Author: Daniel Indiviglio

Netflix is reported to have reached new deals with 20th Century Fox and Universal for movie and TV show rentals. Netflix customers will be able to rent out the studios’ titles 28-days after their release for purchase. Moreover, subscribers will also be able to stream a greater portion of the titles from these studios’ libraries and will be granted better access to movies-by-mail. While the deal is painted by most accounts as a fair compromise, Netflix appears to be getting a sweeter deal.

The Studios’ Demand

The 28-day delay is intended to serve as an opportunity for the studios to sell more DVD and Blu-ray copies over that time period. The studios believe that anyone who really wants to see the title as soon as it hits the shelves won’t want to wait for Netflix and will feel compelled to purchase it. Will this really increase disc sales that much?

First, consider Blockbuster. TheWrap notes that the movie rental franchise must be very happy about this announcement. It already gets access to new releases as soon as they hit stores — now 28 days before Netflix. That means anyone who really wants to view these titles immediately can just go to Blockbuster. So it’s still relatively easy for most consumers to avoid purchase, even if impatient.

But even without the Blockbuster element, it’s unclear that studios would get many more sales. Is there really much overlap with those who want to rent and those who are willing to buy? With a significant price differential, it’s unlikely that many would-be renters will suddenly pay several times the price to own the film, rather than wait a little longer to rent it.

Moreover, the agreement will enable Netflix customers to stream more of these movies now. That’s similar to owning the film, since subscribers can view the titles on-demand as many times as they want. So with a little patience and an Internet connection, Netflix customers can get more of these studios’ movies for their permanent library at no additional cost.

The Gain for Netflix

Will Blockbuster’s 28-day head-start hurt Netflix? Some more impatient consumers might care, but most of those likely to rent might not mind. There are two factors at play here: First, any current Netflix subscribers aren’t as likely to spend additional money to go to their local Blockbuster to rent a movie sooner.

Second, think about the psychology of those wanting to see the movie post-theater run. If they first saw the movie in the theater and loved it, then there’s a greater likelihood they’ll buy it anyway, rather than rent it. Those who don’t, or who are less passionate about seeing it again, aren’t likely to be as impatient, and probably won’t mind waiting an additional month.

Then, there are those who didn’t see it in the theater. By definition, these individuals probably aren’t in that much of a rush to see the movie. If they’ve waited this long, they can wait another month. This logic suggests that Blockbuster’s advantage might not amount to much. Any damage to Netflix should be minimal.

Yet, the gain to Netflix from making this compromise is enormous. The expansion of its streaming library is a huge win for the company. This must be its preferred method of subscriber viewing — think of all the savings on shipping costs. the company also would need to purchase fewer physical DVDs if it has more subscribers streaming, which means less warehouse space and fewer personnel. Naturally, its customers who have the ability to stream movies also love this method. Through streaming they don’t have to wait for the movie to arrive in the mail — it’s available at the click of a mouse or the push of a remote control button.

All things considered, the studios and Blockbuster get a little, but Netflix gains a lot.

With retailers reporting cheerier reports for March than analysts expected, some economists and econo-pundits are beginning to revise their skepticism about the duration of high unemployment. The logic goes: if spending ramps up more quickly than anticipated, then the U.S. economy will improve fast too. That will create more jobs than we thought.

For a few examples of newfound optimism, check out a Bloomberg article here and one by Floyd Norris in the New York Times here. Is there now reason to believe that employment will experience a steep recovery? Not when you consider the structural changes in the economy and depths of underemployment.

Structural vs. Cyclical

Most recessions are cyclically driven. The business cycle hits a trough, firms lay off workers. As the economy recovers, those workers get hired back before long. This time it’s different. The real estate industry experienced a major correction. Many people who were in that sector can expect to experience prolonged unemployment. Even when the broader economy improves, real estate will not return to its 2005-2006 levels.

Proof of this can be seen by analyzing the latest job numbers from the BLS and comparing them to stats in prior reports. The economy has lost 8.2 million jobs since the recession began in December 2007. That’s 5.9% of total jobs at that time. The key is thinking about how those might be recovered.

Construction is a perfect example of an industry with real estate-driven jobs that won’t be coming back for a very long time. The sector saw a peak around August of 2006, with 7.7 million jobs. As of March, there were just 5.6 million. That’s loss of 2.1 million jobs, representing a 28% decline. The financial services industry tells a similar, but less severe, story: it lost 750,000 jobs since December 2006, amounting to 9%. Again, many of those aren’t coming back.

Now compare that with cyclical industries. Leisure and hospitality is a perfect example. It lost 500,000 jobs, but that was just a 3.7% decline. Retail trade is also cyclical. Its decline was more significant at 7.3%, but that’s still lower on a percentage basis compared to the structural losses above.

Underemployment Much Worse

The official unemployment numbers don’t tell the whole story either. There are also other Americans who want jobs but aren’t included in these totals for reasons like being discouraged. In addition to the 15 million unemployed according to BLS, an additional 5.7 million more want a job but don’t have one. There are 1.4 million more people in this category than in March 2007.

A much grimmer number would include those wanting to work full-time but can only find part-time work. They are considered employed, even though their job situation is unsatisfactory. This accounts for another 9.1 million Americans. That number was less than half that — just 4.2 million — in March 2003.

This means, in addition to the 15 million unemployed, there are another 14.8 million who are underemployed. A true labor market recovery would need to find those others full time jobs as well. So the mountain that the U.S. economy must climb to pull out of this recession is much higher than even the 9.7% unemployment rate suggests. In order to get us back to the 4.4% “natural” unemployment rate in March 2003, we need 14.4 million more full-time jobs. Even if we have a steady growth of 300,000 jobs per month (about twice the 160,000 in March), then that would still take four years.

Apple announced this week that multitasking would be included as a part of the iPhone’s OS 4. For its users, this is huge news: one of the few frustrating aspects of the device has been its inability to run apps in the background. Apple revealed that the obstacle was mostly related to optimizing the power consumption of background apps to save battery life. After solving that problem, multitasking was quite easy. It will be rolled out to iPhones this summer and iPads in the fall.

