Tuesday, October 21, 2008


Law school can be a fascinating thing. Let me just give you one example.

A tort is, roughly, a wrong committed to another person where there is no preexisting contractual relationship. There, now you know the single fact that most distinguishes lawyers from non-lawyers.

In torts (or "in tort," as I think you are supposed to say), damages are intended to compensate the victim (punitive damages are only for cases where the defendant is particularly nasty), meaning to restore him or her as much as possible to the prior condition. Compensation can be pecuniary (compensation for expenses you incur, like medical costs, lost wages because you were in the hospital, etc.) and nonpecuniary (other compensation for other harm you suffered). Nonpecuniary damages are typically thought of as "pain and suffering."

In McDougald v. Garber, 73 N.Y.2d 246 (New York, 1989) (that all means that it is on page 246 of the 73rd volume of the second series of New York reports, and it was decided by the highest court of New York in 1989 - now you know another thing that distinguishes lawyers from non-lawyers), the plaintiff was comatose - whether she had any conscious awareness was in question. All the judges involved agreed that pain and suffering could only be awarded if the plaintiff had some conscious awareness (because otherwise there is no pain or suffering, as those are subjective by definition). However, they disagreed on the issue of "loss of enjoyment." The idea here is that, for a conscious victim who has no neurological loss, I not only have pain and suffering that I didn't have before, but in addition my quality of life is lower because I can't do things I would otherwise do - play tennis, go skiing, climb mountains, whatever. The question is, should a comatose victim be entitled to damages for loss of enjoyment, even if she has no conscious awareness? Assuming that the "enjoyment" that she lost is worth $1 million, does granting her that $1 million compensate her in any way? Does the fact that the money would almost certainly go to her family or heirs make a difference? (They could potentially bring a separate suit for loss of companionship.)

There, that's law school for you.

Saturday, September 27, 2008

Airport Memories

Bulldog Burrito - 0 stars
320 Elm St., New Haven, CT

Cosi - 1 star
338 Elm St., New Haven, CT

Au Bon Pain - 1 star
1 Broadway, New Haven, CT

It's been over a month since I ate in an airport, but that doesn't mean I haven't been able to eat national-chain airport food. Loyal readers will know that one of the most dependable airport staples is the highly Americanized burrito place, and there's one just two blocks from the law school. Bulldog Burrito would fit in quite well in an airport, with its "cilantro lime" (read: white) rice and generally bland fare. Across the street is Cosi, one of my favorite sandwich places back when I lived in New York and a standout of National Airport in DC. Unfortunately, it's not as good when you're a vegetarian; the Greek salad was mostly lettuce, and the lentil soup tasted like it came out of a can (a high-end, organic can like Amy's, but still a can). Finally, the neighborhood also boasts an Au Bon Pain, the cafe I used to go to on Harvard Square when I didn't feel the need to be pretentious and go to Pamplona (I think that's what it was called). Au Bon Pain is my preferred lunch spot in Logan, Pittsburgh, and Philadelphia, because you can get a custom-made sandwich on a decent baguette, and it didn't disappoint here either.

Au Bon Pain is also where I spent Tuesday evening, finalizing the FT op-ed that I mentioned in my previous post. My co-author (and brother-in-law) Simon and I also decided to launch a blog, The Baseline Scenario, dedicated to global economic issues and, for the short term, to the current financial crisis. If you're at all interested in the most profound economic crisis this country has faced since the Great Depression, I encourage you to check it out.

As a result, I may be posting less often to this blog, but I'll try to make it at least once a week. (And I know, I still have to write about Sally's and Pepe's.)

Thursday, September 25, 2008

You Want to Work Where?

Jasmine - 1 star
Church and Grove Streets, New Haven, CT

There is a chill in the air, but it's still warm enough to get out of the law school for lunch, so I went to Jasmine, a Thai pushcart on the streets of New Haven a few blocks away. It's cheap, convenient, and filling. I got "drunken noodles" - rice noodles (I think) with that basil-soy flavor common to Thai food - and a mango curry with vegetables and tofu. The curry was a not as spicy as I would have liked, but overall it was pretty good and definitely worth $5.

I was eating with a 3L whom I met a year and a half ago when I was deciding whether or not to go to law school. Ironically enough, we were meeting because he is thinking of working at McKinsey and wanted my advice. McKinsey is interviewing YLS students this week for summer associate and real associate jobs, and a surprisingly high number of people seem to be interested. I guess I can understand that; I haven't been a corporate lawyer, but between the two working at a big law firm sounds equally dehumanizing, less interesting, and more career-limiting. And I certainly can't criticize anyone for wanting to make some money.

