times:

The UK has a strategic nightmare: it has a strong comparative advantage in the world's most irresponsible industry. So now, in the wake of the biggest financial crisis since the 1930s, the UK must ask itself a painful question: how should the country manage the cuckoo sitting in its nest?

The question is inescapable. London is one of the world's two most important centres of global finance. Its regulators have, as a result, an influence on the world economy out of proportion to the country's size. In the years leading up to the crisis, that influence was surely malign: the "light touch" approach led the way in a regulatory race to the bottom.

The fiscal costs of this crisis will be comparable to those of a big war....Loss of jobs and incomes will also scar the lives of hundreds of millions of people around the world.

All this occurred, in part, because institutions replete with highly qualified and highly rewarded people were unable or unwilling to manage risk responsibly....This is a time for self-examination.

A recent report on the future of UK international financial services...fails to provide such self-examination...the report's remit was "to examine the competitiveness of financial services globally and to develop a framework on which to base policy and initiatives to keep UK financial services competitive".

If you ask the wrong question, you will get the wrong answer. The right question is, instead, this: what framework is needed to ensure that the operation of the financial sector is compatible with the long-run health of the UK and world economies?

Quite simply, the sector imposes massive negative externalities (or costs) on bystanders. Thus, the recommendation "that the financial sector be allowed to recalibrate its activities according to the sentiments and demands of the market" is wrong. A market works well if, and only if, decision-makers confront the consequences of their decisions. This is not – and probably cannot be – the case in finance: certainly, people now sit on fortunes earned in activities that have led to unprecedented rescues and the worst recession since the 1930s. Given this, the industry has become too big. If implicit and explicit guarantees and externalities, including volatility, were fully charged, the sector would surely shrink.

So how should one manage a sector that produces such "bads"? The answer is: in the same way as any polluting activity. One taxes it. At this point, the authors of the report will surely ask: "How can you suggest taxing a sector so vital to the UK economy?" The answer is: easily. Financial services generate only 8 per cent of gross domestic product. They are more important for taxation and the balance of payments. But this tax revenue turns out to be perilously volatile. True, in 2007, the last year before the crisis, the UK ran a trade surplus of £37bn in financial services, partially offsetting an £89bn deficit in goods. But smaller net earnings from financial services would have generated a lower real exchange rate and more earnings elsewhere. Given the costs imposed by the financial sector, a more diversified economy would have been healthier. Such sacrilegious ideas are, of course, not to be found in the Bischoff report.

How then should the UK approach policy towards the sector? I would suggest the following guiding ideas.

First, the UK needs to make global regulation work. It should discourage regulatory arbitrage even if it expects to gain in the short run.

Second, it must, in particular, help ensure that owners and managers of financial institutions internalise most of the costs of their actions.

Third, it must reject egregious special pleading from the industry. The sector argues that moving derivatives trading on to exchangesmight damage innovation. So what? Maximising innovation is a crazy objective. As in pharmaceuticals, a trade-off exists between innovation and safety. If institutions threaten to take trading activities offshore, banking licences should be revoked.

Fourth, while trying to create a stable and favourable environment for business activities, the UK should try to diversify the economy away from finance, not reinforce its overly strong comparative advantage within it.

Fifth, UK authorities need to ensure that the risks run by institutions they guarantee fall within the financial and regulatory capacity of the British state. They should not let the country be exposed to the risks created by inadequately supported and under-regulated foreign institutions. At the very least, they should not undermine other governments' efforts to regulate their own institutions.

The "old normal" was simply unsustainable. The "new normal" must be very different. It is far from clear that the industry and government recognise this grim truth.

 

 

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A Right Skewering

 

 

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A Right Skewering

via Financial Armageddon de panzner le 19/05/09

When it comes to skewering individuals and institutions with language, those who come from "across the pond" are in a class of their own. Though I'm not quite sure why the British are so adept at wielding carefully chosen words like razor-edged swords -- perhaps it stems from a unique combination of education, cultural rigidity, social reticence, and moral superiority -- it is often a sight to behold (unless, of course, you happen to be on the receiving end).

Whatever the reasons, one English-born banker and journalist who uses words so effectively to cut through the gobbledy gook of modern finance and economics is Martin Hutchinson, author of Great Conservatives, contributing editor to the Money Map Report and Money Morning, and author of the weekly "Bear's Lair" column at Prudentbear.com.

In his latest commentary, "The Wreck of Modern Finance," Hutchinson does a mesmerizing job of calling to task some of the "experts" (and their theories) who helped get us to where we are now.

Over the last 30 years, the capital markets have been restructured through the tenets of modern finance in its various forms, which together have gained six Nobel Prizes (Modigliani, Sharpe, Markowitz, Miller, Merton, Scholes) and might have generated a couple more (Fama and Black.) This has been enormously profitable for the financial services sector, which has doubled its share of U.S. economic output. As we are only now coming to see, it has proved pretty well disastrous for the global economy as a whole.

The most fundamental error of the modern financial edifice was its assumption of randomness in market movements, without a true understanding of the conditions necessary for randomness to hold. The laws of probability and the idea of randomness were generated by the 17th century French mathematician Blaise Pascal, who used them to help in winning card games, roulette and other activities in which tiny physical variations cause a discrete change in results. Since tiny physical variations are themselves unpredictable, their results are truly random.