While multitasking is a very welcome addition to iPhones, it will mostly serve to provide the smartphone with better entertainment value. After all, you can’t do any real work on an iPhone. But for the iPad, multitasking has the potential for the new gadget to take on an important new dimension. With this new capability, they begin to compare more to netbooks and could actually be used for work.

If using the iPad in a mobile setting, then you still probably won’t get much work done, since its on-screen keyboard will make productivity challenging. But if you’ve got it set up on your desk with a Bluetooth keyboard, suddenly it will feel a lot like a computer. You can switch back and forth between a spreadsheet, a presentation, an web browser, etc.

How the iPad’s multitasking will work hasn’t yet been revealed. On the iPhone version, you can have multiple applications going at once, but you can only display one at one at a time. However, what if the iPad’s multitasking includes an additional layer of functionality? Imagine if it allows users to display more than one window at a time on the screen. That would provide an additional dimension to its work productivity potential.

On the iPhone the mere physical constraint of its screen size could explain why this additional multitasking capability wasn’t an option. If you had two windows on its tiny display, you couldn’t see what was going on. But for the iPad, users have a lot more screen to work with. For that reason, having more than one application display side-by-side would work just fine.

One of the problems here could be power usage. Remember, that’s what constrained Apple from including multitasking in the first place. If more than one application is being displayed simultaneously, it’s hard to imagine that the battery could sustain much of that activity. Then, the background power-saving tactics wouldn’t apply to whatever apps are displayed.

Still, even without multiple app display, multitasking will make the iPad a far more useful device for work. Even if it remains a little less functional than a netbook or laptop for that end, you could get real work done. That should allow the iPad to appeal to a broader audience — beyond just the crowd who wants another entertainment device.

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Bond Insurer Ambac announced a surprising fourth quarter profit of $558 million today. That’s after a $2.34 billion loss in the fourth quarter of 2008. This news market quite a turnaround for the troubled insurer which has been ailing ever since the housing market’s collapse. Like most of its competitors, losses from mortgage-related guarantees have plagued the firm. Does this improvement mark a change for the troubled bond insurance industry?

First, the company reports that the improvement was partially driven by a $472 million tax benefit that allows Ambac to carry back losses. Taking that away, the firm had a much smaller profit — just $86.1 million. That is still much better than a loss in the billions, however.

Why else did Ambac improve? It incurred fewer residential mortgage-backed security (RMBS) losses. They were $385 million in 2009, down by 58% from its $916 million loss in the final quarter of 2008. The value of its credit derivatives portfolio also increased by $133 million. That compares to a $594 million loss the portfolio incurred in the same quarter a year prior.

Ambac’s net investment income also improved — up 8%. Net premiums declined by 19% year-over-year, however.  

These results are certainly encouraging and explain why its stock is up around 70% this morning. The value of its credit derivatives will continue to improve as the market does. The severity of its RMBS if should also benefit if home prices have hit the bottom.

But it’s too soon to know if Ambac and its brethren are out of the woods. Foreclosures continue to soar, which will lead to continued losses on RMBS. The housing market’s fate after the home buyer credit expiration in April is also unclear. If employment and consumer sentiment levels don’t improve, it’s hard to imagine there will be much demand on the part of potential new home buyers to soak up the increasing inventory of houses. That won’t bode well for home prices.

Still, today’s news provides some reason for optimism. If the real estate market really has hit the bottom, any bond insurers who have lasted this long could manage to survive. Of course, that’s a big “if.”

Yesterday, when former Fed Chair Alan Greenspan testified (.pdf) before the Financial Crisis Inquiry Commission, much of the hearing was focused on accusation and causation, with far less emphasis on solutions. Earlier today, Atlantic Correspondent Ben Heineman Jr. pointed this out, and highlighted the former central banker’s call for regulatory reform. In doing so, he mentioned some of Greenspan’s ideas. One, in particular, could mark a promising step towards solving the too big to fail problem.

The idea of a resolution authority sounds great in theory. A regulator that can neatly and quickly wind down a large financial institution would definitely have helped a few years ago. But on a practical level there’s some fear that if only select firms are subject to the resolution authority, it could provide a competitive advantage. There’s also some question of what liquidation costs would be covered through a resolution fund, as creditors would lend more cheaply to a firm if they know some of their investment is guaranteed even if an institution fails.

And that’s where Greenspan’s idea comes in. It roughly follows the bail-in theory described here, where large troubled institutions could convert debt to equity in order improve their capital levels, without needing to be wound down. The problem, of course, is that a resolution authority can’t do this haphazardly, or the market would just have even more uncertainty. You can’t leave such details up to the whims of regulators. Greenspan’s solution: detail how this conversion would work. In his prepared testimony, he said:

The solution, in my judgment, that has at least a reasonable chance of reversing the extraordinarily large “moral hazard” that has arisen over the past year is to require banks and possibly all financial intermediaries to hold contingent capital bonds–that is, debt which is automatically converted to equity when equity capital falls below a certain threshold. Such debt will, of course, be more costly on issuance than simple debentures, but its existence could materially reduce moral hazard.

However, should contingent capital bonds prove insufficient, we should allow large institutions to fail, and if assessed by regulators as too interconnected to liquidate quickly, be taken into a special bankruptcy facility. That would grant the regulator access to taxpayer funds for “debtor-in-possession financing.” A new statute would create a panel of judges who specialize in finance. The statute would require creditors (when equity is wholly wiped out) to be subject to statutorily defined principles of discounts from par (“haircuts”) before the financial intermediary was restructured. The firm would then be required to split up into separate units, none of which should be of a size that is too big to fail.

