Archive for February, 2009

If we are now facing 1996 prices for the S&P 500 (making this prediction oddly prescient), why is anyone surprised by talk of NY real estate dipping to – horrors – 2002 prices?

With just under 50 units, the building is currently priced around $1,000 per square foot. Minimum bids will probably be set at around $600 per square foot, the lender said.

Here’s my question – what is the marginal cost of building another square foot in NY?  If you walk around Manhattan, one of the things you notice is that while there is plenty of new construction, in general the new buildings are not the tallest around; the big 40+ story residential towers generally predate the late 1970s economic meltdown.  $600/foot sounds high for the extra steel, concrete, and labor of putting up another floor.

One of the finest articles I have ever read on real estate hit the NYT Magazine on March 5, 2006 – just in time, as it turned out.  It is a profile of Edward Glaeser and his work on the impact of zoning regulations.

As Glaeser says: “It’s so easy to forget the world that we were living in around 1970, when basically almost all of the value of houses was in the physical infrastructure. That was actually the cost. There was some land, and it was worth something, but it wasn’t worth more than 20 percent of the value of the house.” Even in New York City, Glaeser says, the price of an apartment back then was essentially the cost of building the next floor. In researching New York City’s housing prices, in fact, Glaeser and Gyourko discovered that over the past 30 years, the average height of new residential buildings in Manhattan decreased in size. “That’s crazy,” he insists, especially in light of how much the demand to live in New York has increased. “You know, if prices in Manhattan are skyrocketing, you should be building more and more at 50 stories, rather than at 30. Not the reverse.”

Let’s go back to Manhattan in the 1920’s, Glaeser says. “New York in the 1920’s is a pretty developed place, a pretty mature place. But they’re producing a hundred thousand units a year. They’re tearing up swaths of Manhattan and building higher buildings.” That would be legally and politically impossible today, but as he and Gyourko see things, it is precisely those legal and political roadblocks to “tearing up” the city that have made the place so expensive. Actually, in 2004, the two men took a close look at Manhattan and estimated that one half or more of the value of condominiums in the borough could be thought of as arising from some type of regulatory constraint preventing the construction of new housing.

And on the subject of bubbles, here is Doug Short‘s graph of market crashes:

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Sucker in the Room

From the AP:

Citi will offer to exchange up to $27.5 billion of its existing preferred stock held by private investors at a conversion price of $3.25 per share. That’s a 32 percent premium over Thursday’s closing price of $2.46.

Bank of America made an idiotic decision to buy Merrill at a premium, but the world looked different the weekend before Lehman Monday; perhaps sitting in Charlotte, surrounded by Countrywide swag, everything was going to be sunny and they needed to lock in the deal quickly.  And, in fairness, the Treasury did put the screws to them and force them not to declare a material adverse change and walk away from the Merrill deal after the true extent of the disaster became clear.  Maybe it ended up being a case of Paulson strong-arming a very weak Ken Lewis to protect John Thain.

But giving up seniority at a premium?  Why?  Does anyone believe the fiction that the government does not already control Citi?  What could we get that would possibly justify giving away a third of our capital for the privilege of converting down?

And check out Treasury’s explanation:

Citigroup is planning to strengthen its capital structure through conversion of a significant portion of its preferred securities to common equity in a series of exchange offers…This transaction does not increase the amount of Treasury’s investment in Citigroup.

If we are not injecting any new capital, how does rearranging the ownership and liquidation preference strengthen anything?  It is a closed loop; all we have done is decide that Treasury now owns less of whatever is left over after the bondholders are paid and the previous common shareholders now own more.  Call it what you will, it is nothing more or less than a gift.

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One of Obama’s proposals is to alter the mortgage interest deduction so that no matter the tax bracket, the deduction hits at the 28% bracket.  Previously, if you were in the 33% or 35% brackets, you could deduct interest at that bracket.

The change is not enormous – the deduction is capped on the principal amount of $1mm, so change is at most $4,000 or so for a family earning over $210,000/year – but, as mentioned previously, it scares the pants off the realtors and house builders.