This true randomness almost never holds for economic activities. Some of them are governed by complex underlying equations, impossible for mediocre mathematicians to solve, which produce pseudo-random "chaotic" behavior, in which prices or other variables appear to move randomly but are in reality mostly determinate. The interaction between economic variables is partly random (itself partly caused by inadequacies in our ability to measure economic quantities quickly) and partly determined by these kinds of complex non-linearities.

Other economic variables are also not random, and may not be governed by discoverable laws; they are simply unknown. Next year's Gross Domestic Product, for example, is theoretically determinable from factors we could already know (plus a few random elements). But it is mostly not random; we simply do not know what it will be.

Pretending that deterministic (but chaotic) quantities or unknown quantities are random is a huge category error. If such quantities are not random, they will not obey the laws of randomness. In particular calculations that depend on the properties of randomness, such as Monte Carlo simulation, the Value at Risk methodology or the Black-Scholes options model will be quite simply wrong, often very badly wrong.

For non-random quantities, one of the most important properties of truly random quantities, the tendency of their distributions' "tails" to disappear at around three standard deviations from the mean, will not hold. In probability, the chance of four events happening is the product of their four probabilities; in fuzzy logic, the alternative analytical system for the unknown, the "belief" of four events is the minimum of their beliefs. If each event has a probability/belief of 1 in 10, it's the difference between 1 in 10,000 (random) and 1 in 10 (unknown).

Nassim Taleb in his best seller criticized Wall Street for being "Fooled by Randomess." He had it precisely wrong; in reality, Wall Street and the economists and "mathematicians" (mostly not very good ones, or good ones who figured out there was a problem but stayed around for the money) have been fooled by assuming randomness where it does not exist.

That assumption makes the equations easier to solve; random quantities tend to be linear, exponential or normal, the three types of equations economists know how to deal with. Chaotic quantities generally obey power-series equations, or even nastier ones, while unknown quantities by definition don't obey any equations at all.

Financial quantities, mostly a mixture of the chaotic and the unknown, are thus frightfully hard to model; one has some sympathy. Even Benoit Mandelbrot, a truly superior mathematician who invented fractal geometry, made devastating criticisms of others' models in his 2004 "The misbehavior of markets," but was unable to come up with a better alternative.

The invention of PCs, together with the intellectual "advances" of modern financial theory, from around 1980 caused an explosion of mathematical modeling on Wall Street. Models were used to price options, to value complex packages of securitized debt, to manage investments and above all, to manage risk, even being incorporated into the "Basel II" bank capital requirements.

In the "Value at Risk" risk management system, for example, the model calculates the maximum possible loss in 99% of periods covered. Even if the model worked, that would be a foolish way to manage risk for an entire bank when the periods are as short as a day or a month; 100 trading days is only five months and even 100 months is only eight years. While the 200 year life expectancies of the old merchant banks may have been excessively conservative, eight years is surely rather too short a life expectancy for banks if the market is to function soundly.

The VAR assumption, that even in the other 1% of periods the model wouldn't be too far wrong, is completely and dangerously false. When David Vinear, chief financial officer of Goldman Sachs, said in August 2007, "We were seeing things that were 25-standard-deviation events, several days in a row," he was condemning his risk management out of his own mouth. In a truly random system, 25-standard-deviation events would not just be rare, they would be literally impossible, of infinitesimal probability during the entire history of the universe.

Not only are price movements not random, the market is not "efficient." It is subject to bubbles and periods of depression – indeed one of the most profitable strategies during the latter, employed by the late Sir John Templeton and others, is to buy small out-of-the-way stocks at random, since analysts stop covering the lesser names when business is bad, and their prices drift down arbitrarily far. (Conversely, that's why many of the best investment managers, mostly invested in small stocks, did so badly in 2008, down 70% or 80% when the market overall was down only 40%; the market was de-arbitraging as the financial system fell apart.) As innumerable behavioral finance professors have demonstrated, expectations are not rational.

The Capital Asset Pricing Model also doesn't work, as many have found to their cost. On the corporate side, it combined with the tax-deductibility of debt interest and short-term oriented compensation systems to leave banks and corporations excessively leveraged. Lehman Brothers shareholders have lost more through bankruptcy than they previously gained through leverage; business failure is in itself an extremely expensive process. Of course, bailouts here, there and everywhere have mitigated the costs of owning, say, AIG or Citigroup shares, but on the other hand, being a debt-holder in Chrysler or General Motors has proved unexpectedly expensive, as the Obama administration has reallocated resources to its union friends. In the last six months, the resource allocation process has become almost entirely political, and will remain so until the U.S. government runs out of money, which fortunately shouldn't take too long.

On the investment side, the CAPM has led to the development of innumerable phony asset classes, whose returns were supposed to be uncorrelated to the stock market, but which were mostly notable for the hugely greater fees they provided to their sponsors. Hedge funds depend on excessive leverage and the continuance of misguided financial engineering; private equity funds depend on the existence of a thriving public market for takeout; and emerging markets funds depend on the health and liquidity of the world economy. None of them diversify risk more than marginally and all of them add huge new layers of cost. The Yale Model of investment management does not work – except for the lavishly rewarded investment managers who developed it.