Greenspan’s point about moral hazard is very important. The big worry is that if large institutions will be rescued, then their creditors will provide them cheaper debt. But if investors’ bonds will be converted to equity at some relatively unfavorable conversion rate, then suddenly creditors won’t be as willing to provide big firms a significant funding advantage. Indeed, the idea of paying more for debt might even discourage firms from growing so large in the first place. The key would be to force most or all debt of systemically relevant firms to be subject to equity conversion when some pre-determined capital inadequacy trigger has been hit.

He further calls for firms to fail if the conversion won’t restore capital to a sufficient level. This would make the possibility of rescuing a firm through debt-to-equity conversion a sort of “Chapter 11” bankruptcy mechanism. Firms that can’t be saved even through this means would be resolved. That would be closer to traditional “Chapter 7” liquidation. This would allow firms that aren’t sick enough to require wind down to have a sort of managed bankruptcy reorganization through debt-to-equity conversion.

The only area where Greenspan might lose some public support is his thought that taxpayer funds should be used for debt-in-possession financing. But that could be easily fixed through the creation of a resolution fund through assessments on large institutions, as the regulation measures in Congress already call for.

Other than that, Greenspan’s idea would be a welcome addition to the resolution authority. It would eliminate a great deal of uncertainty regarding failure scenarios of giant firms, but also require their failure if that’s the best option.

Americans might not be as eager for financial reform as Washington thinks, according to a new YouGovPolimetrix National Omnibus/Hamilton Place Poll out today. Just 44% of respondents strongly or somewhat favor “new laws to overhaul government regulation of financial institutions.” And some of the more granular results are even more surprising.

For starters, most of those polled don’t think financial reform should be one of the top two priorities for Washington. In fact, just 18% think it should be given that level of importance by policymakers. 61% did, however, believe that financial reform was at least fairly important.

It would probably be useful if the same question was asked a year earlier: with the financial crisis still clear in the memory of Americans back then, it’s likely that there would have been more interest in financial reform. Democrats may have squandered their opportunity pursue more aggressive regulation with broader public support at that time compared to the effort’s current lackluster support.

Speaking of Democrats, they led those who support more regulation with 69% in favor. But it’s astonishing how few independents support reform — just 37%. Only 23% of Republicans support it.

Possibly the most shocking part of the poll: just 12% of respondents believe establishing a consumer financial protection agency is the most important aspect of financial reform. Most are more worried about the too big to fail problem that leads to government rescues. 36% ranked that the most important, split between the general elimination of bailouts (33%) and creating a resolution authority (3%).

Here’s how that breaks down by respondents’ political affiliation:

Even though bailouts are a major concern, those polled are utterly skeptical that the government can prevent them in the future. Only 14% have “quite a bit” or a “great deal” of confidence that new regulation could stop bailouts. 45% have very little confidence or none at all.

The results were pretty similar regarding the likelihood that reform can protect consumers. Just 15% of respondents have “quite a bit” or a “great deal” of confidence that new regulations could provide more rights to consumers that would significantly improve the way banks and financial institutions treat customers. In fact, 52% have a “quite a bit” or a “great deal” of concern that additional regulation could raise costs or limit credit for average customers and small business. These stats don’t speak well for the political popularity of a consumer financial protection agency.

At this point, financial reform isn’t likely to involve the passionate protest and lively debate on the part of average Americans that was seen during the fight for the health care reform. The poll found that only about half of Americans are even paying somewhat close attention to financial reform currently. But as Congress begins more aggressively pursuing a bill, the public’s interest could increase.

Note: According to Hamilton Place this is a purely independent policy poll intended to add additional understanding to the regulatory reform debate.

Yesterday, General Motors announced that it would be shutting down its Hummer brand. Until late-February, it was thought the business unit might be purchased by Chinese firm Sichuan Tengzhong Heavy Industrial Machines Co. Unfortunately, Chinese regulators didn’t approve. Consequently, GM is thought to have no choice but to liquidate Hummer’s assets. But another report today indicates that there may still be an interested buyer — and from the U.S.

TheCarConnection (TCC) breaks the story that a Raser Technologies, a Utah-based engineering firm, has been interested in Hummer all along. TCC’s sources indicate that Raser bid to acquire the brand after the Tengzhong deal died. The article also says that Raser met all of the bidder requirements.

Raser specializes in electric-conversion and hoped to make plug-in hybrid Hummers, according to TCC. The firm had developed technology similar to what will be used in GM’s upcoming Chevy Volt, which would allow long distance travel, but on very little gasoline. That could have made Hummer a perfect fit: there’s definitely an underserved market segment for big plug-in hybrid SUVs.

So why no deal? That remains unclear. Perhaps GM was unhappy with Raser’s bid. But since Tengzhong’s bid of $150 million was initially accepted, it’s hard to imagine how much more insultingly low it could have been. GM may have determined that it would be financial better off just liquidating the brand’s assets rather than selling it for whatever Raser offered.

That move certainly won’t please Hummer employees or fans of the brand. Moreover, the prospect of a greener Hummer might have conjured up new demand for the re-engineered vehicles. Still, as Saab has shown, a GM division isn’t dead until it’s completely gone. After failed acquisition talks and a decision to wind down Saab, Spyker Cars ultimately swooped in to purchase that brand. So Hummer lovers can still hope for a similar result where GM takes Raser up on its offer.

Wall Street is attempting to create a new exchange that would allow investors to trade future contracts based on how well upcoming films do at the box office. While this might excite movie buffs who hope to finally monetize their overabundance of film knowledge, Hollywood is not amused. In fact, the Motion Picture Association of America is trying to prevent the creation of the new exchange. It has some legitimate reasons for doing so, but the film industry could benefit significantly from the new futures market.

The New York Times explains several of Hollywood’s complaints. Some are sensible, others are not.

Legitimate Worries

Conflicts of Interest

The movie industry worries that studio employees could be tempted by the possibility of making money through this new futures market. If so, then that could affect their work. Think about a sports player or coach betting on a game. If a football quarterback bets against his team, then he could a purposely mess up so that he profits. The same could happen with a movie if its fate could be bet on.