On the subject of money, and at the risk of blowing my what's left of my anonymity, my brother-in-law and I wrote two op-ed articles on the financial crisis this week. One was published in the print edition of the Washington Post on Tuesday, and the other only in the online edition of the Financial Times on Wednesday. Enjoy.

Monday, September 22, 2008

Saturday, September 20, 2008

At What Price?

I'm forgoing the usual restaurant review because there is a pressing question I want to raise about the mother of all bailouts, announced at $800 billion but almost certainly going to cost far more than that: what's the price? It's a question passed over almost entirely by the financial journalists, who are proving that they know no more (and probably a good deal less) about the financial markets than they know about their favorite baseball teams. So far they have repeated breathlessly that Treasury is asking for $800 billion of your and my money to buy mortgage-backed securities from banks, and that this will prevent the financial system from collapsing. But what price will they pay?

In my previous posts, I told the story of how poor lending practices led to mortgage-backed securities which led to major investment banks going bankrupt. The situation today is something like this (the numbers are obviously illustrative, but they reflect the basic facts). Some big bank has $190 in loans and "$200" in assets, which means it has $10 in capital. Of those "$200" in assets, $140 is in "normal" assets that are considered reasonably safe, and "$60" is in mortgage-backed securities. I say "$60" because there is virtually no market for mortgage-backed securities, so the bank is guessing (hoping?) that they are worth $60. Originally those securities were worth $100, but they've already been written down multiple times to $60. However, if the bank absolutely had to sell them on the market today, it would probably only get $20. (In July, Merrill Lynch - remember them? - sold $30 billion of mortgage-backed securities for 22 cents on the dollar.) The problem is that those $190 in loans are coming due, and no one is willing to roll over the loans or lend new money, because no one believes that the assets are really worth $200. And without new loans, the bank will go bankrupt. Since we don't know exactly what is on each bank's balance sheet, we can only assume that many, many big banks are in this situation.

Paulson is asking for $800 billion dollars to create a giant hedge fund, owned by the government, that will buy these illiquid mortgage-backed securities. The idea is that by getting them off the books of the banks, investors and the general public can have confidence that the banks won't go out of business and that the financial system won't collapse. But everything hinges on the price that this hedge fund will pay for those securities, because that's where your $800 billion are going.

We know that the government isn't going to pay market price ($20), because (a) the banks could sell the securities for $20 today without any government intervention, and (b) if they only got $20 they would go bankrupt, because then their assets would be less than their liabilities. In fact, the whole plan only works if the government pays enough to keep these banks solvent. But if the government pays whatever the banks think the securities are worth, then $60 of your money is being exchanged for "$60" worth of mortage-backed securities - which, according to the free market (remember that?) are only worth $20. So we all lose $40, and the bank gains $40; it's a handout, pure and simple.

There is only one scenario under which everything works out. There are some people who believe that, if held to maturity (basically, if you hold onto the security and see how many people actually pay their mortgages), it will turn out to be worth $60; the fact that no (sane) person would pay $60 for it today is just a result of irrational panic. If that is in fact the case, then the banks will get bailed out, and we the taxpayers will not lose money. Of course, this is predicated on the belief that markets are not efficient; if they are (which free market advocates would have us belief), then $20 really is what they are worth.

So of that $800 billion, we will get some fraction back, but most is disappearing into the pockets of the banks. Now, we are told that this is necessary to avert a complete meltdown of the financial system and the economy. But are there ways we could have accomplished this objective without taking $800 billion of our money and handing it to a hedge fund created by a former head of Goldman Sachs and undoubtedly staffed by investment bankers, whose purpose is to overpay banks for their bad investments?

Well, think about this. Even after the government buys those mortgage-backed securities at artificially high prices, the banks that have just gotten bailed out will still be able to foreclose on the homeowners at the beginning of the chain, because that $800 billion is just going to the banks, not to anyone else. And this will create another wave of social costs that the taxpayers will have to pick up. What if, instead, we used the $800 billion to help homeowners pay off their loans instead of defaulting? In addition to helping the homeowners, that would also help the banks, because that $800 billion of cash would increase the number of mortgages that get paid off, thereby increasing the value of all those mortgage-backed securities that all those banks are holding. The difference? In one case all the benefit goes to the banks, in the other it is shared between ordinary homeowners and the banks.