Securitization appeared to be a mechanism that allowed banks to remove assets from their balance sheets, while providing relatively low-risk, liquid assets for investors. It also didn't work. First, banks were left with most of the residual risk, so allowing them to remove the assets from their balance sheets merely encouraged excessive leverage. Second, the ratings agencies assumed randomness of outcome in, say, pools of subprime mortgage assets, an assumption that proved to be laughably wrong. When mortgage underwriting standards deteriorated, they deteriorated everywhere, so all pools ended up with their share of almost-worthless "liar loans." Even when underwriting standards were maintained, real estate mortgage losses were not probabilistically independent, since a nationwide housing-price decline caused an ever-increasing cascade of losses, far beyond past experience. Housing and credit card loans are not probabilistically independent, because the business cycle isn't random; in a down cycle they all go wrong at once.

The largest nirvana for mathematically-generated profits was the derivatives markets. Here the "vanilla" markets were relatively sound, with risks manageable and finite. They were, however, almost infinitely arbitrageable, so became a trading desk heaven, with far too much volume for the contracts' real uses, endless speculative games played, and infinitesimal margins. Most important, they produced an explosion of counterparty risks so that even the dodgiest bank or broker active in the markets could not be allowed to go bust. That problem can largely be solved by President Obama's proposed legislation forcing standard derivatives to trade over recognized exchanges, eliminating most of the counterparty risk and concentrating the rest in one place.

In order to increase profits, traders devised more and more complex derivatives types, the management of which required dangerously false assumptions about randomness. These more complex contracts up-fronted most of their profit, leading to bonus bonanzas, while leaving their risks ticking like a time-bomb through their entire duration of several years – so we may not yet have seen all the loss explosions this business will produce.

Finally, there were credit default swaps (CDS). As derivatives, these were poorly designed, because their settlement rested on a primitive auction procedure that is itself gamed by the major dealers, who use it to extract rent from the U.S. government and any companies unfortunate enough to near bankruptcy. As we have recently seen in two cases, Abitibi-Price and General Growth Properties, CDS deviate even further than most derivatives from the theoretical efficient-market modern finance ideal in that they allow debt-holders to "game" the default process itself.

In essence, CDS holders, who if they are also bondholders can vote in the bankruptcy process, act like spectators at a suicide, yelling, "Jump! Jump!'' and pushing companies into default in order to reap bonanza profits from their CDS. This is particularly attractive if the CDS were issued by AIG and so effectively guaranteed by taxpayers.

CDS also act as highly efficient vehicles for short selling; their cost is so low in relation to their potential profit and their volume so large that they can provide huge incentives to unscrupulous speculators to drive viable companies over the edge – this was part of the problem at Lehman Brothers, for example.

In summary, the dangers of CDS are so out of proportion to their modest advantages as risk management tools that it seems wisest for the authorities to ban them altogether, not something I would normally recommend.

We gave poor Jeff Skilling of Enron 24 years in jail for inventing a new trading platform that turned out to be unsound. As we peer out from the wreckage that modern finance has left, one can't help thinking that there are a number of Nobelists who more deserve such Draconian punishment.

 

 

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Retirement in the US : lessons for France

 

 

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Don't Count on Your 401(k)

via The Big Money de mark.gimein le 15/05/09

"Our nation's system of retirement security is imperiled, headed for a serious train wreck.That wreck is not merely waiting to happen; we are running on a dangerous track that is leading directly to a serious crash that will disable major parts of our retirement system."

—John Bogle, Feb. 24, 2009

If several years before the financial and credit crisis hit someone had told you that the housing market was preposterously overvalued and derivatives were headed for cataclysm, would it have been worth paying attention to? The answer's pretty clearly yes, ain't it? Of course, some of the best minds in finance—from Warren Buffett to Yale housing economist Robert Shiller—did. It's just that hardly anyone listened.

Now there's another crisis building. It's just as big. Again, some of the best thinkers in the financial world are warning about it. (Yes, Buffett's one of them.) And yet again, as is often the case with gathering storms, most of us are doing our best to ignore the warning signs.

Americans lost almost one-quarter of their retirement savings last year. But even if there were no market drop, we'd still be facing a disaster in the making.

The urgent lines at the top of this story come from John Bogle, founder of the Vanguard group of mutual funds and father of the low-cost stock-index fund, the simplest and most cost-efficient tool yet devised for individual investing in stocks. Of all the people who've thought longest and best about individual investing, Bogle has to rank near the top. For decades before the financial crisis ripped open the country's retirement accounts, Bogle was tirelessly warning people away from their brokers' fads and follies.

Bogle's voice is now one of the loudest, most cogent of those calling for a rethinking of American retirement. He made the remarks above earlier this year to a congressional panel looking at the security of American savings. Like much of what is said about retirement, Bogle's words passed by without much attention. But much of what he has to say is seriously worth listening to.

Over the past two decades, we've embarked on what is essentially a novel experiment, replacing the pension plans of the past with a patchwork of individual accounts such as 401(k)s and IRAs. We had sound reasons for this: Letting people choose how much they save for retirement instead of counting on their employers to give them a decent pension if they put in enough time makes sense. But if the basic idea of personal responsibility for retirement is appealing to most, the reality is a lot thornier.