Insider Trading Concerns

This also leads to a broader concern: insider trading. This potential problem was also brought up here. Anyone who knows nonpublic information about an upcoming film has an advantage on betting for or against it. One problematic example, in particular, is movie screenings. These early viewers have seen the product ahead of time and can capitalize on their experience. Will movie studios really be expected to submit lists of those who have viewed the film to the SEC to control insider trading? Anyone obtaining an illegal bootleg could also benefit. The last thing Hollywood wants is more incentive for hackers to acquire movies before release.

Irrational Fears

Market Manipulation

But not all Hollywood’s worries are so serious. One reported fear is that people could manipulate the market by creating rumors about a film. If there’s anything that the entertainment industry already has plenty of, it’s rumors. There are entire magazines devoted to celebrity gossip. More rumors might be annoying, but if a film is legitimately good, then rumors shouldn’t ultimately have much effect on its box office receipts.

Short-Selling

Movie studios are also apparently falling victim to the fallacy that short sellers can wreck a movie’s profits. Let’s think about different futures — those for corn. Imagine that investors overwhelmingly believe that something is going to hurt the corn market and prices will plummet. They short corn futures. How does that affect how well the corn grows? It doesn’t. Does it affect how many people ultimately by the corn? Nope. The same goes for movies. If a film is good, then short sellers will have precisely zero impact on its box office receipts. Moviegoers aren’t going to start checking the futures market before they go to the theater — they’re going to rely on previews, advertising, reviews and word-of-mouth, as always.

One Huge Advantage

It’s a little surprising that the movie industry is fighting this exchange, because it could ultimately benefit them in a very big way: it will encourage investment in films. If someone is worried about the risk inherent in funding a new motion picture, that person can now hedge the investment through a futures exchange. The ability to hedge allows for a smoother, less risky and more predictable revenue stream — something the movie business currently lacks. This serves as the legitimate business purpose for trading film futures, according to Cantor Fitzgerald and Veriana Networks, the firms trying to create the new market.

Yesterday, Kansas City Federal Reserve President Thomas Hoenig gave a speech (.pdf) reiterating his believe that the central bank shouldn’t assure the market that interest rates will be kept low for an “extended period.” According to CNBC and others, investors were not pleased with his comments. Yet, it’s unclear why they were so concerned — Hoeing didn’t say anything shocking or new, and he’s the only one passionately making this argument on the Fed’s Open Market Committee (FOMC).

Here’s the strongest language in Hoenig’s speech:

Under this policy course, the FOMC would initiate sometime soon the process of raising the federal funds rate target towards 1 percent. I would view a move to 1 percent as simply a continuation of our strategy to remove measures that were originally implemented in response to the intensification of the financial crisis that erupted in the fall of 2008. In addition, a federal funds rate of 1 percent would still represent highly accommodative policy.

No News Here

First, Hoenig’s stance is not news. Indeed, the market has been reacting to his view that the Fed might need to raise rates sooner than later since January. At that month’s FOMC meeting he began dissenting with the rest of the committee about the using the phrase “for an extended period” to describe how long rates would be held near zero. Yesterday’s speech didn’t present any unexpected view: he just provided a little additional detail. Hoeing’s opinion should already have been priced into the market since January.

A Lone Voice

In March, he made the same argument. But as in January, he was the sole dissenter. That shows that he must not be convincing anyone on the FOMC that rates might need to be raised soon. If nine voters believe something and one voter believes something different, there’s probably not a whole lot to worry about. Even though some members could be sympathetic to Hoenig’s view, none are so agreeable that they joined him to dissent in March. Unless others start making similar speeches or begin dissenting with the majority, then there’s little to worry about.

And those other FOMC members aren’t likely to be convinced by Hoenig’s desire to raise rates soon either. They are still cautious about the economy and won’t likely want to raise rates until unemployment begins to see a more substantial decline. Remember, full employment is an also explicit policy goal of the Fed, along with price level. And with core prices slightly deflationary, inflation is not likely a greater concern for most members than 17% underemployment.

The Federal Reserve reported that consumer credit fell by 5.6% in February. That erased all of January’s 5.2% gain. In the first month of the year, total credit had expanded for the first time since January 2009. Now, that looks like just a blip. March could see higher levels of credit, however.

Breaking down the credit into its components also reveals that credit shrunk almost across-the-board in February. Revolving credit declined by 13.1% and non-revolving credit fell by 1.6%. The federal government was the only major holder of credit that saw its balance rise, by around 2%.

This chart below shows how revolving and non-revolving have changed since the start of 2007.

As you can see, most of total credit’s decline has been due to revolving credit. Non-revolving credit has declined only 1% over that time, while revolving is down 10%.

Here’s another chart showing the month-over-month change in credit since the start of 2009:

This demonstrates just how rarely credit has grown during over this period. A smoothed version of that chart, utilizing a 3-month average, tells a similar story:

March, however, could be different. Retailers are indicating that spending was up last month. Considering hourly earnings actually declined by 0.1% in March, consumers are likely relying more on credit in order to make those purchases. Pending home sales were also up in February, which should raise non-revolving credit. These indicators suggest March has a shot at seeing some credit growth.

The Securities and Exchange Commission voted 5-0 today to propose sweeping new rules for the securitization market. With mortgage-backed securities (MBS) playing a prominent role in the financial crisis, the market for packaging loans and selling the resulting bonds has come under intense regulator scrutiny. Both versions of financial reform in Congress include new securitization rules, some of which are echoed in the SEC proposal. Though today’s vote just started the process, after receiving public comment the regulator will determine which rules to adopt.

The precise details of the upcoming proposal are not yet known, but some highlights were provided by a fact sheet from the SEC. In contains some good ideas and some not-so-good ideas.

Good Ideas

Income Verification Clarity

A failure to sufficiently verify a borrower’s income plagued some ultimately toxic subprime mortgage-backed securities. In these cases, the borrower’s income was sometimes stated, but unverified or verified through flawed means. Today’s proposal would require new securitization deals to disclose how borrowers’ incomes were confirmed for the loans being sold.