At the end of the day, Paulson's plan could be the largest and most egregious example of self-dealing in the history of the American financial system, under cover of a legitimate emergency - which should come as no surprise from an Administration whose modus operandi has been using the levers of power to enrich the already rich.

Thursday, September 18, 2008

Sub-prime crisis, continued

Indian cart, the U.N. - 1 star
Prospect St., New Haven, CT

New Haven is currently enjoying its beautiful two-week season of early fall, with crystal-clear skies and temperatures in the low 70s. So for lunch today, Kiel, Tommy, and I took a stroll up Prospect St. to the School of Management, Yale's idiosyncratically-named business school. The object of our quest was an array of pushcart vendors outside the SOM. There are a Thai cart, an Indian cart, a Japanese cart, a Mexican cart, a Middle Eastern cart, and probably others I've forgotten. In Berkeley, there's a food court on Durant that my friend Nancy dubbed the U.N., because all of the developing world countries were represented (there was an Afghan place that I particularly liked), so I'm going to call this place the U.N., too.

You can get a rice plate with up to four things on top, for just $4.50 (vegetarian, at least); I had channa masala (chickpeas), which was pretty bland, and a good spicy potato dish, as well as a samosa. Kiel also got Indian, including a big, chewy piece of naan, and Tommy got Thai noodles. We sat on the patio of the SOM and talked about capitalism. Ah, to be young again.

Today in procedure class, while the conflagration in the financial system continued to swirl around all of us, we learned about the distinction between personal jurisdiction and venue. In short, if you are a citizen of Connecticut who was harmed by an operation performed in New York by a doctor who lives in New York, and you sue him in federal court in Connecticut, that court will probably have personal jurisdiction (depending on the extent of that doctor's connections to Connecticut) but will not have venue; but if instead you sue the hospital where you got the operation, you will almost certainly have personal jurisdiction and you will have venue. At the end, the professor said there was no coherent theory that could explain that difference, and we just moved on.

One other person in my small group independently noted that there is a stunning silence at Yale over this week's events, which people will be studying for the next hundred years. I don't have any particuar insights, but I thought I would take a stab at explaining some of the mechanics that are usually glossed over in the newspapers, either because the financial reporters take them for granted, or (more often) because the financial reporters don't understand them.

Last time I wrapped things up by talking about how high leverage can cause banks to have negative capital even if there's only a moderate fall in the value of their assets. That's basically what happened to Lehman Brothers; their assets were over 30 times their capital, meaning just a 3% fall would have wiped them out, and no one believed their assets were properly valued anyway, meaning most people thought they were already underwater. In that situation, no one wanted to do business with them, and if you are an investment bank and no one will loan you money, you are dead. (Lehman had liabilities of over $600 billion to support all those assets; as the loans came due, no one was willing to roll them over or make new loans to Lehman, so they were about to simply run out of cash.)

AIG was a bit more complicated. Like Lehman, AIG was highly leveraged and owned big piles of securities that were plummeting in value. In addition to mortgage-backed securities, AIG in particular was engaged in perhaps hundreds of billions of dollars worth of credit-default swaps; under the terms of these swaps, AIG was essentially insuring payment on bonds, including mortgage-backed securities. So as those mortgage-backed securities became more and more risky (see the earlier post), the chances that AIG would have to pay out on insurance claims went up, and the value of their swap holdings plummeted. So they were stuck with real debts on the one hand, and on the other hand they had a pile of assets that were falling in value and that no one wanted to buy, and it looked like they were going to run out of cash this week, because no one wanted to lend them money. In particular, as they looked more and more risky, the ratings agencies lowered their ratings for AIG; and the way loans to big companies are often structured, if the ratings fall past a certain point, the company has to "put up more collateral," which means they have to pledge more cash or assets to the lenders. (It's as if, as the price of your house falls, your bank says that you need to pledge another house to secure your mortgage ... but you don't have another house.) In this case, ratings downgrades on Monday forced AIG to come up with over $13 billion in cash or collateral, and they just didn't have it.

On Friday AIG was asking for a $20 billion loan, but by Sunday it was $40 billion, by Monday it was $75 billion, and by Tuesday the eventual federal bailout was $85 billion. This is a very worrying sign; it probably means that according to AIG's books they needed $20 billion, but when the other investment bankers looked at the actual securities holdings and swap positions they decided they were worth a lot less than AIG had assumed they were worth, and hence the need for more cash. The problem is that many people are now assuming that every bank has similarly optimistic assumptions about its assets, and if that's true then we are in big trouble.

