Monday, August 30, 2010

Free Credit Reports

You are entitled by law to a free credit report once a year. If you don't know how to get it, here's how. Go to the Federal Trade Commission website: Click on the link to That will take you to a site where you can order a free credit report from the three major credit reporting companies (Experian, Equifax and Transunion). The reason for starting from the government website ( is to avoid all the confusing clutter in the search results if you just Google "free credit reports."

Even when you get to, each of the credit reporting agencies will try to sell you services you have to pay for. Just say no. They, by law, can't force you to pay for anything. Eventually you'll get to a place where you can order your free annual credit report.

It's a good idea to get your free credit reports. Mowing the lawn or washing the dishes would be more fun. But if there are problems on the reports, the sooner you deal with them, the better off you'll be. Good luck.

Wednesday, August 25, 2010

The Federal Reserve Fighting Market Forces

Every year, in late August, financial regulators, academic and private industry economists, and the like gather in Jackson Hole, Wyoming, for a talkfest. This year, Fed Chairman Ben Bernanke will speak on Friday (Aug. 27), and will probably announce more quantitative easing. That would mean further efforts to lower medium and long term interest rates (the Fed has already lowered short term rates to zero). What, technically speaking, the Fed will do remains to be seen. But the goal is to prevent deflation.

Policy makers tell us to shrink from the horrors of deflation. Consumers, we are told, will stop buying in anticipation of lower prices. Holders of capital will stop investing, hoping for better deals later. Home values will sag, discouraging consumption all the more. The nation will sink into another Great Depression.

One problem: that describes current conditions. People have cut back on consumption. Holders of capital (at least individuals who tend to be long term investors) are fleeing the stock market. Real estate prices are stagnant or falling in most of the country. We're not in another Great Depression. But we already have deflationary behavior.

Another problem: deflationary behavior makes sense. With unemployment high and not falling in a meaningful way, it's rational to spend less and save more. People have relearned the age-old lesson that debt is undesirable, and they're deleveraging. Private industry is hoarding cash, as are the big banks, to have a fallback in case the economy fades again. There are still so many bad home loans outstanding, and so many foreclosed houses, that real estate prices can't rise significantly, not for years to come.

The prosperity from the early 1980s to 2008 was built on an ever expanding cushion of credit. Credit spurred home values to rise, allowed consumers to raise their living standards even as their incomes stagnated, and puffed up stock and other asset prices. Credit became the cure for all problems economic. That is, until it was used well beyond the limit of its logic and the credit bubble burst. Deleveraging set in, and still continues. Asset values are falling--as they should in a time of deleveraging. Consumers are cutting back, which is a logical consequence of deleveraging. Our current stagnation is understandable. It's just the result of market forces in operation.

The Fed is trying to fight the market. It's printing money to keep asset values inflated. It's bought a ton of mortgage-backed assets in order to support real estate values. It's essentially given the big banks a big subsidy so the banks can continue to support, through lending, market making and trading operations, the values of all kinds of asset classes.

Any experienced Wall Street trader knows you can't fight the market. The market always wins in the end. Deflation may not be pretty, but it's a natural result of the bursting of a credit bubble. Deflation pushes prices down, but at some point consumers see bargains they can't pass up. Investors see stock values they genuinely find attractive. When home prices fall far enough, plenty of buyers will qualify for loans even with today's stringent credit standards. Demand will revive, as will the economy.

By substituting monetary policy for market forces, the Fed is creating an artifice, where people hold back because they know current prices aren't right. They fear that buying now means losses tomorrow. The more the Fed delays the operation of the market, the longer people hold back. Eventually, they may permanently embrace parsimony. In the capital markets, no one wants to invest long term because they can't believe current prices are solid. Individual investors head for the hills, while professional investors clog up the markets with low risk, high speed trading and other short term speculation financed with the Fed's bargain basement interest rates. No one is embracing risk. Everyone's running from it. On a certain level, the Fed's interventions create deflationary behavior.

The mother of all quantitative eases has been taking place in Japan, and it hasn't worked. Japan's stock and real estate markets have deflated, while its structural unemployment has risen. Japan isn't in a Great Depression. But it can't pull itself out of the quagmire. Market forces were blocked from normal operation in Japan, and now Japan's economy doesn't function well.

America isn't Japan, but market forces are the same worldwide. The Fed can't suppress the market forces pushing America toward deflation. Maybe it can mask their impact to some degree. But the Fed's relentless printing of money is bound to distort markets, asset values and capital allocation. Deflation isn't pretty, and for the unemployed, it's a Depression. But deflationary behavior today is rational, and the Fed wants people to act contrary to their sensibilities. If the Fed doesn't allow market forces to operate, what exactly is supposed to happen? What's the substitute game plan? Does anyone really know?