Standardized Loan-Level Data Provided

Another problem during the bubble was that MBS investors often didn’t always have detailed data to analyze. Aggregated statistics were offered, but this could sometimes mask deeper problems with the loans in the pool sold. The new proposal would require computerized loan-level data provided initially and on an on-going basis.

Additional Time for Analysis

During the height of the mortgage market, MBS deals sometimes sold just hours after hitting the market — there was incredibly strong investor demand. So anyone who wanted to invest in the stuff didn’t have time to think very deeply about what they were buying. The SEC seeks to change that by allowing investors more time to ponder the information about the loans in the securitization pool before purchase.

Not-So-Good Ideas

Issuer CEO Certification

It might sound like a smart idea to have the originator’s chief executive officer certify that it’s reasonable to expect that the assets in question will perform as expected. While that does put some responsibility on the shoulders of the CEO to ensure the loan quality is as advertized, it’s hard to see how this standard would have made much difference if in place during the bubble. These mortgage companies actually believed that the losses would be roughly what they indicated. They were simply wrong.

5% Skin in the Game

The idea that whoever securitizes loans retain a portion of the risk associated with those assets is a pretty popular concept. The assertion is that if the bank creating these assets had some skin in the game, then they would care more about the quality of the bonds they sell to investors. But as the financial crisis has proven, these banks already held plenty of these toxic securities in their own portfolios — so many that they needed to be bailed out due to fears about the associated losses. Forcing securitizers who have some skin in the game sounds great in theory, but actual experience has shown that poor assumptions — not trying to trick investors — led banks to the creation of bad securities.

SEC Computer Model for Analyzing Securities

The SEC wishes to force whoever issues an asset-backed security to provide a computer program (a model) that investors can use to analyze the deal. The utility of this is questionable. Part of being an investor is developing such models on your own. Different basic assumptions could result in the creation of different models. Reliance on a one-size-fits-all model isn’t really feasible. Investors should determine what assumptions to use and the amount of time spent developing analytical methods. Standardizing models would just result in the same sort of lazy investor problem that led to too much demand for bad securities in the first place. The burden of analysis should be placed on the investor, not on the securitizer.

Spirit Airlines announced this week that it will begin charging between $20 and $45 for carry-on bags that don’t fit underneath a seat. That’s in addition to similar fees already in place for checked luggage. This has many travelers fuming, annoyed by this latest attempt by an airline to nickel-and-dime them through additional fees. But really, consumers are better off with more a la carte pricing: it provides more spending discretion, should lower overall fares and will make for a smoother airport experience.

In the press release, Spirit CEO Ken McKenzie explains the airline’s rationale:

“In addition to lowering fares even further, this will reduce the number of carry-on bags, which will improve inflight safety and efficiency by speeding up the boarding and deplaning process, all of which ultimately improve the overall customer experience,” says Spirit’s Chief Operating Officer Ken McKenzie. “Bring less; pay less. It’s simple.”

Obviously, many people are cynical about the assertion that ticket prices will decline as a result of this move. But as long as the airlines remain competitive, they will have to. If fares don’t change, then that means airlines weren’t charging enough for tickets in the first place. Given the airline industry’s troubles in recent years, that’s certainly plausible. So either way, fliers would ultimately have been responsible for the same total cost.

Let’s consider the three benefits of a la carte pricing McKenzie alludes to:

More Spending Discretion

Let’s say you think it’s worth packing lighter and saving $20 to $45 on the cost of your flight. Now you have the ability to do so. Before, that cost would have been unavoidable, since it was included in the price of the ticket. Consumers should welcome this flexibility.

Lower Ticket Prices

Travelers now have a clear incentive to pack as lightly as possible. That should result in more fliers deciding to bring less baggage. Consequently, planes will use less fuel. Airlines will then face lower fuel costs, and ticket prices should decline.

A Smoother Airport Experience

Probably the dumbest thing that airlines have done over the past decade was to charge luggage fees on only checked bags. That encouraged people to carry on more baggage, slowing the boarding and security processes, which resulted in more delays and headache. Airlines should have done what Spirit is doing now: charge customers the same for a bag, whether checked or carried-on. Now, travelers will be indifferent to those storage options, if they need to bring along a suitcase. In fact, there’s a slight advantage to checking — since you can generally pack more in a checked-bag for the same price. This should result in shorter delays.

For these reasons, consumers should hope that all airlines also adopt Spirit’s new policy. More a la carte pricing options allows travelers greater flexibility to control their flying experience based on their affordability.

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Former Federal Reserve Chairman Alan Greenspan said (.pdf) today that the creation of subprime mortgages didn’t cause the financial crisis — the secondary market demand for these subprime mortgages drove the bubble that was to blame. He made these comments during a Financial Crisis Inquiry Commission (FCIC) hearing. Some blame Greenspan’s easy monetary policy for beginning to inflate the housing bubble. His testimony makes clear that he sees the cause elsewhere.

There’s a strong argument that the mere creation of subprime mortgage couldn’t have inflated a housing bubble: such loan products had been around for many years. Why hadn’t their origination been as great in the past as it was over the last decade? There was a demand shift. Secondary market purchases of subprime mortgages, including bonds resulting from securitization, became much more popular over that period. With ample funding for these risky mortgages, more were created and the subprime mortgage bubble began growing.

Greenspan sees Fannie and Freddie as a driving force. He says:

The firms purchased an estimated 40% of all private-label subprime mortgage securities (almost all adjustable rate), newly purchased, and retained on investors’ balance sheets during 2003 and 2004. That was an estimated five times their share of newly purchased and retained in 2002, implying that a significant proportion of the increased demand for subprime mortgage backed securities during the years 2003-2004 was effectively politically mandated, and hence driven by highly inelastic demand.