There is some talk that the government will get its $85 billion back, at 12% interest, and this is certainly possible. But it rests on the assumption that AIG's assets are somehow worth more than the investment bankers think they are, and that once the market settles down they will be able to sell those assets at a better price. If they could get that price now, they would just sell them and they wouldn't need a loan. So the government is betting that prices of these assets, colloquially known as "toxic waste," will go up. After the last twelve months, I wouldn't bet on it.

Tuesday, September 16, 2008

Yale Law School of Pizza

Est Est Est - 1 star
1176 Chapel St., New Haven, CT

Bella Haven - 0 stars
240 College St., New Haven, CT

Typical YLS organization meeting - 0 stars

New Haven is justly known for having some of the world's best pizza; of all the places I've been, including Boston, New York, and California, I would say that only Naples has generally better pizza. And when you go to Yale Law School, you end up eating a lot of pizza.

However, after three weeks, I have yet to go to Sally's or Pepe's, the two most famous New Haven pizzerias (although I've been to both in the past - I think Sally's is slightly better, but Pepe's is much more convenient in many ways). YLS is known for providing lots of free food to students, and most of that free food comes in the form of meetings held by organizations, student groups, reading groups, and so on, and they all provide pizza as an incentive to attend. For example, yesterday the Schell Center for Human Rights had a meeting, this evening there is a student organization fair and then a meeting of all of the journals, tomorrow I'm sure there's pizza but I'm going home to see my family, and Thursday there is a training session for the Temporary Restraining Order project that I may attend.

Unfortunately, and undoubtedly for cost reasons, the pizza at these events is not that good. Although it would probably get one star elsewhere in the country just for getting the basic formula right - a crust that is slightly blackened, flexible enough to fold, yet strong enough to hold the toppings; fruity, bright red tomato sauce; a reasonably high sauce-to-cheese ratio; and mozzarella cheese (believe it or not, in California some ordinary pizzerias have streaks of yellow cheddar cheese on their pizzas) - by New Haven standards YLS pizza counts as marginally passable. The downtown pizza-by-the-slice places not that much better. I tried Bella Haven because it has the unique advantage of being across the street from my apartment, but it seemed like I might have been anywhere in the Northeast; Est Est Est would probably count as one of the better pizza places in almost anywhere in the country, but is nothing special for these parts.

All the free pizza contributes to another feature of Yale Law School: the isolation. As a 1L, you spend basically your whole day shuttling around a single small building with largely the same people, going to 18 hours of classes per week and several hours more of lectures and meetings. In many ways it's a wonderful thing, and a huge advantage of going to a small school. At other times, it's easy to forget that the outside world exists. Yesterday, in perhaps the most tumultuous day in our financial system since 1929 (the markets fell more in 1987 and 2001, but neither time was there the structural turmoil we had yesterday), I didn't hear a single word about what was going on, except one professor's oblique reference to Merrill Lynch that half the class probably missed. Today, the markets just opened 2% down, the world's largest insurance company is about to go bankrupt unless it gets a $75 billion loan in the next few hours from a banking sector that has no capacity left to make loans (according to my torts professor, "insurance makes the world go round," which I also believe), and not a tremor troubles the calm of the Yale Law School.

Thursday, September 11, 2008

Another September 11th

Thali Too - 2 stars
65 Broadway, New Haven, CT

One of the best things about Yale Law School (one shared, I'm sure, with many other law schools) is small group. (This is not the best thing about Yale; the best thing is that there are no grades for required classes, and everyone passes. But I digress.) In the first semester, you take one of your classes in a group of about 14 people (mine has 14), and all of your other classes (which have 40-60 people) include those same people. This being a touchy-feely school, this becomes an exercise in mutual support and admiration.

Today, my small group went out for lunch to celebrate completing our first week of law school. We went to Thali Too, which has the advantages of being close to the law school and being entirely vegetarian (my small group has at least four vegetarians, at least five if you count people who don't eat land animals, and at least one ex-vegetarian). It is a slightly Americanized pan-Indian restaurant, meaning that it has both northern Indian food (the kind you've probably had) and southern Indian food (the kind you probably haven't had). I had a veggie utthapam, which is something I had previously only found at one southern Indian restaurant in California, a kind of soft pancake with assorted sauces, and hot masala fries. They also make all the vegetarian Indian standards, plus lots of things I would love to try. I'm not sure the food deserves 2 stars, but it was fun and we got to try a lot of different things.

