Tuesday, January 31, 2012

LBO Chop Shop

With Mitt's running for president, Private Equity is in the spotlight. Mitt hasn't done a great job of defending it, but large parts of what they do are pretty indefensible. For the best attempt, check out Epicurian.

Carried interest, in particular, is clearly a loop hole written into law by the Private Equity industry, for the Private Equity industry. If they wish to be taxed at capital gains rates, then they should invest as LPs. This area is clearly indefensible, but I don't anticipate it changing.

Second is the financial engineering that comes with that tax benefits of leverage. If one is to have a tax on corporations, then there's a good argument for making interest payments on debt tax deductible. Better, though, to stop taxing corporations altogether.

Third, there is Epicurian's defense of the infamous dividend recap, where the PE firm takes cash out of the company as a dividend, and lets the firm take on more debt. If the firm goes bankrupt, the PE company keeps the money they extracted earlier.

Epicurious fails to mention whether the lenders in question get paid when they make the loan, or when the loan gets paid back.

Thursday, January 19, 2012

Look for shocks

Baseline Scenario succumbs to its bias, and gets the causality wrong.
If talent and a strong work ethic is heritable, through genetics or upbringing or some combination of the two, then one would expect limited social mobility.

The real test of social mobility in a system is how it responds to shocks. Say, someone who is lazy and an idiot is born into Bill Gates' family. He might be wealthy, but what would his income be? Or suppose a hard working genius was born to a poor family in New York? Would they be left to languish, or would they be successful?

Wednesday, January 11, 2012

What Google cannot help you with

Google's PageRank algorithm is good at goal directed queries -- "flowers", "cheap airline tickets", or "nearest library". It is not good at non-directed queries, like "funny", "inspirational", "entertain me".

Facebook is great at entertaining people who have no goal cheaply. Instead of making content like TV stations do, it just parades photos of your friends, which are very entertaining because they are your friends. If you want to waste time, Facebook is the place to go (and this is why social games on Facebook are so inane, but also so successful).

This new Google ad is interesting because the queries are exactly the type of queries that Google was bad at, but Google+ hopes to be better at.

"Awesome things you can do with a paperclip"
"Awesome things you can do"
"Awesome things"

Delicious was actually great at this, back when it was a live product. TechCrunch doesn't get it at all.

Tuesday, January 10, 2012

Building Credit

Megan McArdles has a number of good posts about credit unions, and how they help (or don't) build credit.

When I graduated from college, I had a well paying job, was living in New York, but had no credit history. I was a foreigner, and had used my parent's credit card in college, so although I had reasonable income, debt etc. I could not get a credit card of my own.

I ended up getting a secured card from Capital One, with ruinously high fees, and I had to send in a check for $200 (which was the limit on that card). Using the card for convenience, my credit score improved, and I switched to a regular Visa card a few months later.

I don't know what the details are with the teacher in Megan's examples, but I would like to add that there are lots of instruments out there that seem (and are) pretty awful deals, but once you start borrowing and paying back, you build credit very quickly and don't need to stay in those products long.

Friday, January 06, 2012

RIP: Kodak

Kodak seems to be filing for Chapter 11 bankruptcy.



Thursday, January 05, 2012

Not understanding banking is an impediment to regulating banks

MacroResilience demonstrates why not understanding banking is an impediment to regulating banks:
Amar Bhide’s idea essentially seeks to turn back the clock and forbid much of the innovation that has taken place in the last few decades... But it is not enough to mitigate the moral hazard problem... Let us assume that banks can only take deposits and make loans to corporations and households... Banks can simply lend to other firms that take on negatively skewed bets. You may counter that banks should only be allowed to lend to real economy firms. But do we expect regulators to audit not only the banks under their watch but also the firms to whom they lend money?
In a word--yes!

First, bank lending is capital constrained (not reserve constrained), so limits to leverage (especially derivatives, which hide leverage very well) are at the very core of regulation. When a bank makes a loan, the impact of that balance sheet expansion must be risk weighted. So, buying US Treasuries -- go nuts! Buying anything else -- you'll hit your cap earlier.

And yes, this means that regulators need to look at the loans banks are making. In fact, regulators cannot regulate without looking at the loans banks are making. This is baked into the Basel accords that specifically risk-weight capital requirements.

Second, if banks were also required to keep all their loans on their books, then they would have an incentive to make good credit decisions, something they are not motivated to do if they can offload risk to third parties.

Third, if counterparties failed, loans went bad, and banks went under, so long as the Fed gave the bank open access to the discount window and didn't shut it down when it fell under it's capital requirements, a bank with a negative equity position can continue to clear checks.

But, if you believe "unless short-term deposits are deployed to match long-term investment projects" then these regulatory options are inconceivable.