Those are pretty compelling facts. The GSEs comfort with those loans likely also drove investors to purchase more of these securitized subprime mortgages on their own as well. Of course, rating agencies made matters worse by slapping AAA-ratings on many of the resulting bonds. Everyone began believing the same fallacy that home prices couldn’t decline, so investor due diligence was inadequate to properly identify the risk inherent in these loans.

Phil Angelides, the FCIC Chairman, however, wasn’t buying Greenspan’s argument. He demanded to know why the Federal Reserve didn’t act to create rules prohibiting abusive subprime mortgage products. Greenspan responded with an explanation that the Fed began worrying about subprime mortgages as early as 1998, and began providing guidance shortly thereafter (documented in the appendix of his prepared testimony – .pdf). But Angelides didn’t think guidance was enough, and pressed that the Fed should have created stricter rules to prevent some of the practices that resulted.

Why didn’t Greenspan engage in stronger regulation? Subprime mortgage products had been around for decades on a small scale and never posed a problem. They only became dangerous when underwriting standards declined and funding for them became too cheap, driven by the demand for their purchase by the GSEs and investors. Greenspan says that the Fed was not aware of the extent of the GSEs subprime mortgage exposure until September 2009 — far too late.

In the retrospect, it’s easy to say that the Fed should have acted to limit the growth of subprime mortgages. At the time, however, no one realized the massive problem they would eventually pose, particularly since they never had been much of an issue before. And even if these mortgages did go bad, the Fed believed any resulting losses would just fall on banks and mortgage companies, with little impact on the broader economy. That shows the more important lack in foresight on the part of the Fed: its failure to see how interconnected all facets of finance had become.

Yesterday, a U.S. appeals court ruled against the FCC’s net neutrality regulations, which sought to force service providers to treat all Internet traffic the same. Internet freedom advocates consider the ruling a major defeat, while companies including Verizon, AT&T and Comcast are the clear winners. How will the average Web surfer be affected?

Service providers would like to be able to charge data hogs more for usage — or slow down their file transfers, so not to hinder other network traffic. Even though the Internet seems like a magical technology with no limits, there actually are physical constraints and costs that service providers need to worry about. This FCC ruling allows them to better manage their networks accordingly.

But if the Internet goes completely unregulated, then there is a potential for those companies to take advantage of the system. Wired imagines one such scenario:

A broadband company could, for instance, ink a deal with Microsoft to transfer all attempts to reach Google.com to Bing.com. The only recourse a user would have, under the ruling, would be to switch to a different provider — assuming, of course, they had an alternative to switch to.

Far-fetched? Yes. Impossible? No.

So the FCC and Congress should work to ensure that such shenanigans are forbidden. Service providers shouldn’t be allowed to arbitrarily discriminate. For example, Comcast also shouldn’t be able to block any Verizon ads that websites are running. But fairly uncontroversial net neutrality legislation could set reasonable limits. Such new laws could ensure that any discrimination on the part of service providers be grounded in controlling costs so to actually benefit the average Internet user and forbid those based on ends including payoffs, political gain, anti-competitive behavior, etc.

Let’s think about what might and might not pass that sniff test. The Wired example certainly wouldn’t: that consisted of a payoff resulting in the average consumers being worse off with access to fewer websites. But charging data hogging websites more or slowing down their traffic would ultimately benefit the average Web surfer: these sites are imposing a disproportionate cost on the service provider, which is spread over everyone if absolute net neutrality is in place.

Asserting the Internet should remain open and unrestrained isn’t the same as saying service providers shouldn’t have any control over their own networks. They have a business to run, and as long as they don’t arbitrarily or unfairly discriminate among various users or websites, but do so based on the cost the traffic imposes, then such mild limits to net neutrality actually would benefit the average user in the long run.

Wish Americans didn’t have such a negative view of the housing market? According Fannie Mae’s National Housing Survey, they don’t. Consumer sentiment, the safeness of a home as an investment and the importance of paying debts all scored relatively high marks.

A Good Time to Buy

Perhaps the most surprising result was the strength of consumer sentiment towards buying a home. Approximately the same number of respondents believes that now is a good a time to buy a home as did in 2003:

So should we expect a new housing boom, like the one we saw in 2004-2006? Not exactly. Just because people think it’s a good time to buy a home doesn’t mean many will do so. Consumers must also be able to buy a home. Considering the economic challenges the U.S. continues to face, fewer Americans have the income, wealth and credit needed to purchase a house now than in 2003.

Still A Safe Investment

Interestingly, the housing market’s collapse hasn’t deterred many people from appreciating a home’s value as a safe investment. The survey also found that the vast majority of Americans still consider a home a very safe place to invest your savings:

Perhaps they should read this post from earlier, which argues that home prices shouldn’t generally increase much.

Strategic Default Is Unacceptable

Another fascinating finding: few Americans likely view so-called strategic defaults favorably. Those occur when borrowers who can afford to pay for their mortgages decide to stop doing so, usually because the home is worth less than their mortgage balance. The survey found that 88% of Americans (and 70% of those delinquent) did not believe it was “acceptable” for people to stop making payments on underwater mortgages. Only 8% thought it was acceptable. But when the poll factored in financial distress, that 8% rose to 15%.

The news wasn’t all good. Only 31% thought that the U.S. economy was on the right track, though the poll was conducted from December 12th 2009 through January 12, 2010, so sentiment has likely improved since that time.

The Federal Reserve released the minutes from its March 16th meeting today. As in January, Fed economists continued to see signs of economic improvement, but have no intention of raising interest rates anytime soon. Also the same as in January was Kansas City Fed President Thomas Hoenig’s dissent regarding the usage of the “extended period of time” language for how long rates would be kept exceptionally low. Hoenig is just one voice on the committee, but the March minutes may indicate that investors took his dissent very seriously.

The Staff Review of the Financial Situation from the minutes says:

The decision by the Federal Open Market Committee (FOMC) at the January meeting to keep the target range for the federal funds rate unchanged and to retain the “extended period” language in the statement was widely anticipated by market participants. However, investors reportedly read the statement’s characterization of the economic outlook as somewhat more upbeat than they had anticipated, and Eurodollar futures rates rose a bit in response.