Most of the people in my small group are, well, young, but, this being Yale Law School, they can be shockingly accomplished. After lunch, Valarie went down to New York to attend a screening of her documentary film, Divided We Fall, which she began shooting as a college student after the first September 11th. The film, which documents hate violence in the aftermath of 9/11, has won piles of awards around the world, is being shown in 70 different cities around the country this month, and will be released on DVD later this year. And last night, before her big day, Valarie was preparing ... by staying up past 1 am (I know this because she sent out an email) doing her reading for contracts ... and she got cold-called in class this morning, where she acquitted herself gracefully. (The case had to do with whether a verbal agreement by a husband to pay his wife 30 pounds a month was intended to have legal consequences and was, therefore, an enforceable contract.) Not bad for a day's work.

Wednesday, September 10, 2008

Back in the Ivory Tower

Copper Kitchen - 2 stars
1008 Chapel St., New Haven, CT

In the mid-1990s, my girlfriend (not the woman I ended up marrying) went to art school at Yale. (Little-known fact: Yale has one of the best art schools, and perhaps the most prestigious one, in the country. Its music school is pretty good, too.) She is known in some circles for having painted an obscene painting about a Yale art school professor - while she was still a student. I don't remember much about those years - and I only spent about 6 weeks in New Haven, anyway - but one of our favorite places to eat was the Copper Kitchen, which is an old-school diner. It is old-school in two ways: first, it doesn't have fake-50s decor, like most diners in most parts of the country; and second, it doesn't have a 20-page menu with every dish you could possibly imagine. Back then, you could get two eggs, home fries, toast, and coffee for $2.85; today, it costs $4.00, making it still one of the best bargains anywhere. It's also right around the corner from my apartment, so I ate lunch there one of my first days here for school. I had an egg and cheese sandwich with fried onions on a hard roll (something I grew up with, but that I haven't seen outside the Northeast), which was perfect, and a Greek salad, which was passable (like virtually all Greek salads you see, it was at least 50% lettuce, which is a bit anomalous).

I came to Yale because it seemed like the friendliest, nicest law school around (OK, given my geographic location, the only one I was comparing it to was Harvard), and so far it hasn't disappointed. We had four days of orientation, the lessons of which can be summed up as follows:
  • Be nice to each other
  • Remember why you came to law school
  • Help each other
  • It's more important to do something you believe in than to make money
  • All your first-term classes are pass/fail, and everyone passes, so don't worry about it
  • Find out who you are as a person and what you stand for
  • Love each other
I've heard some people grumbling about how touch-feely everything is, but I think it's all great. Maybe it's my age. I do believe it's important to know who you are, feel comfortable with yourself, and treat other people well.

In the words of the great philosopher Anna Kournikova, "Why are people afraid of getting older? You feel wiser. You feel more mature. You feel like you know yourself better. You would trade that for softer skin? Not me!" What that quotation has to do with the rest of this post is left as an exercise for the reader.

This is the view from my New Haven apartment. Nice, no?

Saturday, August 16, 2008


Rendezvous Bistro - 3 stars
380 South Broadway, Jackson, WY

I was walking up from the Yellowstone River to the Tower Falls overlook, and there was a portion of the path that traversed a steep incline, with slippery sand underfoot. A man was helping his children across. Then I went across and held out my hand to make sure my father didn't slip. You reach a point in your life where you take care of your children, and you reach a point when you take care of your parents as well.

Actually, my father can take care of himself very well for a 77-year-old man. He's in good health and relatively fit. But I planned this whole trip to Yellowstone for him, because I know he wanted to go there, and I spent the whole time trying to make sure he was having a good time. At the same time, since he is my father, he was also trying to make sure that I was having a good time. Which led to some frustrating moments, when each one of us was trying to tease out what the other person wanted to do. I would float one idea, he would suggest another, then fifteen minutes later he would suggest my idea, and I would suggest his. It's much simpler with my daughter: she's the star of the show, and we both know it.

