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

Ten Years Have Got Behind You

It has been almost ten years since:

  1. Bear Stearns folded
  2. Lehmann collapsed of its own free will
  3. I posted on this blog
  4. All of the above

Those who guessed “c” or “d” are optimists. Those who are expecting a long series of posts dwelling on the correct answer of “b” (with some references to “a” and AIGFP) will not be disappointed.

But this is an introduction. I have been trying to think of how to simplify ten years of lessons as if there were one root cause. And I think I finally have it.

Two friends were claiming that Democratic politicians have to be nice, noting that otherwise Republicans will obstruct anything they try to do if there is ever a free election in the United States again. My response of “So what?” (a more direct version of my usual “Ma nishta ha’lailah hazim?“) was met with reminiscence from them of the Good Old Days when the Democrats had a fighter in the mix: James Carville.

So I have been thinking about Carville today, and especially his most famous quote:

I used to think if there was reincarnation, I wanted to come back as the president or the pope or a .400 baseball hitter. But now I want to come back as the bond market. You can intimidate everybody.*

And therein lies the problem. He said this in the early 1990s. By the time fifteen years had passed and the world economy went over a securitization cliff abetted by “Weapons of Mass Destruction” that are used in ways so obviously non-economic that an economist looking at the market for the first time called them out ten years ago—and virtually nothing (on net) has been done to ameliorate the situation since.

But back to the bond market. If there is one lesson from basically Hallowe’en of 2006 to September of 2008 should have taught everyone, that should have been that the problem isn’t that the bond market is feared; the problem is “What if the bond market is correct?”

Select for full-size view

To be continued…

*His most accurate quote may well be “What I’m suggesting is, stand for yourself, be for something and the hell with it. Because the hand-wringers and the editorialists and the sigh-and-pontificate crowd will be against you, whatever you do.”

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Derivatives, water and financial risk

David Zetland comments on future funding of ‘water’ risk management.  There are plenty of examples of misguided government interventions, as well as examples of private enterprise run amok.  Now a derivatives market? :

The danger of flashing wrong signals

Have you heard the stories of people who have driven through fields, into lakes or off cliffs while following their GPS units? Any outsider would have told them to use their common sense before making a right turn over a cliff, but are WE so wise when it comes to our indicators?
Although the water sector really needs more and better information (that’s why I founded the water data hub*), I worry about people putting the wrong weight on the wrong information — a worry that puts these recent stories into a different context:

Now, I’m not worried about the discussion of water risk. I think that it’s a topic of growing importance, as the end of abundance exposes business models, bureaucratic assumptions and personal habits formed in an era of too much, too cheap water to a new reality of scarce water that cannot be taken for granted.

From the IBM/Waterfund  link comes this excerpt:

The principals involved sat down with the Daily Ticker to explain.

“At one end of the spectrum you have housing, the most over-financialized sector of our economy,” Scott Rickards, President and CEO of Waterfund. “At the other end, you have water – there’s not a single financial product. Investors, Wall Street have pretty much ignored water. What we’re doing is using derivatives and insurance products to link to the index and enable risk management to actually take place for the first time in the water industry.”

“There’s plenty of capital that’s beginning to take an interest in investing in water,” notes Peter Williams, IBM Distinguished Engineer and Big Green Innovations CTO. “What we think the index will do is make it easier to invest in water by establishing a risk benchmark against which people can then lend. And the idea then is to encourage capital inflows into the water sector.”

This means for governments, municipalities, and water agencies looking for ways to finance the estimated $1 trillion in investment needed in water infrastructure in the U.S. alone, they could more easily raise this money and keep the liquidity (i.e. water) flowing to citizens.

On the note of risk, the misadventures of mortgage-backed securities during the housing crisis (not to mention commodity bubbles) may raise eyebrows when it comes to the idea of speculation over an element so essential to life.

Rickards argues, “It’s taken 25 years for housing to go from non-financialized to where we are today after everything that occurred four years ago.” When it comes to water, “if it ever gets there where speculation is a problem, that will not be a bad thing because we will have come a long way in the meantime.”

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Social Security as you know it, it’s over, forget about it.

