Relevant and even prescient commentary on news, politics and the economy.

Links Worth Rants

Busy day on several fronts, but these should be discussed and I’ve already posted one rant this week, so a riff on the second piece would be overkill. Sort of an Open Thread, with four topics.

  1. Tyler Cowen argues that, instead of giving out stimulus monies, the government should just hire people directly. No, really:

    Let’s say seventy percent of the stimulus gets spent on labor at all, and only forty-two percent of that gets spent on unemployed labor….That’s less than thirty percent of the initial expenditure being spent on unemployed labor and that is before any other problems with the expenditures kick in. It’s hard for me to see that as a triumph of the program (NB: we are only talking about one part of ARRA here); would direct government employment have overhead costs that high?

    UPDATE: Matt Yglesias comes the same conclusion I did: that the Jones and Rothschild study advocates “a targeted make-work program for unemployed people.” And Mike Konczal does the definitive takedown of pretending the study reads as anything other than that ARRA was successful and too small.

  2. Anyone who thinks that S&P will be in business five years from now should read this piece. Not even the market is stupid enough to believe that house prices cannot decline 5%, or that the costs of payment delays and the like will not eat the “value” of these securities. That’s not unique; what has changed is that investors are saying so.
  3. Marshall Auerback suggests that Germany may be preparing to exit the Euro. My rough sketches suggest that’s a bad idea for their banks, but it might do their companies some good. As he notes, “[his] view, which was once considered borderline crazy, is now getting more serious consideration.”
  4. Everyone who claimed that Jon Huntsman is a “sensible, sane Republican” owes the rest of us a sackcloth-and-ashes level apology. Anyone who still does it is a pawn or an idiot.

Another Reason You Can Have Him

Fitch won’t downgrade the U.S., but they have downgraded Chirstiedom, officially because he didn’t pillage the state’s severely-underfunded Pension Funds enough.

Of course, those Pension Funds wouldn’t be so underfunded if they had been funded instead of f*ck*d by the Whitman Administration’s Coke-Induced Budgeting Practices. (The “miracle of compound interest” includes that it doesn’t compound so much when there’s no principal.)

[UPDATE: Blue Jersey highlights the line I missed:

Fitch believes that meeting the requisite increases in pension contributions will be challenging and is likely to conflict with other long term challenges, such as property tax relief, school funding, and infrastructure needs.

Gosh, you mean you have to pay for services? As for the other highlight:

The state’s recent economic performance has been weak and the state is expected to lag the nation in recovering from the recent recession.

we could always use The Texas Solution: Hire More and More Government Workers.]

So, if you want him, as I said at Skippy, you can have him. He’s got experience with ratings downgrades.

Sadly, I suspect Joe Wiesenthal has it right:

It might not be a big deal, and it might not be his fault, but this should probably kill any buzz about him running for President right now, given that THE DOWNGRADE is expected to be such a salient point of attack for any eventual GOP nominee.

And since the downgrade was engineered by a Romney supporter, any suggestions of conspiracy here are unjustified.

Forthcoming Tyler Cowen articles that will be Echoed by Felix Salmon

References are here (Cowen) and here (Salmon).*

  1. Just because Charlie Sheen got drunk, did some other drugs, and committed adultery doesn’t mean he’ll do it again.
  2. Just because someone who calls himself Jack the Ripper has killed two women in London doesn’t mean he’ll do it again.
  3. Just because the U.S. dropped a hydrogen bomb that emits massive amounts of radiation on Hiroshima doesn’t mean they’ll do it again.
  4. Just because Megan McArdle makes mistakes when she tries to do financial analysis doesn’t mean she’ll do it again.

Feel free to add more in comments.

Cowen, by the way, wins the intellectually-inconsistent-in-a-short-period award (partially because Felix’s argument meanders more than Moses in the desert):

[T]he “we should have had a much bigger stimulus” argument is unlikely to go down in intellectual history as the correct view. Instead, Ken Rogoff and Scott Sumner are likely to go down as the prophets of our times. We needed a big dose of inflation, promptly, right after the downturn. Repeat and rinse as necessary.

Shorter Tyler Cowen: we didn’t need to put a lot more dollars into the economy than we did. Instead, we needed to put a lot more dollars into the economy than we did.

UPDATE: Mark Thoma is collecting reaction to the S&P’s alleged rationale as only he does. See especially Economics of Contempt’s post and this e-mail from the someone who has Been There and Done That.

*Who follows up his far-too-nuanced-for-me “FAQ.” But I am a Bear of Very Little Brain compared to such analysis.

Game for the Weekend

Find a set of Mortgage-Backed Securities that are (1) still rated AAA by S&P, (2) have a WAL the same as (close to) an on-the-rin US Treasury, and (3) still have a Factor within 5% of the expectation of a generic MBS of that maturity  (that is, are not clearly impaired).

Post the CUSIP(s) in comments, along with that of the reference UST, and let’s track relative values on a regular basis for the next several months.

Anyone betting on where the relative value will be?

Greek Debt Ratings

Moody’s has downgraded its rating on Greek sovereign debt:

Greece debt rating cut further by Moody’s

Moody’s has downgraded Greece’s debt to “highly speculative” prompting an angry response from the finance ministry. Greek bonds fell after the rating agency cut its rating from Ba1 to B1.

