Thursday, July 12, 2007
This Could Be Fun: A Third Post I Don't Have to Write
by Ken Houghton
English translation: Your pension fund is SNAFU.
The perversity of it is that in a vibrant market, you shouldn't have to buy a CDO. But that's another post.
This is why, all those posts ago, I compared this "meltdown" to the Structured Note market. I tried at one point to go short a Structured Note (don't ask) and cover it in the Repo market. After almost a full day, no one could find it. As with CDOs, the assumption is that you will Hold to Maturity. You bought it, you own it—even if it breaks.
And, most preciously:
It's arguably not collusion when everyone, working in their own self interest, does the same thing—just as it wasn't collusion when they bought the paper in the first place. And the glut of hedge funds created in recent years makes it fairly clear that a "barriers to entry" argument will fly about as well as, say, Amaranth did late last year.
If I were thinking lawsuit, I'd be using terms such as "fiduciary responsibility" and "prudent" and looking at mutual fund investments in hedge funds: low-hanging fruit may not be the tastiest, but it is the most accessible.
Felix Salmon gives a briefing of how difficult it would be to show collusion in CDOworld. Select excerpts:
Firstly, the big banks are not generally big holders of CDO tranches. The whole reason why CDOs exist in the first place is that they're a mechanism for moving risk off the balance sheets of the sell side, and onto the balance sheets of the buy side.
English translation: Your pension fund is SNAFU.
Part of the reason is that they don't need to collude in order to hold on to their CDOs. CDOs, by their very nature, are a buy-and-hold investment. There's almost no liquidity in them, and the explicit tradeoff in the CDO market is that investors get a higher coupon by giving up liquidity.
The perversity of it is that in a vibrant market, you shouldn't have to buy a CDO. But that's another post.
You can't short something which never trades, and as far as I know no one is writing credit protection on CDOs. There are lots of people writing credit protection on MBSs, including subprime-backed MBSs, but they're a different instrument entirely.
This is why, all those posts ago, I compared this "meltdown" to the Structured Note market. I tried at one point to go short a Structured Note (don't ask) and cover it in the Repo market. After almost a full day, no one could find it. As with CDOs, the assumption is that you will Hold to Maturity. You bought it, you own it—even if it breaks.
And, most preciously:
One option is to address the general topic without quoting my question [presumably the post's title, "Why There Aren't Anti-Collusion Lawsuits in the CDO Mess," in question form) and without mentioning magic words like "antitrust" and "collusion."
Frankly, I'm not clever enough to answer this question without quoting it and without using the magic words.
It's arguably not collusion when everyone, working in their own self interest, does the same thing—just as it wasn't collusion when they bought the paper in the first place. And the glut of hedge funds created in recent years makes it fairly clear that a "barriers to entry" argument will fly about as well as, say, Amaranth did late last year.
If I were thinking lawsuit, I'd be using terms such as "fiduciary responsibility" and "prudent" and looking at mutual fund investments in hedge funds: low-hanging fruit may not be the tastiest, but it is the most accessible.
Labels: Antitrust, Economics, fiduciary responsibility, hedge funds, subprime
Friday, June 29, 2007
Leegin vs. PSKS: Vertical Price Fixing is Good for Some
by Tom Bozzo
As an equity holder in an economic consulting firm, my first reaction was, "Woohoo! The economic consultant's full employment act of 2007!" The second reaction, after seeing Justice Kennedy refer to economic literature (Greg Mankiw, via PGL at Angry Bear, has the story as told in his principles textbook) on potential beneficial effects of RPM arrangments was, "Oh, really?"
Before going further, these RPM agreements are not the same sort of restrictions as are provided by minimum markup laws such as Wisconsin's Unfair Sales Act. Such laws directly affect the terms of interbrand competition — the Shell station is limited in its ability to try to underprice the Mobil station down the street — whereas the RPM agreements (directly) limit intrabrand competition. The former are much likelier to have adverse effects on consumers.
The standard story (again via Mankiw) suggests that RPM agreements may be valuable in that they ensure retailers enjoy sufficient markups to pay for what the manufacturer considers to be valuable ancillary services — retail shop ambiance, demonstrations of complex products, etc. In the absence of such arrangements, it's claimed, there's a free-rider problem as cut-price retailers direct their customers to go to full-service stores for the free services and then to come back to buy the product on the cheap. In the end, the full-service retailers can't provide the services (or underprovides them) and everyone's worse-off.
One thing about this type of arrangement is that it appears, on the face, to be allocatively inefficient. That is, in static resource allocation problems, the "market" puts resources to their best possible uses when prices and marginal costs are equal. RPM agreements increase the gap between prices and marginal cost of the affected retail products in order to subsidize the provision of ancillary services at zero price. Whether and how much consumers benefit depends on how they value the ancillary services; it seems uncontroversial that there are, indeed, some people who don't need the hand-holding and/or don't care about having a "free" skinny chai latte while they shop.