I caught a bit of Jennifer Granholm’s The War Room for 2/23/12.  She was talking gasoline prices and had Ron Klain on for his ideas. He is a past chief of staff for Gore and Biden as VP’s. Mr. Klain also published his thought at Bloomberg2/20/12.
This post is not about solving the rising gasoline costs. This post is about the further screwing of the 99% by further reducing their security from the risk of life and living.
Let’s cut to the chase: 
One idea might be a “pocketbook protection” plan, which would work as follows: If the average price of gas exceeds $4 a gallon, an additional, automatic payroll tax cut of 1 percent would kick in, as much as $50 per month, per person. The cut would stay in place for at least 90 days; it would disappear when the price fell below $4.00 per gallon.
There are three advantages to this approach. First, because the plan is of limited duration and is capped at $50 a month, its cost is relatively modest — about $5 billion a month, or $20 billion total, assuming the usual four-month gas-price surge. Second, because it isn’t a reduction in gas taxes, it doesn’t weaken any incentives for fuel conservation or efficiency: All workers get $50 to soften the blow of higher gas prices, but the less fuel they use, the more money they save. And third, the relief provides the greatest relative help to lower-income workers who need gas to commute and feel the price pinch the hardest.
I have to assume our Colberly’s head has just popped. What Mr. Klain has proposed is the exact danger many have warned about regarding the use of SS as a means to make up for what is a major functional problem of our current economy: lack of share of income to the masses.

I have pointed out many times that we can not make up for the $1.1 to $1.4 trillion per year of income no longer in the hands of the 99% that is in the hands of the 1% with tax reductions. It can not be done. With that fact, considering taxation reduction in any form as a method to address this specific issue is nothing more than the continuation of the false economy that financialization created as observed from the position of those in the labor part of the economy. It quite literally is the government now using the mathematical gymnastics pioneered by Wall Street to trick the masses into believing that home equity was the same as earned income. Getting a tax cut anywhere is not the same as receiving a greater share of the nation’s income.  It is money, by the way, that you are more than justified to receive because you helped to create it. The rich used to have an opportunity to relearn this lesson every time there was a major strike, say the NY City trash collectors going on strike.
People, I hope we have learned that one’s home, your house has a more important roll to play in your life other than that of asset appreciation. The home is one of the foundations used to reduce the risk of living, of having a life: shelter. Social Security is another one of those life’s risk reducing foundations: longevity. I have asked often here: How many times to do we have to relearn a lesson?
Using SS as a means to offset the results created over the long term from bad policy is the polluting of a very good policy. We can look at the housing crisis as another already experienced pollution. The good policy was promoting home ownership. The bad policy was setting up an economy that changed the perception of home ownership from a life risk reduction activity to an asset building activity. Now that SS has been used once as a solution to an unrelated problem and extended once in a manor that moves it further from the original purpose (reduction of risk of living), with Mr. Klain’s proposal, the use of SS as a back stop for non-related policy results has become an unquestioned and considered reasonable use.
Mr. Klain’s proposal so exemplifies what our politico’s now consider acceptable for SS’s use that he even proposes to pay for it via a general funding solution: 
The plan could be almost entirely paid for with a modest, no-loopholes surcharge on corporate taxes on profit derived from the higher gas prices. The administration would be able to avoid pejorative terms such as “windfall” or “excess” profit tax, because the tax is neither confiscatory nor punitive. With higher gas prices, oil companies will make record profit — and a partial surcharge will still leave that profit at record high levels. In other words, the plan isn’t vulnerable to suggestions of creeping, soak-the-rich redistribution. It would leave in place all incentives for oil companies to increase production, do more research and development, and explore alternative fuels. But a modest surcharge would help fund at least a partial pocketbook protection program to make sure the cost of the oil companies’ gain isn’t excessive pain for the rest of us.
Just to be clear, that Mr. Klain proposes using SS for anything other than SS is the problem. The only difference in such action compared to the housing crisis which was tied to the removal of specific banking regulation is that it took us 10 year or so to experience the warning of Senator Byron Dorgan.