Luckily he told me to pick dinner our last night in Jackson, and after a week in Yellowstone I was ready for a good restaurant. I doubted we could get into the Snake Creek Grill, so we went to the Rendezvous Bistro on the edge of town, where all the tables were taken by 6.30 but we could eat at the bar. I had a sidecar that was too sweet, but everything else was excellent. The redundantly named "panzanella bread salad" was a tantalizing blend of tomatoes, bread, arugula, and fresh mozzarella cheese; the risotto cake was covered with perfectly grilled carrots, asparagus, and portobello mushrooms (and I never like portobello mushrooms); the warm chocolate bread pudding was scrumptious.

If I'm lucky, 36 years or so from now I'll be on vacation with my daughter, and we'll be having the same issues. Things could be worse.

Friday, August 08, 2008

The Subprime Crisis, Explained

Cactus Cantina - 1 star
3300 Wisconsin Ave NW, Washington, DC

I was in Washington to visit my sister's family (after seeing my wife's whole family). We ordered takeout from Spices, a passable pan-Asian restaurant in Cleveland Park, and the next day we all went to Cactus Cantina, supposedly George W. Bush's favorite restaurant in Washington. I guess that fits: it's Tex-Mex, boisterous, friendly, and relatively uninteresting - not too surprising for a "Texan" who grew up in Connecticut and Maine. But they do rush the kid's dishes to the table, and they have one of those big tortilla makers that pumps out hot, fresh flour tortillas (not that you'll see many flour tortillas in Mexico, but this is Tex-Mex, remember?). The vegetable fajitas are just about the only vegetarian option, and the vegetable selection is healthier than fajitas have any right to be. The mojitos were also too sweet, but overall it was a fun place to be.

During the visit we drove past the headquarters of Fannie Mae, also on Wisconsin Ave, several times. Fannie Mae and Freddie Mac, as you probably now, are currently the epicenter of the financial crisis that could very well push the country into the worst economic slowdown since the Great Depression (matching the Depression is pretty unlikely). Despite the importance of the crisis to all of us, I think that ordinary, intelligent, well-educated people find it difficult to understand what is going on - at least judging by some of my friends and relatives. One problem is that even general news accounts presuppose an understanding of terms like "securitization," "CDO," and writedown." So I thought I would provide my own translation.

Historically local banks took deposits from savings account customers and lent money to homebuyers. They paid 1% for the savings accounts and collected 6% on the mortgages, and the spread (5 percentage points in this case) was more than enough to compensate for any homebuyers who couldn't pay their mortgages.

Then, as any explanation of the subprime crisis says, banks started reselling and securitizing mortgages. But what does it mean to resell (let alone securitize) a mortgage?

To understand this, you have to look at it from the bank's point of view. To them, a mortgage is a product. This product gives them a monthly stream of payments - about $1,000 per month for a 30-year, fixed-rate mortgage on a loan amount of $150,000 (numbers are very approximate), but that stream is not guaranteed; the homebuyer might not be able to pay (in which case they might have to renegotiate or foreclose, both of which are costly), or might pay the whole thing early. The price they pay for this product (this stream of payments) is just the loan amount; from their perspective, they are giving you the loan amount to "buy" the stream of payments. The lower the interest rate you get, the higher the price they are paying for your payments.

If Bank A resells a mortgage to Bank B, Bank B buys your payment stream from Bank A in exchange for a lump sum of money. Under stable market conditions, the lump sum that B gives A will be about the same as the lump sum you received from A (in which case A only makes money from various fees). You can also think of this as Bank B loaning you the money for your house, with Bank A acting as an intermediary.

Now, in practice, Bank B (or C, or D, ...) is often an investment bank. And Bank B often securitizes your mortgage. This means they take your mortgage and combine it with many (thousands of) similar mortgages. If the mortgages are similar according to certain objective criteria - creditworthiness of borrowers, loan-to-value ratios, etc. - they can be treated as homogeneous. (Something similar happened with corn in the 19th century; certain standards were established for different grades of corn, and from that point bushels of corn from different farms didn't have to be separately shipped and inspected by buyers, but could be poured together into huge vats.) Now you have a pool of, say, 10,000 mortgages, with about $10 million in payments coming in from borrowers every month. That pool as a whole has a price - the amount someone would pay to get all of those payment streams of that riskiness. In a securitization, the investment bank divides the pool up into many small slices - say 1,000 in this case. Each slice can be bought and sold separately, and each slice entitles the buyer to 1/1,000th of the payments streaming into that pool.