Moody’s cited “endemic tax evasion”, “very ambitious” austerity plans, and the possibility that the EU may force a debt restructuring on Greece after 2013 as reasons for its decision.

Greece’s finance ministry said the move was “incomprehensible” and called for tighter regulation of rating agencies.

“Ultimately, Moody’s downgrading of Greece’s debts reveals more about the misaligned incentives and the lack of accountability of credit rating agencies than the genuine state or prospects of the Greek economy,” said the Greek finance ministry in a statement.

“Having completely missed the build-up of risk that led to the global financial crisis in 2008, the rating agencies are now competing with each other to be the first to identify risks that will lead to the next crisis.”

I have to say, I agree completely with the sentiments expressed here by the Greek finance ministry. In my mind, the credit rating downgrades have become a lagging indicator of problems, and have demonstrated little or no predictive power. Take a look at the chart below.

The blue line shows the interest rate spread on long-term Greek government bonds over the equivalent bonds issued by the German government. The other two lines show the ratings assigned to Greek sovereign debt by S&P and Moody’s since January 2008, normalized so that they’re on the same scale.

The question I ask myself is this: would paying attention to ratings have helped me make (or save) any money on Greek debt? If we assume that the market is charging the Greek bonds a higher interest rate to compensate for the higher chance that the Greek government will default, then the interest rate spread is a rough measure of the market’s estimation of the likelihood of Greek government default. The market seems to pay little attention to credit ratings, and if I had used the credit ratings as a cue to buy or sell Greek government bonds, I can’t see that it would have provided me with any benefit.

But this has become completely typical of credit ratings in recent years – just think about how badly they mis-rated a giant swathe of assets leading up to the financial crisis of 2008. All in all, I’m not quite sure why we should care about what rating Moody’s and S&P assign to Greece’s sovereign debts – or any other debt, for that matter.

Part of the Problem Becomes Part of the Solution

Moody’s had always assumed banks and their securities were “Too Big to Fail.” Not any more:

Moody’s Investors Service will no longer assume that holders of the securities will benefit from government support to shore up troubled lenders, after the global financial crisis proved this wasn’t the case, Moody’s said in an e-mailed statement today.

“In some cases government bank interventions throughout the crisis have not benefited, and have even hurt, the holders of those instruments,” Barbara Havlicek, a senior vice- president at Moody’s, said in the statement. “It is clear that hybrids are highly susceptible to losses due to their unique equity-like features.”

Since ratings are essentially answering the question “Should I expect to receive full payment on this security?” the previous proclivity to rate paper AAA based on the idea that the U.S. Government would make investors whole in the case of a crisis* contributed to rating inflation.

This change is a welcome first step.

*This is essentially the same scenario as all the lendings that caused the S&L crisis: “we think the land has oil in it” so it’s worth $X. So the banks lent X. And the land very often didn’t have oil in it. So $X had been given for a dust pile in West Texas around which the also oilless land was selling, if at all, for Y, X>>Y. Oops.

Ratings, Stocks, and Credibility

There is a reason I never believe people who judge the health of a company by its credit rating: the evidence isn’t there, and everyone in the market knows it isn’t there.

Here is a prime example: General Electric (GE; the company that Jack eviscerated) has a AAA credit rating. It is also paying a 31 cent per share quarterly dividend.

The stock is trading at $12/share as I type.

That’s a yield of 10.31%, per MarketWatch.

The 30-year Treasury, as I write (presumably the Friday close) is yielding 3.32%.

Rounding off—I doubt anyone would seriously quibble the basis point—we have an allegedly-AAA company whose stock is trading 7.00% above Treasuries. At a time when the average “redemption yield” for investment-grade bonds is 6.47%.

Now, in sane circumstances, people would be saying, “Oh, but that’s because GE will, certainly, cut its dividend. And investors know that.” However, CEO Jeffrey Immelt (the man charged with cleaning up Jack’s mess, who instead compounded his predecessor’s actions) assured investors that the dividend will not be cut, even as he noted that GE expects an “extremely difficult” 2009.

Moody’s has GE on credit watch with “outlook negative,” but they’ve only been there since 13 January 2009. This is a company that is paying about 15% of its net earnings out in dividends. Calling GE “not a growth stock” is like calling Sears anything other than a real-estate play: so bloody obvious that it shouldn’t need to be said.

Yet, for some reason, it needed to be said. And Moody’s is hanging there, ten days into “outlook negative” while the bleeding stock market is screaming “junk bond yield” on the equity.

Don’t get me wrong; GE is probably still investment grade. Their store credit card business ownership of NBC and affiliates consumer products division defense contracts alone should keep them there. But that’s what we said about GM too.

GM stock, which is the downside risk cited by MarketWatch, is currently yielding 28.5%. If General Electric (GE) were yielding that level with the current dividend, it would be priced around $4.35—about another 64% decline. [As noted in the comments, GM has suspended its dividend and actually yields nothing; the MarketWatch site for some reason reports the yield based on the suspended dividend anyway. -ATB]

If you’re asking me, this points the way to a good piece of the other part of the “equity premium puzzle.” But more on that in a later post.