They know they cannot just come out and say “we really like the subsidy.”  They need to couch it in terms of fighting for the common man – which is the last thing they really want to do.  So check out this press release from the National Association of Home Builders:

At this critical point in the recession, we should be doing everything we can to stimulate demand in housing and avoid proposals that would reduce housing affordability and further destabilize prices.

Quick question: if you want to make something more “affordable,” do you raise or lower its price?

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Offscreen Voice

Freakanomics is asking why animated movies use famous actors to voice the parts.  Levitt’s guesses are:

  1. Stars are better at speaking than non-stars;
  2. Stars don’t charge much for their voices;
  3. People like to hear the voices of stars (a variant of #1);
  4. Expensive stars are a credible signal of confidence in a movie.

I don’t think I agree.  First of all, for most of the history of animation, the voices were anonymous.  The most famous person in Little Mermaid was Buddy Hackett.  But Jeff Katzenberg had the idea of including famous people in Lion King (Matthew Broderick, Jeremy Irons, James Earl Jones) along with some unknown voice actors.  When he left to co-found Dreamworks, he went all-in and made Prince of Egypt with an entirely celebrity lineup (Val Kilmer, Ralph Fiennes, Michelle Pfeiffer, Sandra Bullock, Jeff Goldblum, Patrick Stewart, Danny Glover, Steve Martin, Martin Short).  It was a success, and the arms race was on.

So I would suggest the real reason is probably a bit of Freakanomics #3, plus:

  • Celebrities can promote a movie.  It’s easy to get Val Kilmer on Letterman.
  • Covers your ass if the movie fails.  Far from answer #4, I think it’s a case of wanting to be seen as checking every box.  A big animated movie is a couple hundred million dollar proposition, fully loaded.  If it flops and used no-name voices, the execs involved will forever be second guessed for saving $10mm.  If it flops and they used celebrities, well, we did the best we could.

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I hope there are better arguments against nationalization.  Because saying that it was really difficult is pretty weak when your solution is:

The Obama administration should declare that nationalization of any major bank is off the table; that the government stands behind our entire banking system; and that our banks will continue to receive a nonvoting form of equity capital, such as convertible preferred stock, from the government to the extent needed.

That whole “stand[ing] behind our entire banking system” bit means putting taxpayer money at risk for private decisions.  Why wouldn’t we get all the benefits of control – the right to hire, fire, and restructure, the economic return of any appreciation – in exchange for taking a greater risk than any private investor is willing to take?  Anything else is providing a gift to the shareholders of the banks – the group who got us into this mess and precisely the people we should not be rewarding.

Krugman and Greenspan have both acknowledged the need to nationalize.  The serious analysis is not really in any doubt.  I wonder if the problem is not more cultural; the government has invested so much in proving it is not a bunch of arugala-eating Trotskyist academics that it has a hard time recognizing the circumstances.  As Dave Leonardt puts it:

[Obama's] top advisers, including Geithner and Lawrence Summers, have spent much of their careers trying to persuade other Democrats of the virtues of private enterprise. They have pushed the party to grasp the folly of Mitterrand and acknowledge the limits of government. As this crisis has made clear, the private sector has its limits, too. Will the people who have Obama’s ear be able to acknowledge those limits when the time comes?

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Just thinking of the late-night TV reshuffling, which brought to mind the funniest clip in network television history:

Wonder if an 11:30pm Conan will tolerate one guest destroying another guest’s career:

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David Brooks

Back when he was fun to read:

All we know, or all we think we know, about Red America is that millions and millions of its people live quietly underneath flight patterns, many of them are racist and homophobic, and when you see them at highway rest stops, they’re often really fat and their clothes are too tight.


The kinds of distinctions we make in Blue America are different. In my world the easiest way to categorize people is by headroom needs. People who went to business school or law school like a lot of headroom. They buy humongous sport-utility vehicles that practically have cathedral ceilings over the front seats. They live in homes the size of country clubs, with soaring entry atriums so high that they could practically fly a kite when they come through the front door. These big-headroom people tend to be predators: their jobs have them negotiating and competing all day. They spend small fortunes on dry cleaning. They grow animated when talking about how much they love their blackberries. They fill their enormous wall space with huge professional family portraits-Mom and Dad with their perfect kids (dressed in light-blue oxford shirts) laughing happily in an orchard somewhere.