The price of these slices is based on current assumptions about the riskiness of those payments - the riskier those payments are perceived to be, the lower the price anyone will pay for a slice of them. The problem, as every overview says, is that at the time those mortgages were securitized, the buyers assumed that housing prices could only go up, and therefore the payments were not very risky; when housing prices began to fall, many more borrowers became delinquent than had been expected. As a result, if you own a slice of that pool, you still own 1/1,000th of the payments coming in, but your expectations of how many payments will come in are much lower than they were when you bought the slice. (There were some very sophisticated ways of dividing up those pools, but that is an advanced topic.)

This brings us to writedowns and, eventually, to the subject of banking capital. Let's say you are a hedge fund and you paid $1 million for a slice of a securities offering (a pool). You put that on your books as an asset (in the world of finance, a stream of payments coming to you is an asset) valued at $1 million. However, a year later, that slice is only worth $200,000 (you know this because other people selling similar slices of similar pools are only getting 20 cents on the dollar). You generally have to mark your holding to market (account for its current market value), which means now that asset is valued at $200,000 on your balance sheet. This is an $800,000 writedown, and it counts as a loss on your income (profit and loss) statement. And that is what has been going on over the last year, to the tune of over $100 billion at publicly traded banks alone.

The next problem is that, over the last two decades, most of our banks have become giant proprietary trading rooms, meaning that they buy and sell securities for profit. Let's say you start a bank with $1 million of your own money. That's your "capital." You go out and borrow $9 million from other people, typically by selling bonds, which are promises to pay back the money at some interest rate. Then you take the $10 million and buy some stuff (like slices of mortgage pools), which pays a higher interest rate (the expected stream of payments, divided by the amount you paid for it). Suddenly you are making money hand over fist. But then let's say that housing prices start falling, securitized subprime mortgages start plummeting in value, and your $10 million in assets are now only worth $8 million. Since the value of your debt ($9 million) hasn't changed, you are technically insolvent at this point, because your losses exceed your capital; put another way, the money coming in from your slices of mortgage pools isn't enough to pay your bondholders. And this is where Fannie and Freddie were until they were bailed out by the U.S. government (meaning you and me, and our children); by certain accounting rules, they had negative capital. Basically they borrowed huge amounts of money at low cost (because everyone assumed their debts were backed by the U.S. government) and used the money to buy mortgages (and slices of mortgages of mortgage pools), making them vastly profitable and earning their CEOs tens of millions of dollars in just a few years. Now their assets are plummeting in value and they need to be bailed out. That's American capitalism for you.

Well, there it is. Hopefully that will help you make sense out of your newspaper's business section - which, despite my retirement from the business world, remains my favorite section of the (virtual) paper. What lessons can we draw from all of this? There was a lot of greed, corruption, and incompetence all around, but most fundamentally I think that homeownership is overrated, both individually and as a societal goal. It warrants a separate post, but in summary buying a house is an incredibly risky thing to do with your money, makes absolutely no sense as an investment (it only works out for most people because home prices do usually go up a little bit, and the massive leverage created by a mortgage turns that into a good return), and is hardly the thing our government should be encouraging people to do (via the mortgage interest tax deduction most notably, which perversely subsidizes people in proportion to the size of their houses and the size of their incomes).

Thursday, August 07, 2008

The Worst Place To Be a Vegetarian

Rising Tide Restaurant - 1 star
96 King St., Scarborough, Maine

Portland Lobster Company - 1 star
180 Commercial St., Portland, Maine

Omaha, Nebraska? Paris, France? No, it's the Maine coast in the summertime, when the only thing anyone wants to sell you is lobster. I was at Higgins Beach with my family and my nephew, who was visiting us for a few weeks. Higgins Beach is relatively undeveloped, which is good and bad - good because there is no congestion and the beach itself is beautiful, bad because there are few hotels or restaurants in the immediate vicinity. We stayed at the Higgins Beach Inn, which is basically a dump - tiny rooms, soft beds, showers that don't work properly, not enough beach towels, few electrical outlets, etc.; there was one other hotel near the beach, and it was full.

But we did eat at two restaurants that I think were good, at least according to the animal eaters. The first was Rising Tide, a seafood place with the ambiance of a shack, behind a fisherman's cooperative and right on the docks. I had a salad and onion rings (which came out of the freezer), but apparently the lobster roll was good. That night we ate at the Portland Lobster Company, on the docks in Portland, at a bright red picnic table under a large tent in the midst of a driving rainstorm. They at least had a couple of vegetarian options - I had an avocado and cheese wrap, which was heavy on the lettuce but otherwise good, and a Greek salad with too much dressing - and I hear the lobster roll was even better (the fried haddock sandwich was also said to be good). What's more, I drank local draught beer in a plastic cup, perhaps for the first time since college, and it was not bad at all.