Friday, August 20, 2010

What the Smart Money is Doing in the Financial Markets

If you want to find out what the smart money is doing, look at money managers. Not wealthy people, some of whom put their money with Bernie Madoff. But people who have successfully managed money for wealthy people.

This past week, Stanley Druckenmiller, a long standing hedge fund maven, announced he would return investor money from his firm, Duquesne Capital Management LLC, and close up shop. He was followed a couple days later by Paolo Pelligrini, a former sidekick of John Paulson who help to engineer the mother of all short sales--the 2007 thumbs down on the mortgage market--that made Paulson billions (and Pelligrini mucho millions). Pelligrini had left Paulson and set up his own fund. But now he, too, has decided to return investor money and manage only his own money.

There are a shipload of supposed experts on Wall Street who will tell you to do this or that with your investments. But just about all of them are looking for a way to pocket some of your money. Investors circa 2010, suffering from battered portfolio syndrome, have learned to be wary of people with sales agendas. Druckenmiller and Pelligrini are doing the exact opposite. They're returning investor money they currently manage--the anti-sales maneuver.

That's a sign of the times. One can infer that Druckenmiller and Pelligrini don't see a lot of low hanging fruit in the financial markets. Neither said they were ditching their personal portfolios and going to cash. But it's not hard to imagine that they expect to play more defense than offense in the foreseeable future. It's hard to explain to investors the pedestrian returns that playing defense produces. But the markets don't always cooperate when people want home runs. Sometimes, strong winds blow in from the outfield bleachers. A couple of home run hitters just took themselves out of the game. That may be a hint to be cautious about swinging for the fences.

Sunday, August 22, 2010: today comes the news that one of Warren Buffett's premier stock pickers, Lou Simpson, is going to retire soon. See This is a guy who's usually beaten the S&P 500. And now he's opting for a retirement watch. One starts to get the impression that people who know where the top is are getting out at the top.

Tuesday, August 17, 2010

Back Door Deficit Spending

The best kind of deficit spending, if you're the spender, is the kind other people (like taxpayers) don't see. Even though deficit reduction is now the political flavor of the month, acolytes of John Maynard Keynes still work their agendas quietly.

With mortgage rates now running 4.5% and even lower, courtesy of the Fed's 24/7 money printing presses, proposals are being floated to consciously spur mortgage refinancings--not to increase homeownership levels, but to put more cash in the hands of existing homeowners to spend. This would add who knows how many billions of consumption to the economy. Of course, it would entail a relaxation of lending standards. One proposal is to allow homeowners with mortgages guaranteed by Fannie Mae or Freddie Mac who are current on their payments reduce their rates to 4% and borrow up to the appraised value of their homes, regardless of the value of their homes or their current financial circumstances. (Presumably, only those who aren't underwater could increase the principal amount of their loans, but those that are underwater but current could get a lower rate.) There is a name for this loan: the no doc loan. We had problems with it during the financial crisis, and some of those problems still burden us today.

Despite repeated denials by the Federal Reserve, the Treasury Department, the President's economic advisers, and other notable officials, scholars and experts, there still isn't such a thing as a free lunch. If mortgage refi standards are relaxed to spur consumption, investors currently holding the mortgages that would be refinanced would be losers. Early prepayments would cost them money because the refinanced mortgages available to investors would pay a lower rate. Overall interest rates have been falling as well, so investors wouldn't have attractive alternatives. They'd simply end up with less yield. Refinanced homeowners would have more to spend, but mortgage investors would have less to spend.

Other losers would be--guess, and you have only one chance, but you'll get it right because there's no possible answer other than--taxpayers. That would be you and me. We're already on the hook (line and sinker) for Fannie and Freddie because they've been nationalized. Nationalizing them has already cost us over $300 billion. That's more than the economies of most countries. Relaxing underwriting standards means a higher risk of loss--a lesson from the 2008 financial crisis that some seem to have forgotten. Early onset Alzheimer's must be prevalent in economic policy circles. Throw a lot of cheap refi money at people who aren't demonstrably able to repay it, and guess what? Some of it won't be repaid.

Because Fannie and Freddie remain "private" corporations in a technical sense (you can still trade their stock if you're in a mood to speculate), their balance sheets are not incorporated into the federal government's financial statements. Indeed, Fannie was privatized back in the 1960s because Lyndon Johnson wanted to indulge in massive (for the times) deficit spending in order to advance his Great Society program while fighting a major war in Southeast Asia. Keeping Fan on the federal balance sheet would have been a political roadside bomb. So Johnson did the expedient thing (imagine that, an expedient politician) and turned Fannie over to private investors. Everyone pretended not to notice the market assumption that the government implicitly backed Fannie, and we were launched on the trajectory that led to the 2007 mortgage and credit crisis.