For those warning about the proverbial slippery slope phenomenon of using SS as a back stop for bad policy results leading to furthering the destruction of SS, it’s only been about 3 years since this application of SS first became a reality. This use is now acceptable. Social Security has now officially been changed from a purpose specific funded program to an general revenue program.  The establishment is so comfortable within this frame of use for SS we get a proposal such as Mr. Klain’s.   We also have on the record a warning in the vein of Senator Dorgan’s  from Senator Harkin:
“This Congress will be making a grave mistake — a grave mistake — and reinforcing a dangerous precedent,” Harkin said in a dramatic Senate floor speech late Thursday.
Mr. Klain freely proposing another application of a SS tax cut is proof of the truth to Senator Harkin’s warning.  The precedent stands.  It is “codified”.   And, with this precedent the conservative/monied movement has neutralized another barrier protecting SS and it’s status as the end-all be-all of the New Deal: the Democratic Party.
The Movement has also successfully completed the instillation of it’s virus known as Financialization into the nervous system of our government. Social Security no longer thinks as the mind of one living in a labor economy; as the 99%.  It thinks as the mind of one living in a money from money economy; as the 1%.

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And So Happy Xmas…Now with Canadian Content

A couple of days ago, James Bianco, chez Ritholtz, noted a WSJ article entitled “Dividend Stocks Become the Heroes”:

This year, the 100 stocks in the Standard & Poor’s 500-stock index with the highest dividend yields are up an average of 3.7% before dividend payouts, according to Birinyi Associates. The 100 lowest-yielding stocks are down an average of 10%.

Is this a good idea? I understand the move to dividend-paying stocks—companies that admit they don’t know what to do with their excess cash are almost by definition better-run than those that hoard it without announcing future plans for its use (hi, MSFT!). And some companies have a lot of excess cash right now.

But there is a difference between paying a dividend because it’s the best use of funds for your investors and having a high dividend yield. Don’t believe me? Ask Bank of America shareholders ($2.56 Annual Dividend, just under an 8% yield) ca. 2008:



Or those who bought The Big C for its $2.08-cents-per share Annual Dividend (around 6-7% yield) in late 2007*:

Of course, banks might be the except. But here’s the past five years of Toronto Dominion, which was paying around a 3% p.a. Dividend** around the same time period:

What would have happened to your overall investment if you had gone for the higher-paying firms? It’s not pretty:

I like dividends; they’re an admission from a firm that it doesn’t know better than its owners what to do with some of its cash. But high-yielding dividends are often a sign of bad management giving away “excess” cash in good times.***

The first rule of finance: when something appears too good to be true, it probably is. Caveat emptor and may all your investments for 2012 be good ones.

*The graphic scale and dividend amounts were distorted somewhat by the 10:1 reverse split earlier this year.

**An annual dividend of US$2.28, with the stock trading around US$70-75 per share.

***This is not an unusual story, sadly. The collapse of LTCM, for instance, occurred after the fund gave much of its investment monies back to investors and then count not remain solvent for so long as the market remained irrational. (The contemporary equivalent is MF Global.)

(cross-posted from skippy the bush kangaroo)

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GOP wants to repeal Dodd-Frank: instead they should listen to Nassim Taleb

by Linda Beale

GOP wants to repeal Dodd-Frank: instead they should listen to Nassim Taleb

Nassim Taleb, the author of the book on long-tail events, suggests in a Nov. 6, 2011 op-ed in the New York Times that “it is only a matter of time before private risktaking leads to another giant bailout like the ones the United States was forced to provide in 2008.”

That’s pretty strong language, and should be cause for worry among those GOP debaters who have been in a pissing contest over how much legislation they can suggest for repeal, like Dodd-Frank, health care reform, and environmental protection.  Instead of defending big banks, the GOP should start thinking about how to break them up.  Instead of suggesting that we need to repeal Dodd-Frank and end regulation of banks, Taleb says we do need  regulation but can’t depend on it alone: “Supervision, regulation, and other forms of monitoring are necessary, but insufficient.”

And instead of defending risk-taking bankers as innovators and entrepreneurs, Congress should be considering measures to undo the incentives for risk taking.  Taleb says–End Bonuses for Bankers.

