Dumb and Dumber on the Price of Risk

Could I ask one favor from James Pethokoukis – stop emailing me stupid stuff like this:

For a more upbeat take, here is another of my favorite guys, Don Luskin of TrendMacrolytics:

The price of risk in credit markets has returned to normal levels, but for those who gorged for years on a zero price of risk, it feels like whiplash.

It’s bad enough that you cite the Stupid Man Alive on any economic issue. When Luskin says “the price of risk” is zero, what is he babbling about? If he is defining risk as diversifiable risk, he has finally discovered the Arbitrage Pricing Theorem. Or is he saying the price of systematic risk is zero? If that were the case, the expected return to stocks would equal the risk-free rate. So much for his free lunch solution to the alleged Social Security crisis that he keeps babbling about. No – I suspect he is referring to the price of credit risk, which in an efficient market would represent the expected losses from possible defaults on credit.

So what is a normal level for something like a credit spread and has this spread been zero recently? Well, let’s look at the difference between interest rates on BBB rated corporate bonds and the ten-year Federal bond rate as a proxy for this idea (if Luskin has a better measure, it’s a shame he failed to mention it). It would seem that this credit spread has not been zero for the past several years. In fact, it was higher in 2002 and 2003 than it is today. So when Donald Luskin claims people have “gorged for years on a zero price of risk” – he has no idea what he is talking about. And neither does James Pethokoukis. Yet – Pethokoukis relies on Donald Luskin as some alleged subject matter expert. Dumb and dumber!