The part of the theoretical story that I buy less is that the subsidy is necessary to solve the free-rider problem. An alternative is not that the provision of the ancillary services collapses, but rather than full-service retailers explicitly charge for them (or at least those with nontrivial costs). This happens quite a bit in some markets. For example, interior decorators can (and do) "unbundle" their design services by charging for design consultation; they can (and will) rebate the design fees for customers who subsequently purchase stuff through the designers. Car dealers in Wisconsin can charge a fee to cover "reasonable" costs related to the sales process. The stickers advertising these fees seem to have become much more prevalent since the advent of Intertube-assisted car buying. We haven't yet had the opportunity to determine whether those fees are negotiable. Clothing stores charge for alterations on sale merchandise. The list, I'm sure, could go on.
PGL also points to a very interesting Wall Street Journal Econoblog face-off on the subject. There, Larry White raises some rhetorical questions that don't obviously have the answer he perhaps implies:
To the extent that the potential market failure doesn't turn into an actual one, then it's very hard to see how consumers would enjoy significant net benefit from RPM arrangements. The appearance of amici such as the American Petroleum Institute and National Association of Manufacturers — not exactly defenders of the Little Guy — in favor of the legality of RPM heightens my doubt that consumer benefits are what's really at stake in the case. And I'm skeptical that maintaining brand images by keeping up the appearance of high prices has dynamic efficiency benefits to speak of.
That said, the SCOTUS majority's view that, in effect, the costs and benefits should be weighed isn't that controversial. However, the end result may still be consistent with Justice Breyer's expectation, in the dissent, that the main effect will be higher retail prices.
Yesterday, the Supreme Court's conservative majority decided that arrangements to fix minimum retail prices ("resale price maintenance," or RPM) between manufacturers and their retailers are not "per se" anticompetitive and must instead be judged by the "rule of reason" on the merits or demerits of particular RPM deals.
As an equity holder in an economic consulting firm, my first reaction was, "Woohoo! The economic consultant's full employment act of 2007!" The second reaction, after seeing Justice Kennedy refer to economic literature (Greg Mankiw, via PGL at Angry Bear, has the story as told in his principles textbook) on potential beneficial effects of RPM arrangments was, "Oh, really?"
Before going further, these RPM agreements are not the same sort of restrictions as are provided by minimum markup laws such as Wisconsin's Unfair Sales Act. Such laws directly affect the terms of interbrand competition — the Shell station is limited in its ability to try to underprice the Mobil station down the street — whereas the RPM agreements (directly) limit intrabrand competition. The former are much likelier to have adverse effects on consumers.
The standard story (again via Mankiw) suggests that RPM agreements may be valuable in that they ensure retailers enjoy sufficient markups to pay for what the manufacturer considers to be valuable ancillary services — retail shop ambiance, demonstrations of complex products, etc. In the absence of such arrangements, it's claimed, there's a free-rider problem as cut-price retailers direct their customers to go to full-service stores for the free services and then to come back to buy the product on the cheap. In the end, the full-service retailers can't provide the services (or underprovides them) and everyone's worse-off.
One thing about this type of arrangement is that it appears, on the face, to be allocatively inefficient. That is, in static resource allocation problems, the "market" puts resources to their best possible uses when prices and marginal costs are equal. RPM agreements increase the gap between prices and marginal cost of the affected retail products in order to subsidize the provision of ancillary services at zero price. Whether and how much consumers benefit depends on how they value the ancillary services; it seems uncontroversial that there are, indeed, some people who don't need the hand-holding and/or don't care about having a "free" skinny chai latte while they shop.
The part of the theoretical story that I buy less is that the subsidy is necessary to solve the free-rider problem. An alternative is not that the provision of the ancillary services collapses, but rather than full-service retailers explicitly charge for them (or at least those with nontrivial costs). This happens quite a bit in some markets. For example, interior decorators can (and do) "unbundle" their design services by charging for design consultation; they can (and will) rebate the design fees for customers who subsequently purchase stuff through the designers. Car dealers in Wisconsin can charge a fee to cover "reasonable" costs related to the sales process. The stickers advertising these fees seem to have become much more prevalent since the advent of Intertube-assisted car buying. We haven't yet had the opportunity to determine whether those fees are negotiable. Clothing stores charge for alterations on sale merchandise. The list, I'm sure, could go on.
PGL also points to a very interesting Wall Street Journal Econoblog face-off on the subject. There, Larry White raises some rhetorical questions that don't obviously have the answer he perhaps implies:
It's the manufacturer's judgment that [the RPM arrangement] is the best way to sell the product. Shouldn't the manufacturer's judgment be controlling? Isn't that what a market economy generally relies on to benefit consumers?Neither is a clear affirmative. Why shouldn't the retailer's judgment be controlling? They, presumably, have better information about the demand for ancillary point-of-sale services than the manufacturers. And it would seem reasonable to believe that vigorous competition among retailers would help ensure efficient provision of those services.
To the extent that the potential market failure doesn't turn into an actual one, then it's very hard to see how consumers would enjoy significant net benefit from RPM arrangements. The appearance of amici such as the American Petroleum Institute and National Association of Manufacturers — not exactly defenders of the Little Guy — in favor of the legality of RPM heightens my doubt that consumer benefits are what's really at stake in the case. And I'm skeptical that maintaining brand images by keeping up the appearance of high prices has dynamic efficiency benefits to speak of.
That said, the SCOTUS majority's view that, in effect, the costs and benefits should be weighed isn't that controversial. However, the end result may still be consistent with Justice Breyer's expectation, in the dissent, that the main effect will be higher retail prices.