It’s no secret that investors hang on the Fed’s every word. But if you compare the January and December economic outlook sections, it’s very hard to see how investors saw a significant, unanticipated difference. Here are the changes in the economic outlook sections from December to January tracked (click on it for a bigger image):

As you can see, they’re pretty similar. The FOMC made changes like replacing “pick up” with “strengthen” and “appears to be” with “is”. The more significant differences included removing sections about businesses cutting back spending and policy actions stabilizing the market. It’s hard to see how the Fed could have been slightly more optimistic but have changed much less. Did the market really react these tweaks?

Perhaps, but it’s more likely they reacted to a much more significant difference from past meetings: a committee member dissent. The January statement also said:

Voting against the policy action was Thomas M. Hoenig, who believed that economic and financial conditions had changed sufficiently that the expectation of exceptionally low levels of the federal funds rate for an extended period was no longer warranted.

Now that’s a change. Suddenly, we’ve got a FOMC voter now adamantly arguing that interest rates might need to be raised sooner than the market might anticipate. He felt so passionately that he chose to be the sole dissenter. Investors more likely saw this as a sign that it wouldn’t be long before other committee members agreed and the Fed began more formally backing away from stating that interest rates would remain very low “for an extended period.”

One of the major sticking points in the Senate’s financial reform bill involves the non-bank resolution authority. Its architect, Banking Committee Chairman Christopher Dodd (D-CT), wants to allow regulators sufficient authority to stabilize the financial market in times of turmoil. Republicans worry that this flexibility could result in more bailouts. Richmond Federal Reserve President Jeffrey Lacker articulated the latter view during an interview with CNBC’s Steve Liesman that aired this morning. Lacker thinks Dodd’s bill is too soft on forcing bankrupt firms to fail.

Here’s a transcript of the relevant part of the discussion, though the whole video can be watched at the bottom of the post:

Lacker: The issue of our time has to do with the government safety net for financial firms. And it’s grown tremendously, and containing that, establishing clear boundaries of that, is the number one priority. As I read the Dodd bill and the mechanism it sets up for the resolution authority, it doesn’t strike me that it’s likely to help us there. And in fact, it seems to me like a major danger is that there’s going to be more instability in financial markets instead of less.

Liesman: The Dodd bill allows for a three-bankruptcy judge panel to declare insolvency. It allows losses to go to unsecured creditors; it allows management to be replaced and shareholders to be wiped out. How much clearer could the government be in this bill that there will be real losses to investors?

Lacker: It allows those things, but it does not require them. Moreover, it provides tremendous discretion for the Treasury and FDIC to use that fund to buy assets from the failed firm, to guarantee liabilities of the failed firm, to buy liabilities of the failed firm. They can support creditors in the failed firm. They have a tremendous amount of discretion. And if they have the discretion, they are likely to be forced to use it in a crisis.

Whether financial reform should be stricter on failing firms isn’t a simple question. For example, imagine a firm that should fail in its current form, but through restructuring its debt and equity could survive. Should it just be wound down and obliterated, or should a regulator work to restructure the firm (assuming no loss to taxpayers)? The harder line would call for wind down, but Dodd’s bill might allow for restructuring.

Even though this question is a hard one, financial reform shouldn’t leave it unanswered. That’s why Lacker is right to call for more specificity in the powers of the resolution authority. What “costs” will be covered by the resolution fund? Under what circumstances can a firm be restructured? These sorts of issues should be specifically defined.

For example, can the resolution authority perform a debt to equity conversation to enhance capital levels of a troubled firm to keep it afloat? If so, under what conditions? Those details should be explained so that creditors can understand how that might shake out. Will the resolution authority cover a part of a firm’s derivatives exposure and pay out counterparties? If so, how many cents on the dollar can a counterparty expect?

Working out such details will serve to eliminate market uncertainty. It should also destroy the perception that systemically relevant firms would remain too big to fail. Instead, investors could just look at how the resolution process would work and figure out under what conditions a firm could survive a government resolution. (And survival shouldn’t be easy.) Of course, determining such specifics ahead of time would make for more accurate risk-based assessments paid into the resolution fund by firms as well.

And although Lacker doesn’t mention it, the resolution authority’s rules should apply to all firms, not just large ones. That way, investors can evaluate all market participants on a level playing field. If only the big firms receive the potential advantages that a resolution authority provides — even if explicit bailout isn’t one of them — then smaller firms will experience a competitive disadvantage when trying to acquire funding.

A while back a debate began on the question of whether or not a house is an investment. Even if it is an investment, then Harvard economist Edward Glaeser explains why it’s a particularly poor one in a piece by from the New York Times Economix blog today. He argues that it’s pretty plausible that your house’s value won’t rise.

First, it’s Glaeser actually does appear to believe that a home is a sort of investment, as he refers to houses as assets. He says that it pays the owner back dividends in the form of living space. But that may be all that some owners get back: there’s no economic reason why the price should generally increase:

Some pundits look at the ratio between housing prices and income as if that should remain stable, which would mean that prices should at least rise with incomes.

But that doesn’t make much more sense than expecting a constant ratio between income and either computer or car prices. Declining construction costs, and rising incomes, led the ratio of housing value to income to drop by 40 percent or more between 1980 and 2000 in places like Houston, Minneapolis and Phoenix.

In principle, declining construction costs could also lead homes to become more affordable year after year.

So prices would actually decline. Glaeser notes that scarcity also matters. If housing in some area is in low supply, then it’s more likely prices could increase there. Thus, in rural locations, where scarcity is less of a factor, construction costs likely drive price.

Those are supply-side effects, but demand matters too. If an area is seen as extremely attractive due to its climate and or economic condition, then more people will want to move there. When housing growth can’t keep up with the population growth, home prices increase. That’s why you saw booming real estate markets in places like Florida even before the housing bubble began.