By this point, there is hardly anyone left who hasn't heard of a 401(k) or doesn't know that they should open one. With some tweaks in the rules for 401(k) enrollment, the Obama administration is hoping to get participation in individual retirement plans up to 80 percent of Americans.

The bad news from Bogle, though, is that the way it's set up now, the 401(k) isn't the panacea that policymakers on all sides of the spectrum hope it will be. What's wrong with the 401(k)?

* Simply having a retirement account is not enough. Much of the discussion this past year has focused on getting workers to open 401(k)s. The problem is that the big majority of retirement accounts don't really hold nearly enough money.

According to Bogle's numbers, the median IRA has $55,000 in it. By his calculations, that's enough to provide a steady income of $2,200 a year—less than $200 a month. That's it. And 401(k)s? The typical 401K holds only $15,000. Bogle argues that to reach the level of income they hope for in retirement, Americans need to put 15 percent of their earnings in retirement accounts for their entire working lives. Very few do.

* One of the biggest differences between individual accounts and traditional pension plans is that they transfer what Bogle calls "longevity risk" from pension funds to individuals. What that means in practice is that you need to save more—a lot more—in your account than a pension plan would include in order to cover the chance that you'll live to a very old age.

Right now, we have no good solution to this. In theory, you should be able to put your money into an annuity at retirement that'll cover this risk. But as Bogle points out, there are virtually no annuities that will let you do this at a low cost. So now your underfunded retirement account looks even worse.

* We all know the financial advice about putting retirement assets in safe investments as we grow older. But in practice, we don't come close to following it. The big majority of retirement fund assets are in equities. And it doesn't get much better for people approaching retirement: According to Bogle, 30 percent of them have 80 percent of their IRA investments in stocks.

What this means in practice is that some people (not many, Bogle thinks, as most people make terrible investment decisions) will do very well. And others, such as the people retiring this year in the wake of the massive stock market drop, will do very badly. It's what Bogle calls investment risk, and like longevity risk, moving from pension plans to 401(k)s and IRAs has transferred that from corporations to retirees.

Bogle proposes the beginnings of several solutions to our retirement problem. Clearly, finding ways to nudge people to put more money into retirement accounts is part of the answer. But it's only a small part. It does nothing for longevity risk and nothing to distribute investment risk. Pension funds did that: If you happened to retire the year the market crashed or if you lived to be 90 years old, that was OK, because your risks were shared with people who retired in other years or failed to live as long.

As it stands now, 401(k) plans do nothing for those risks. On the contrary, many of the bad practices that Americans have fallen into, such as putting much of their retirement money in their own employer's stock, exacerbate them.

Bogle points to several tools—the creation of annuities that would work a lot like pension plans to level investment and longevity risk—that would help give Americans the equipment they need to manage their retirement. But developing those tools and making them widely available right now just isn't on the political agenda. And Bogle (who wryly urges casting the "money changers" of Wall Street out of "the temple of finance") warns that we shouldn't expect them to come from the big financial companies.

We're already witnessing the beginnings of a retirement catastrophe now: You can see it if you look at the growing number of older Americans who have kept working into their 60s and 70s or gone back into the work force. Without a dramatic change not just in the amount of money that we save but in how we save, it will get much worse. In the 1980s, Britain launched what turned out to be a disastrous experiment in asking people to take responsibility for their retirement investments without giving them the tools to do it. We're now well on our way to repeating it on a much bigger scale.

Without it, we're facing a one-two punch in the retirement future. The left hook is the shortage of savings. The right hook is the added investment and longevity risk that the new model of retirement brings. It's a potential disaster as big as the mortgage and credit crisis. And as with those, if we get to it, folks in finance will be out in force, crying that nobody could possibly have seen it coming. That's just not true.

 

 

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Retirement in the US : lessons for France

 

 

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Don't Count on Your 401(k)

via The Big Money de mark.gimein le 15/05/09

"Our nation's system of retirement security is imperiled, headed for a serious train wreck.That wreck is not merely waiting to happen; we are running on a dangerous track that is leading directly to a serious crash that will disable major parts of our retirement system."

—John Bogle, Feb. 24, 2009

If several years before the financial and credit crisis hit someone had told you that the housing market was preposterously overvalued and derivatives were headed for cataclysm, would it have been worth paying attention to? The answer's pretty clearly yes, ain't it? Of course, some of the best minds in finance—from Warren Buffett to Yale housing economist Robert Shiller—did. It's just that hardly anyone listened.

Now there's another crisis building. It's just as big. Again, some of the best thinkers in the financial world are warning about it. (Yes, Buffett's one of them.) And yet again, as is often the case with gathering storms, most of us are doing our best to ignore the warning signs.

Americans lost almost one-quarter of their retirement savings last year. But even if there were no market drop, we'd still be facing a disaster in the making.

The urgent lines at the top of this story come from John Bogle, founder of the Vanguard group of mutual funds and father of the low-cost stock-index fund, the simplest and most cost-efficient tool yet devised for individual investing in stocks. Of all the people who've thought longest and best about individual investing, Bogle has to rank near the top. For decades before the financial crisis ripped open the country's retirement accounts, Bogle was tirelessly warning people away from their brokers' fads and follies.

Bogle's voice is now one of the loudest, most cogent of those calling for a rethinking of American retirement. He made the remarks above earlier this year to a congressional panel looking at the security of American savings. Like much of what is said about retirement, Bogle's words passed by without much attention. But much of what he has to say is seriously worth listening to.