Small-headroom people tend to have been liberal-arts majors, and they have liberal-arts jobs. They get passive-aggressive pleasure from demonstrating how modest and environmentally sensitive their living containers are. They hate people with SUVs, and feel virtuous driving around in their low-ceilinged little Hondas, which often display a RANDOM ACTS OF KINDNESS bumper sticker or one bearing an image of a fish with legs, along with the word “Darwin,” just to show how intellectually superior to fundamentalist Christians they are.

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Three Card Monte

This one I simply don’t understand.

Supposedly the plan being discussed between the government and AIG would break AIG into three operating units:

  • Asian operations
  • International life insurance
  • US personal lines

Those sound like good companies.  I wonder why they need to do this.  Oh, right, there’s one more:

A fourth unit, comprised of AIG’s other businesses and troubled assets, could also be formed.

It’s those pesky “troubled assets” again.  One business, three businesses, twenty businesses; the issue is that AIG’s liabilities greatly – very greatly – exceed its assets.  I was never a good math student, but I am pretty sure there is no way to split the company without at least one remaining entity still having liabilities in excess of assets.

Furthermore, if the idea were to hive off the three businesses with going concern value and then declare bankruptcy at the remainder, wouldn’t that be a pretty textbook definition of fraudulent conveyance?

The problem with AIG is that it took on a massive position in credit derivative swaps, and the government is unwilling to allow this position to wind up in a bankruptcy proceeding for fear of the damage this would do to the counterparties (Goldman and the Chinese government are counterparties of particular concern).  I disagree with this approach; I think we would be better off taking the pain today and recapitalizing those entities that really need it than spraying cash into a system we do not have under control.  Regardless of where you stand on the larger topic, however, changing the letterhead of the subsidiaries does nothing for the government or for AIG’s counterparties.  The best this particular plan might do is that the failed entity might not be called “AIG”, and no Congressman will give Treasury/Fed a hard time for “blowing a hundred billion at AIG and it still went broke.”

If it’s purely to save face, I would then suggest we keep AIG as one corporate entity and rename it “Iraq”.  If anyone asks about the losses, we can just add it to the trillion and change we have already wasted.

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I guess March Madness got started a bit early this year.  Grainy video, but you’ll figure it out:

Reminds me of this wonderful moment:

Too bad Spike Lee wasn’t in Wabash, Indiana last week…

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The next-generation TARP is online at the Treasury.  Some highlights:

Capital provided under the CAP will be in the form of a preferred security that is convertible into common equity at a 10 percent discount to the price prevailing prior to February 9th.

Wonder what the significance of February 9th might be…  Anniversary of the Treaty of Luneville?  Anniversary of the first flight of the Boeing 747?  Or – as wondered on Calculated Risk – the highest Citigroup share price in February?

CAP securities will carry a 9 percent dividend yield and would be convertible at the issuer’s option (subject to the approval of their regulator)…The instrument is designed to give banks the incentive to replace USG-provided capital with private capital

Because another sucker is going to stand in the way of the massive asset write-downs to come for a 9% yield and the privilege of buying something for $3.56 – convertible at the other guy’s decision, mind you – that is trading for $2.79 when you announce the plan?  No, I think we’re on our own on this one.

As part of the application process, banks must submit a plan for how they intend to use this capital to preserve and strengthen their lending capacity – specifically, to increase lending above levels relative to what would have been possible without government support.

This was a topic in the State of the Union as well as the various finance hearings, and it makes little sense.  On some level, the capital obviously preserves lending capacity – with no Federal capital whatsoever the bank would be insolvent.  But within the band of solvency, the bank should be making only such loans as are profitable on a risk-adjusted basis – and there are increasingly few such credits out there.

The giant banks have a giant overhang of lousy assets.  Until these are written down, nothing good is going to happen in the banking system.  Until we nationalize the banks, they won’t write anything down, because the sheer magnitude of the write-downs would put them under.  I’m not sure what Obama meant by holding banking executives accountable – Vikram Pandit sure can’t write a check to make Citigroup whole – and John Thain’s drapes are the least of BofA’s problems.  A government that cannot bring itself to accept the state of events is a much bigger threat.

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