[I]t’s time for a fundamental reform:  Any person who works for a company that, regardless of its current financial health, would require a taxpayer-financed bailout if it failed, should not get a bonus, ever.  In fact, all pay at systemically important financial institutions–big banks, but also some insurance companies and even huge hedge funds–should be strictly regulated.

***

Bonuses are particularly dangerous because they invite bankers to game the system by hiding the risks of rare and hard-to-predict but consequential blow-ups, which I have called ‘black swan’ events.

Seems like sound advice.  Bonuses encourage risktaking, and risktaking encourages breakdowns of TBTF banks.  Breakdowns lead to taxpayer bailouts.  To break the chain, deny the bonuses.

The asymmetric nature of the bonus (an incentive for success without a corresponding disincentive for failure) causes hidden risks to accmumlate in the financial system and become a catalyst for disaster.  This violates the fundamental rules of capitalism:  Adam Smith himself was wary of the effect of limiting liability, a bedrock principle of the modern corporation.

Here Taleb touches on a factor in the expanding risk of our economy–and the expanding immunity of the manager class from the risk they cause.  Corporations provide limited liability to their owners.  And innovations over the last few decades have expanded limited liability to almost all investors even in pass-through entities that pay no entity-level tax, through the limited liability company and the limited liability partnerships. That is one of the reasons I have argued for Congress to enact legislation to restrain the availability of tax-free mergers and reorganizations.  The combination of easily attained limited liability plus easily attained consolidation of entities has been a factor in the growth of the corporatist state.

Taleb has a good point about the incidence of bonuses in the US market system as well.

We trust military and homeland secrutiy personnel with our lives, yet we don’t give them lavish bonuses.  They get promotions and the honor of a job well done if they succeed, and the severe disincentive of shame if they fail.  For bankers, it is the opposite: a bonus if they make short-term profits and a bailout if they go bust.

Eliminating bonuses would make banking boring again, like it was before the repeal of the Glass-Steagall Act.  Boring, in this case, is good.  Congress should consider what kind of legislation could be designed to make bonuses in banking less likely, through tax disincentives or other means.

 

http://ataxingmatter.blogs.com/tax/2011/11/gop-wants-to-repeal-dodd-frank-maybe-they-should-listen-to-nassim-taleb-.html

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How can the Fed precommit to a permanent expansion of the money supply ?

A challenge for monetary authorities in a liquidity trap is that it is hard convince people that they won’t reverse expansionary policies as soon as the economy leaves the liquidity trap. The other problem is that they can’t do much other than affect expectations while the economy is in a liquidity trap. This suggests that they can’t do much at all. This argument assumes model consistent expectations (aka rational expectations) but that doesn’t mean it is totally wrong.

My view has been that the key word is “Much” and that the monetary authority can also bear risk. In particular, I think that the Fed can and should bear mortgage default risk by buying mortgage backed securities.

The disadvantage of this approach is that, if house prices and/or GDP tank, then the Fed’s balance sheet won’t balance. It would not be possible for the Fed to retire as much of its obligations as it might choose, because they are worth more than its assets.

This disadvantage is an advantage. It means if things turn out to be worse than expected, then the Fed will not be able to reverse the expansion of the money supply. This means that, if the Fed loses on its investments, then, when the economy recovers, there will be higher than target inflation — the Fed would like to reduce the money supply but won’t be able to do so.

I think this is exactly what the economy needs. The disadvantage of Fed purchases of risky assets is, in fact, a huge advantage.

If the Fed wins its bet, we win (it would transfer the profits to the Treasury). If the Fed loses its bet, we win (it would automatically commit to high inflation even if when the inflation comes the Fed wants lower inflation).

OK Ken, the ball’s in your court.

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Is This A Bad Thing? Sane Economists would say No.

Yes, I’m working with the null set again, but Peter Bockvar, chez Ritholtz, raises the most common objection to the Greek restructuring’s likely effect on the CDS market:

[I]t will…potentially destroy [the sovereign CDS] market to the point where it will go away. The unintended consequence of what will be next will be those looking to hedge sovereign exposure, mostly banks, will then have to short sovereign debt or outright cut credit to the region. EU officials better be careful what they wish for the holders of Greek CDS.