Over the past two decades, we've embarked on what is essentially a novel experiment, replacing the pension plans of the past with a patchwork of individual accounts such as 401(k)s and IRAs. We had sound reasons for this: Letting people choose how much they save for retirement instead of counting on their employers to give them a decent pension if they put in enough time makes sense. But if the basic idea of personal responsibility for retirement is appealing to most, the reality is a lot thornier.

By this point, there is hardly anyone left who hasn't heard of a 401(k) or doesn't know that they should open one. With some tweaks in the rules for 401(k) enrollment, the Obama administration is hoping to get participation in individual retirement plans up to 80 percent of Americans.

The bad news from Bogle, though, is that the way it's set up now, the 401(k) isn't the panacea that policymakers on all sides of the spectrum hope it will be. What's wrong with the 401(k)?

* Simply having a retirement account is not enough. Much of the discussion this past year has focused on getting workers to open 401(k)s. The problem is that the big majority of retirement accounts don't really hold nearly enough money.

According to Bogle's numbers, the median IRA has $55,000 in it. By his calculations, that's enough to provide a steady income of $2,200 a year—less than $200 a month. That's it. And 401(k)s? The typical 401K holds only $15,000. Bogle argues that to reach the level of income they hope for in retirement, Americans need to put 15 percent of their earnings in retirement accounts for their entire working lives. Very few do.

* One of the biggest differences between individual accounts and traditional pension plans is that they transfer what Bogle calls "longevity risk" from pension funds to individuals. What that means in practice is that you need to save more—a lot more—in your account than a pension plan would include in order to cover the chance that you'll live to a very old age.

Right now, we have no good solution to this. In theory, you should be able to put your money into an annuity at retirement that'll cover this risk. But as Bogle points out, there are virtually no annuities that will let you do this at a low cost. So now your underfunded retirement account looks even worse.

* We all know the financial advice about putting retirement assets in safe investments as we grow older. But in practice, we don't come close to following it. The big majority of retirement fund assets are in equities. And it doesn't get much better for people approaching retirement: According to Bogle, 30 percent of them have 80 percent of their IRA investments in stocks.

What this means in practice is that some people (not many, Bogle thinks, as most people make terrible investment decisions) will do very well. And others, such as the people retiring this year in the wake of the massive stock market drop, will do very badly. It's what Bogle calls investment risk, and like longevity risk, moving from pension plans to 401(k)s and IRAs has transferred that from corporations to retirees.

Bogle proposes the beginnings of several solutions to our retirement problem. Clearly, finding ways to nudge people to put more money into retirement accounts is part of the answer. But it's only a small part. It does nothing for longevity risk and nothing to distribute investment risk. Pension funds did that: If you happened to retire the year the market crashed or if you lived to be 90 years old, that was OK, because your risks were shared with people who retired in other years or failed to live as long.

As it stands now, 401(k) plans do nothing for those risks. On the contrary, many of the bad practices that Americans have fallen into, such as putting much of their retirement money in their own employer's stock, exacerbate them.

Bogle points to several tools—the creation of annuities that would work a lot like pension plans to level investment and longevity risk—that would help give Americans the equipment they need to manage their retirement. But developing those tools and making them widely available right now just isn't on the political agenda. And Bogle (who wryly urges casting the "money changers" of Wall Street out of "the temple of finance") warns that we shouldn't expect them to come from the big financial companies.

We're already witnessing the beginnings of a retirement catastrophe now: You can see it if you look at the growing number of older Americans who have kept working into their 60s and 70s or gone back into the work force. Without a dramatic change not just in the amount of money that we save but in how we save, it will get much worse. In the 1980s, Britain launched what turned out to be a disastrous experiment in asking people to take responsibility for their retirement investments without giving them the tools to do it. We're now well on our way to repeating it on a much bigger scale.

Without it, we're facing a one-two punch in the retirement future. The left hook is the shortage of savings. The right hook is the added investment and longevity risk that the new model of retirement brings. It's a potential disaster as big as the mortgage and credit crisis. And as with those, if we get to it, folks in finance will be out in force, crying that nobody could possibly have seen it coming. That's just not true.

 

 

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Does the ECB/Eurosystem have enough capital?

 

 

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Does the ECB/Eurosystem have enough capital?

via Willem Buiter's Maverecon de Willem Buiter le 14/05/09

'Enough capital for what?' should be the question prompted by the title of this post. The short answer, amplified below, is "enough capital to be able to engage in effective monetary policy, liquidity policy and credit-enhancing policy (including quantitative easing or QE), without endangering its price stability mandate."

Let's consider the conventional balance sheets of the ECB and of the consolidated Eurosystem (the ECB and the 16 national central banks (NCBs) of the Euro Area.