Both supply and demand effects demonstrate the importance of demographic changes to home prices. For example, if people begin suddenly flooding cities from rural areas, then the cities would experience greater demand, and given their relative scarcity of homes, prices would increase. Meanwhile, the price of houses in rural areas would decline. But if people begin leaving cities to move to more rural areas, then the opposite effect would occur, though it’s likely that the appreciation of homes in those rural areas wouldn’t be as rapid as it would be in cities, given the relative scarcity.

You can also apply this logic to the areas that were first helped but ultimately hurt most by the housing bubble. Places like Florida and Arizona might take even longer to rebound if people are leaving to seek economic opportunities elsewhere. (There’s some evidence of that happening in Florida.) After having built too many homes during the bubble, those markets would have to experience significant population growth to bring back housing appreciation. Instead, the opposite may occur, which could actually result in house values declining further.

Fannie Mae and Freddie Mac will begin using a clearing house to trade their interest-rate swaps by year’s end, according to a Wall Street Journal report. The nice thing about trading through a clearing house is that it shields counterparties from losses that would otherwise result if a firm can’t cover its derivative obligations. If such potential losses occur, then the other firms who participate in the clearing house pay for what the troubled firm can’t. Is this good news for taxpayers? Probably not.

It sure seems like it would be through WSJ’s report:

For years, the mortgage firms have purchased the swaps from Wall Street banks to hedge their huge mortgage portfolios against rate swings. The banks, such as Goldman Sachs Group Inc. and J.P. Morgan Chase & Co., make money by structuring the deals and selling them to clients.

With so-called central clearing, banks play a similar role but operate under the umbrella of a clearinghouse that guarantees the trade for both parties in case one side defaults. The guarantee is something that many felt was badly missing during the financial crisis. Then, markets seized up amid fears that some firms would falter and be unable to make good on their swap trades.

The WSJ appears to be indicating that, somehow, Fannie and Freddie will save money now by using a clearing house. The grounds for this assertion are unclear. They will continue to have to pay structuring and placement fees to banks when they create new swaps. In fact, these swaps will likely be more even costly if traded through a clearing house, because Fannie and Freddie will have to put up additional capital in order to use the clearing house.

And the news gets worse. As mentioned earlier, if a firm using a clearing house runs into trouble, then the others who use the trading facility cover any potential losses to counterparties. As a result, the firms who participate in a clearing house won’t let just any firm in: they must be very healthy, so that bankruptcy is unlikely.

If you follow Fannie and Freddie, then you know “healthy” isn’t a word anyone uses to describe them. The biggest of bailout recipients, they continue to struggle with delinquencies. As a result, any clearing house that lets these trouble firms in must be demanding some level of ongoing support from the government to protect it from a GSE default event. The decision to trade through a clearing house will likely make it harder to wean Fannie and Freddie off government support.

Fannie and Freddie do get something for the higher cost they will pay for trading through a clearing house, however. The credit risk of their derivatives exposure will shrink. Now, if a bank goes under who wrote a swap with Fannie, the clearing house will cover the potential loss.

So is the move overall a good one for taxpayers? It depends on how you weight the cost and benefit. The benefit just explained will ultimately be significant to Fannie and Freddie. But the cost of making it harder to privatize Fannie and Freddie is quite bad for taxpayers. After all, if the GSEs were privatized, then taxpayers wouldn’t have to worry about its derivatives exposure anyway.

Over the past several years, unpaid internships have gained immense popularity. But since the onset of the recession, so many young people working for free has raised some eyebrows. Are companies just trying to save money by bring in these interns to do work that they would have paid for in a good economy?

The New York Times had an article this weekend addressing the topic. It said:

The Labor Department says it is cracking down on firms that fail to pay interns properly and expanding efforts to educate companies, colleges and students on the law regarding internships.

“If you’re a for-profit employer or you want to pursue an internship with a for-profit employer, there aren’t going to be many circumstances where you can have an internship and not be paid and still be in compliance with the law,” said Nancy J. Leppink, the acting director of the department’s wage and hour division.

Of course, this matter because in the U.S. workers must be paid. That’s why we have a minimum wage. Even voluntarily working for free is against the law if the company is for-profit.

So how do you tell the difference? The Times article looks to the following Labor Department directive (.pdf), which lists six criteria:

1. The training, even though it includes actual operation of the facilities of the employer, is similar to what would be given in a vocational school or academic educational instruction;

2. The training is for the benefit of the trainees;

3. The trainees do not displace regular employees, but work under their close observation;

4. The employer that provides the training derives no immediate advantage from the activities of the trainees, and on occasion the employer’s operations may actually be impeded;

5. The trainees are not necessarily entitled to a job at the conclusion of the training period; and

6. The employer and the trainees understand that the trainees are not entitled to wages for the time spent in training.

All six must be met.

These criteria are pretty strict. In particular, number four might be a hard one for many companies with internship programs to satisfy. It appears to require that the efforts of the intern not really benefit the company; in fact, they should sometimes impede it. Can you think of many companies that would be better off without their unpaid interns?

What would happen if the government ramps up enforcement to eliminate any internship that fails to adhere to this standard? Most firms would probably just attempt to tweak the internships to be in better compliance. But in cases where that’s impossible, a company would have two options: eliminate the interns or hire them as paid employees.

Obviously, if a business derives advantages through the activities performed by its interns, then it makes sense that they should be paid. But in this tough economic climate, not all firms would be able to afford additional labor costs. Consequently, those companies forced to hire the interns needed for necessary tasks would have a harder time surviving. Others would just eliminate the internship positions, unleashing these young adults on the already swelling ranks of the unemployed.

Neither of these consequences is desirable. Forcing firms to pay interns could do more harm than good. If some workers are willing and able to work for free and feel they’re benefiting from the experience, shouldn’t that be enough to legitimize the relationship? If the economy were flourishing, such arrangements might be harder to justify. But right now might not be the right time to crack down on unpaid internships.