The English translation of this is that Mr. Bockvar suggests—I can’t swear that he believes, though I know which way to bet—that the current prices for sovereign debt are artificially high because of the existence of the Sovereign Debt CDS market.

So, unless you are trading acvtively in both markets, as a buyer, you are being charged too much for sovereign debt.

Wouldn’t it be better to know that up front?

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Notes toward A Blog Post on Chrystia Freeland’s Interview of GE CEO Jeff Immelt

UPDATE NOTE: The following isn’t complete. Many of my notes from the latter part of today’s interview can be found on Twitter, hashtagged #Immelt. At the moment, I both (1) don’t have easy access to them and (2) have other things that need to be done. Feel free to look there, and/or mention anything you want discussed here.)

The fake “news” of the day will be Immelt’s disparaging of America and Americans.

The semi-real news of the day will be that Immelt threw President Obama under the bus four or five times before finally saying that he “respects the President and respects the Presidency.” While this is progress from Jack Welch thinking that Buying George W. Bush the office meant that his firm would be exempted from cleaning up the PCBs GE dropped into the Hudson River (it did result in a nine-year delay and the likelihood that taxpayers, not GE, will foot the large majority of the bill), it’s not exactly a ringing endorsement of the man who gave us the Unforced Error of Simpson-Bowles.

Jeff Immelt, unlike Henry Aaron, believes that Simpson-Bowles is what we need for “growth.”

Jeff Immelt admits that, while the Board of Directors has some input, CEO pay is all about “getting what you believe you deserve.”

Jeff Immelt declares that if unemployment gets back down to 6%, no one will care about his being paid $21.5 million last year (about 40% of which appears to be an increase in his pension benefits; other GE pension contributors haven’t been so fortunate) to continue running GE into the ground to a standstill.

Jeff Immelt says that the US is 25th in math and 26th in science. (He’s wrong on the latter; we’re 17th.) He then spewed some horseshit about the “crisis” of Germans believing that it’s easier to find skilled workers in Mexico than it is in the United States.

Why do I call this horseshit? Well, let’s look at the two countries compared by Immeltian standards (link is PDF):

There are two three possibly-reasonable explanations. Either (1) there are a lot of Stupid Germans or (2) the places where Germans trying to hire are Significant Laggard or “Business Friendly, School Crappy” States.

Oops, or (3) the Germans pwnd Jeff Immelt, who then didn’t check the data.

And that’s without noting that, if you adjust for demographic issues such as poverty or consider racial inequalities, the U.S. is right at the top, no matter what Jeff Immelt says.

Otherwise, mostly, Jeff Immelt lies through his teeth, and Chrystia Freeland—who was tougher on George Soros last year—lets him get away with saying it.

It is left as an exercise whether this is because her boss openly declaring this was going to be a powder-puff interview (“I’m a big fan” of a man who has lost 60% of shareholder value for his investors over the past ten years) or because she decided to let Immelt hang himself. (I know which way I’m betting.)

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Joined the GE Capital Board in 1997

The cause of that “small tax bill”:

Immelt said a small tax bill for 2010 was due to more than $30 billion in losses related to GE’s financial services business during the financial crisis. In 2009, GE Capital’s losses were so large that it company overall lost money on its U.S. operations.

GE’s federal taxes, Immelt said, would rise as the performance of its financial arm improves. [emphasis mine]

Heckuva job, Jeffrey.

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A Brain-Dead "Financial Reporter" at NPR Defines the Problem

Via Doctor Black, who printed the answer but not the question:

PIGNAL: This is actually the second bailout for Dexia. In 2008, it had to be bailed out after exceptionally imprudent investing, including in U.S. subprime mortgages. This time around, it was basically dealing with the legacy of the past, and it was trying to do what it could to get back into safer waters. But with the Eurozone debt crisis in the past year, it basically ran out of time.

SIEGEL: Yeah, that was the past. This is now. And if the 12th most secure bank in Europe just collapsed, does that mean that several more bank collapses are in store? [idiocy emphasized by me]

This is what happens when you try Extend and Pretend while leaving the Management (think Pandit, Moynihan) who screwed up in the first place in charge of the burning building.

Anyone stupid enough to hire Robert Siegel as a “financial reporter” should be defenstrated with all deliberate speed.

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