Saturday, July 26, 2008

The Last Time

Qdoba - 1 star

Au Bon Pain - 1 star

Andale - 2 stars

French Meadow Cafe - 2 stars

This week I took my last business trip. Which was nice, because otherwise my last trip to my company's headquarters would have happened back in May, and I would not have realized it at the time.

As usual, I bought the cheapest ticket I could find, which involved taking the US Airways 6.45 am flight to Charlotte. But the night before I got an automated phone call telling me that flight had been cancelled, so I switched to the 6.15 flight to Pittsburgh - the one I took so many times back in 2003 and 2004 when traveling to Michigan for our first customer.

Although I've never been to Pittsburgh itself, I've been to the airport dozens of times, and I think it is actually quite underrated. It is reasonably compact and has enough power outlets, decent shopping (I once bought a pair of shoes at the Johnston & Murphy because I forgot to pack dress shoes for a meeting), and one of the better food courts around (including a Ben and Jerry's). For breakfast, I had a breakfast burrito of scrambled eggs, potatoes, cheese, "ranchera" (tomato) sauce, and salsa, which is one of my fake-Mexican favorites. Then I got a sandwich for the plane from Au Bon Pain, which has occupied a special place in my heart ever since college. Before cafés were commonplace in this country, there was a large Au Bon Pain right on Harvard Square, and in the summer before my senior year I read most of Being and Nothingness there (my senior thesis was about French intellectuals, including Jean-Paul Sartre, and the Algerian War). I've always thought their bread was pretty good, and the fact that you can order a sandwich with whatever you want is always welcome in an airport. I had Swiss cheese, cucumbers, tomato, red onions, and aioli on a baguette, and it tasted very good somewhere over Nebraska.

On the way home I ate at two of my favorite airport restaurants, Andalé in SFO (the best airport Mexican restaurant and the best airport breakfast I have ever had) and French Meadow in MSP (although this time I had a green tea vodka martini that can only be described as bad), which must be one of the nicest airports in the United States (in case you don't know, there is a second floor above the central shopping area with comfy chairs, electrical outlets, and peace and quiet). I've reviewed both of them before, so I won't repeat myself more than I already have.

Sitting on the two planes, I also tried to reflect on the last seven years, since we founded my company in California just one week before I moved to Massachusetts (what was I thinking?), and, indeed, the last eleven years, since I flew from California to New York to start my first job, as a McKinsey consultant, with a training session at Williams College. I tried to remember the person I used to be and, not surprisingly, failed. What are you supposed to feel when you quietly close the door on a chapter in your life? Of course things didn't work out exactly like I expected - actually, I had no expectations at the time - and I probably wasn't as good at the whole business thing as I thought I would be. But I enjoyed myself more than I expected, I learned a lot about myself, I worked with people I feel lucky to have known, and I'm extremely proud of everything we accomplished together. I couldn't have asked for anything more.

Friday, July 25, 2008

Right Back Where We Started from

China Best - 0 stars
883 Hamilton Ave., Menlo Park, CA

I'm taking one last trip to the office in California before starting law school in September. Since I'm a sucker for nostalgia, I took a drive down to Menlo Park to take a look at our first office, where we started the company back in September 2001.

Our first meeting there was on September 17, six days after you-know-what. We were renting a few cubicles from Autodaq, a company founded by three of Ken's business school friends. I don't think I had been back since we moved in with our VCs in the middle of 2002. We've moved twice since then, and our new offices are in a big glass building that used to house one of Silicon Valley's most prominent companies.

Back then we used to eat either at one of the local taquerias where most of the other customers were Mexicans (and the jukeboxes were full of Mexican music) or in a mini-strip mall off of Willow Ave. I was hoping to go to the Vietnamese place, but it's no longer there, so instead I went to the Chinese place. It was never very good, and if anything it got worse; the broccoli with garlic sauce tasted both undercooked and stale, and even the rice was weirdly oversized (long grain?) and dry.

I doubt I'll be going back to that particular strip mall. But it was one more place I wanted to say good bye to.

(The title of this post, of course, is a reference to the theme song of a TV show that I liked - at least for the first seasson.)