The most recent publicly available balance sheet of the ECB is in the 2008 Annual Report, published in April 2009.  It is reproduced here:

Balance sheet of the ECB on 31 December 2008 and 31 December 2007

Assets (€ bn)			Liabilities (€ bn)
	2008	2007		2008	2007
Gold & Gold Receivables	10.7	10.3	Bank notes in circulation	61.0	54.1
Claims on non-euro area residents in foreign currency	41.6	29.2	Liabilities to euro area residents in euro	1.0	1.1
Claims on euro area residents in foreign currency	22.2	3.9	Liabilities to non-euro area residents in euro	253.9	14.5
Other assets	14.3	11.3	Liabilities to euro area residents in foreign currency	0.3	0.0
Intra-Eurosystem claims	295.1	71.3	Liabilities to non-euro area residents in foreign currency	1.4	0.7
			Other liabilities	20.5	9.4
			Intra-Eurosystem liabilities	40.1	4.0
			Capital & reserves	4.1	4.1
			Profit for the year	1.3	0
Total	383.9	126.0	Total	383.9	126.0

It is clear that if the ECB were all there is to the Eurosystem, the Euro Area would be in trouble.  The ECB has negligible capital (€ 5 billion subscribed, rather less than that paid in; even if we add capital and reserves to 2008 profits, we only get €5.4 bn.  With assets of €3839, that gives the ECB 71 times leverage at the end of 2008, a number that would impress even Deutsche Bank. The previous year, the ECB had 48 times leverage.  On its own, the ECB looks like an overblown pawn shop.

Fortunately, the balance sheet of the ECB by itself is effectively irrelevant and uninformative as to the financial strength of the Euro Area monetary authority.  In 2008, about 75% of the assets of the ECB consisted of intra-Eurosystem claims (the left hand lending to the right hand).

What is informative is the consolidated balance sheet of the ECB and the 16 NCBs of the Euro Area - the Eurosystem.  This consolidated balance sheet of the Eurosystem is available monthly:

Consolidated financial statement of the Eurosystem as at 8 May 2009

Assets (EUR millions) 1 Gold and gold receivables 240,817 2 Claims on non-euro area residents denominated in foreign currency 159,299 3 Claims on euro area residents denominated in foreign currency 123,101 4 Claims on non-euro area residents denominated in euro 21,359 5 Lending to euro area credit institutions related to monetary policy operations denominated in euro 653,352 6 Other claims on euro area credit institutions denominated in euro 26,453 7 Securities of euro area residents denominated in euro 292,405 8 General government debt denominated in euro 36,790 9 Other assets 241,523 Total assets 1,795,099

Liabilities (EUR millions) Totals/sub-totals may not add up, due to rounding 1 Banknotes in circulation 759,502 2 Liabilities to euro area credit institutions related to monetary policy operations denominated in euro 264,137 3 Other liabilities to euro area credit institutions denominated in euro 436 4 Debt certificates issued 0 5 Liabilities to other euro area residents denominated in euro 139,090 5.1 of which General government 130,717 6 Liabilities to non-euro area residents denominated in euro 177,993 7 Liabilities to euro area residents denominated in foreign currency 1,548 8 Liabilities to non-euro area residents denominated in foreign currency 11,407 9 Counterpart of special drawing rights allocated by the IMF 5,551 10 Other liabilities 159,644 11 Revaluation accounts 202,952 12 Capital and reserves 72,840 Total liabilities 1,795,099

A central bank can go broke (become insolvent) despite its ability to 'print money' (issue currency and/or create (electronically) deposits owned by commercial banks and other eligible counterparties that are generally accepted as final means of payment) if it has a sufficiently large stock of liabilities denominated in foreign currency and/or a sufficiently large stock of index-linked liabilities.  Neither condition would seem to apply to the Eurosystem.

A shortage of foreign exchange assets or credit lines is not going to be a material problem for the Eurosystem. As of May 8, 2009, the net position of the Eurosystem in foreign currency (asset items 2 and 3 minus liability items 7, 8 and 9) was EUR 263.9 billion. The ECB is also able to create reciprocal or one-sided swap arrangements with all other serious central banks. As far as I know, the Eurosystem does not have any significant amount of index-linked liabilities.

No, the Eurosystem will not encounter the 'Iceland problem'. It will always be able to create euro base money (either by issuing additional euro currency or by increasing euro bank reserves and similar deposits held with the Eurosystem by eligible counterparties) by any amount required to maintain its solvency. It is, however, possible that the amount of additional base money that would have to be created to maintain the Eurosystem's solvency could endanger the ECB's price stability mandate, operationalised as a rate of inflation, measured by the HICP, below but close to 2 percent per annum in the medium term.

So the question is: does the Eurosystem have enough capital to be able to risk significant capital losses in its monetary operations, liquidity operations and credit enhancing operations (including quantitative easing), without endangering its price stability mandate?

The Eurosystem already has taken a lot of private sector credit risk exposure on its balance sheet.  It accepts as collateral in repos and at its discount window (the marginal lending facility), most private securities (including most asset-backed securities except those that have derivatives as underlying assets) rated BBB- or better.  That includes a lot of rubbish.  Commercial banks throughout the Eurozone (including subsidiaries of Lehman Brothers and of the now defunct Icelandic banks) have repoed with the ECB.  When three banks went belly-up in late 2008, the Eurosystem was exposed to potentially dodgy collateral to the tune of about €10 bn and provisioned about € 5 bn.

With assets of € 1,795 bn and capital and reserves of € 73 bn, the Eurosystem has 24,6 times leverage.  A decline of just four percent in the value of its assets would wipe out its capital.  That does not look like a terribly comfortable position, as the quality of much of the assets it has accepted as collateral from Euro Area banks is likely to be uncertain at best.

Unlike the US banks and the UK banks, Eurozone banks have barely made a start on recognising the toxic and bad assets they are exposed to, on balance sheet or off-balance sheet.  I won't this time single out Iberian banks as likely suppliers of vast quantities collateral consisting of dodgy residential mortgage-backed and commercial-mortgage-backed securities to the Eurosystem.  Being given the evil eye by the Governor of the Central Bank of Iberia is no laughing matter.  And in any case, the Irish banks are likely to have saddled the Eurosystem with collateral that yields to no other Eurozone nation in awfulness.  We know of the dreadful state of most of the German Landesbanken, the fragility of the bailed-out Commerzbank, the opaque balance sheet of Deutsche Bank, the precarious state of the remaining large listed Benelux banks, the exposure of the Austrian banks to Central and Eastern Europe etc. etc.  If any of these banks had good collateral, they would not give it to the Eurosystem.  They would sit on it.

Even before the Eurosystem starts to buy private securities outright (as it is planning to do with high-grade covered bonds, Pfandbriefe, to the tune of € 60 bn), it is certainly within the realm of the possible (or even likely) that it would suffer losses on its assets of €73 bn or more, before this crisis and this contraction are over.

That, of course, would not endanger the solvency of the Eurosystem, which has the present discounted value of current and future seigniorage income (the interest earned (or saved) by being able to borrow at a zero rate of interest through the issuance of currency and through mandatory reserve requirements).

The monetary base issued by the Eurosystem (not all of which is held in the Euro area) is just over a trillion euros.  Eurozone GDP at current market prices in 2008 was about € 9.2 trillion.  So the monetary base is about 11 percent of GDP.  If long-run nominal GDP growth in the Euro Area is four percent per annum (two percent real GDP growth and 2 percent inflation), then, assuming for simplicity that the demand for base money does not depend significantly on the rate of inflation for low rates of inflation), the Eurosystem would be able to issue another 0.43 percent of GDP worth of additional base money each year ($40 bn worth of base money in 2009) withough putting upward pressure on inflation or driving it above the inflation target, assumed to be 2 percent to make the arithmetic easy.

This is likely to be an overstatement of seigniorage revenues at a rate of inflation consistent with the price stability mandate for two reasons.  First, the demand for base money is likely to be boosted significantly and unsustainbly by the extreme liquidity preference of banks and households following the collapse of interbank markets and other ready sources of liquidity.  Also, a large but unknown share of euro notes is held outside the Euro Area, both for legitimate and illegitimate purposes.  This demand for euro currency will not depend on Euro Area income growth, inflation and interest rates.

Even if the 'normal' euro seigniorage as a share of GDP at a 2 percent rate of inflation is only 0.2 percent of GDP, the capitalised value of the current and future stream of seigniorage, assuming that the long-term nomopnal nterest rate exceeds the long-term growth rate of nominal GDP by one percentage point, would be 20 percent of Euro Area annual GDP.  That would allow the ECB to absorb quite massive losses to its balance sheet, which as it happens equals 19.5 percent of Euro Area annual GDP.

A complete blow-out of the balance sheet of the ECB is unlikely, to say the least.  Admittedly, we have to set against the present value of current and future seigniorage the present discounted value of the cost of running the Eurosystem.  The ECB is lean and mean, but many of the NCBs are over-staffed, bloated organisations.  I have not been able to find data on the current and capital costs of the Eurosystem, but it seems unlikely to alter the conclusion that with its monopoly of the issuance of currency in the Euro Area, and its tax on eligible bank deposits (aka reserve requirements), the Eurosystem is so wildly profitable that it can withstand very large capital losses on its conventional financial balance sheet.

Things are different in that regard for the Bank of England and the Fed, where, under normal circumstances, base money is a much smaller fraction of annual GDP than in the Euro Area - typically no more than 4 or 5 percent.  The maximum losses these central banks can sustain without having to either increase base money issuance to a volume that generates inflation above the (implicit or explicit) target, or knock on the door of the Treasury for compensation for their capital losses are therefore less than a quarter of the losses the Eurosystem can tolerate.

That is just as well, since the ECB and the Eurosystem 'swim naked': there is no Euro Area fiscal authority that, explicitly or implicitly, stands ready to act as the recapitalisor of last resort for the Eurosystem.  As the Euro Area develops financially, and as its Southern Fringe becomes less tolerant of tax evasion and the grey and black economies, the demand for base money will shrink as a share of GDP.  This would tighten the intertemporal budget constraint of the Eurosystem and make it more likely that it will have to look for a Euro-Area fiscal indemnity for capital losses incurred in the pursuit of its monetary, liquidity and credit easing objectives.  But that is likely to become an issue only with the next financial crisis, a couple of decades down the road.

 

 

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Credit Default Swaps Holders Likely to Force GM into Bankruptcy

Mais à part ça l'innovation financière c'est quelque chose de merveilleux... Comme le disait Paul Volcker, le seul exemple "récent" d'innovation financière utile c'est l'ATM.

 

 

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Credit Default Swaps Holders Likely to Force GM into Bankruptcy

via naked capitalism de Yves Smith le 11/05/09

It only takes opposition by 10% of the bondholders to stymie an out-of-court restructuring of GM. The FT believes that there are enough bondholders who, via being net short GM bonds via credit default swaps, have good reason to block a negotiated outcome and force the automaker into bankruptcy. And that poses risk to the economy, since there are meaningful odds that the fast track solution of a 363 sale will be opposed successfully, producing uncertainty as to when GM will exit bankruptcy and putting further strain on the supply chain. GM is a big actor in its ecosystem, and too much damage to its supply chain will hurt all US based car-makers, including the transplants.

Here we have financial technology trumping what is in the collective best interest. Creditors when possible prefer to avoid bankruptcy court if a settlement can be reached out of court (it saves costs, reduces uncertainty, and minimizes the risk of loss of customers and key employees during the BK process).

From the Financial Times:

Hedge funds and other investors stand to make billions of dollars on credit insurance contracts if GM declares bankruptcy, a prospect that is complicating efforts to persuade creditors to agree to a restructuring plan for the automaker, analysts say.

Holders of $27bn in GM bonds have until June 1 to decide whether to swap their debt for a 10 per cent equity stake in the company as part of an offer that would give the US government 50 per cent of the shares, a United Auto Workers union healthcare fund 39 per cent and existing shareholders 1 per cent.

However, analysts say the chances the proposal will be accepted have been diminished by the large number of credit default swap (CDS) contracts written on GM's debt.

Holders of such swaps would be paid in the event of a default – but would lose money if they agreed to restructure GM's debt. For investors who own bonds and CDS, this could create an incentive to favour a bankruptcy filing.

According to the Depository Trust & Clearing Corporation, investors hold $34bn in CDS on GM. Once off-setting positions are considered, the DTCC estimates CDS holders would make a net profit of $2.4bn if GM were to default.

The opposition of 10 per cent of bondholders is enough to derail the proposal, which has already triggered protests from investors who argue it unfairly rewards the UAW at the expense of bondholders.

"You have every incentive not to agree," said one bondholder, a large credit hedge fund. "You would be locking in a loss if you did. It isn't only the 'shark' capital; it will be the mom and pop mutual funds who will oppose this deal. "

Moreover, as we have written at length elsewhere, the idea that GM can have a quick and easy bankruptcy looks like a fantasy. The article continues:

"Chrysler looks like a simple two-car funeral compared to the traffic jam of assets and liabilities and contracts at GM," said the credit research boutique CreditSights. "Chrysler provides limited parallel."

John Dizard, in a separate story, explains why a 363 sale is likely to be blocked:

The "363" plan (a provision under the Bankruptcy Act that allows the company to sell assets) is the means for a "good GM" funded by the government to buy assets from the existing company, or "bad GM". The plan, based on a review of some fairly clear precedents from past cases, is a legally flawed way to disregard the rights of certain creditors – in GM's case, their public bondholders....

The 363 loophole, (really 363(b)), was intended to give a judge the authority to allow for the quick disposal of wasting assets, or assets that are not part of the core business, without waiting for creditors to vote their permission. It was not intended as a way to impose what is called a "sub rosa plan of reorganisation". That is a plan of reorganisation of the entire company on which creditors do not get a vote.

In GM's case, the "sub rosa plan" is to sell the valuable assets, with accompanying union contracts, to a new, "good" GM, and leave the money-losing assets in the original company, which is left in the street to bleed cash and die.

GM's law firm, Weil Gotschal, has attempted to use this section of the bankruptcy code in the past, and had only mixed success in doing so. For example, a bankruptcy judge in New York ruled against a similar Weil Gotschal tactic in the Westpoint Stevens case, saying: "The fact that a transaction including a 363(b) sale of assets may ultimately be in the best economic interests of a debtor's various constituencies does not authorise the court to ignore the creditors' rights and procedural requirements of Chapter 11."

Here's how I believe the GM bankruptcy case will play out. The government, the UAW and GM are in a good position to "forum shop", or find a bankruptcy judge who will be sympathetic to the government-UAW plan. That judge may be in New York (convenient for Weil Gotschal, headquartered in New York's GM building), or Michigan (hometown advantage for GM). That judge will almost certainly grant the request of GM, the union and the government for the 363(b) sale.

Then the bondholders do some forum shopping of their own. They could well find a judge in a Federal district court (one level up from bankruptcy court) willing to grant a temporary restraining order blocking the 363(b) sale.

Given the facts of the case, and the precedent on the side of the bondholders, I think it's quite possible that the judge will issue a TRO, and set a hearing on a motion by the bondholders to enjoin the sale.

That will be the end of the good news for the bondholders. The judge will read through the law, and the facts, and then ask an unpleasant question of the bondholders: what's your alternative?...

Their problem is that the US government will be offering not just working capital for GM during its bankruptcy, but "exit financing" for GM's emergence from Chapter 11. That is hard to get now on commercial terms, even on a smaller scale than would be needed for GM.

There are other problems with the government/union plan. The suppliers to the remaining "good" brands will need to spread their fixed costs over fewer parts, and transferring and revising all the contracts is logistically very difficult. Getting effective, decisive management, when the major shareholders have made unconvincing pledges to be hands off and avoid conflicts... very uncertain.

The bondholders still fight a hard, continuing, rearguard action, since they have little or nothing to lose, and want to preserve their rights and legal precedents for future reorganisations.

 

 

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