So using Fan and Fred as refi vehicles to stimulate consumption is likely to add to their liabilities, and in turn to the federal government's liabilities. Not all deficit spending is necessarily bad, even now. But it should be done out in the open, where all can see it and discuss its advantages and disadvantages. As long as Fan and Fred's liabilities aren't incorporated into the federal balance sheet, it's hard to notice a refi giveaway driven increase in deficit spending. For those of the Keynesian persuasion, it's an elegant solution (as academics would put it). Look for mortgage bankers, who have the most to gain from this proposal, to quietly lobby for it. And keep your hand on your wallet. There's always somebody ready to take your money and those somebodies are on the prowl.

Tuesday, August 10, 2010

The Fed Desperately Seeking Inflation

To nobody's surprise, at its meeting today the Fed kept short term interest rates where they are. After all, the slumping economy sags anew with each passing quarter. The Fed also fired a shot across the bow of bond market bears, pledging to use the proceeds of its maturing agency (meaning Fannie and Freddie) debt and mortgage-backed debt to purchase longer term U.S. Treasury securities. This latter measure is tantamount to monetizing federal debt--in other words, printing money for the federal government to spend.

Recall that last year, the Fed bought a shipload of mortgage-related debt in order to loosen up the mortgage market. This pumped a lot of money into the financial system (in effect, providing funds for new mortgage loans). The Fed didn't have the money it used. It simply printed it. We're talking hundreds of billions of dollars of printed money; maybe over a trillion. What the Fed now proposes to do is reinvest repayments of the mortgage-related debt in longer term Treasury debt. That keeps the printed money out in the financial system, perhaps for many years.

Printing money can cause inflation. The Fed believes that a dab of inflation adds a fillip to the economy, allowing businesses to raise prices more easily and debtors to repay creditors with cheaper dollars, thus spurring growth. The Fed has been seeking inflation, with cheap money policies and publicly announced inflation targets. But prices haven't cooperated. While they're still rising, the rate of increase is around 1% a year, the lowest in a half a century. The Fed would like to see 2% or a tad more.

By purchasing Treasuries, the Fed keeps the pressure on longer term interest rates and may push them down. In normal circumstances, lower rates would probably spur growth. But the process of deleveraging from the profligates' ball of the 2000s seems to be getting in the way. Banks don't want to lend, because they still have skeletons in their closets and are holding back cash to cover their butts. The creditworthy aren't borrowing because they're trying to pay down debt, not take on new loans. The uncreditworthy are being denied credit, for the first time in more than a decade but all parties run out of punch eventually. The days when a signature and a pulse could command hundreds of thousands of dollars of credit are over. So lowering long term rates won't be likely to have much stimulative effect. It will only reduce the federal government's interest expenses.

One wonders if that isn't something the Fed intends. There's no way for the federal government to quickly reduce its deficit by a meaningful amount. It will be borrowing a shipload of money as far as the eye can see. By keeping the federal government's borrowing costs low, the Fed prevents even more borrowing by the Federal government to cover rising interest expenses.

In addition, when the Fed uses some of the printed money from maturing mortgage-related debt to buy Treasuries, it's reducing the amount of "real" dollars the federal government has to borrow from holders of capital. That reduces the competition between the government and the private sector for credit. As much as Ben Bernanke jawbones the government to restrain spending, he's making it easier to run federal deficits. Lower prices spur consumption--that's Econ 101. Lower the price of government borrowing and the government will borrow more.

Best of all, printing money is a time honored way for governments to spawn inflation. By investing in longer term Treasuries, the Fed is saying it will keep those printed dollars out in the financial system potentially for a long time, where they might fluff up the price structure.

Or not. The deleveraging process in effect reduces the money supply. That's because a loan increases the velocity of money, which in effect expands the money supply. Paying down debt reverses the process. As our debt besotted society tries to sober up, the Fed's monetization of federal debt may simply offset some of the private sector debt shrinkage. The net impact may be little or none. This could be what's happening in Japan, where the private sector has gone through a gargantuan deleveraging from the mother of all credit expansions in the 1980s. Government debt in Japan runs 200% of GDP (America's is around 65%-70%), but inflation is almost non-existent. The economy is stagnant. Government leverage seems to have taken the place of private leverage, but on a net basis not much has changed.

So the Fed's monetization of debt, at least at the prospective levels indicated by today's announcement, may not spur inflation. And even if it did, there's no guarantee things will improve. Throwing a lot of cash out the door of the Federal Reserve System (directly or indirectly into the hands of the federal government) won't necessarily do anything to bolster the real economy. The cash has to be spent the right way, increasing investment in productive activity--meaning the production of goods and services that people want to buy--not more subsidies for banks that hoard cash that is invested in U.S. Treasury debt. To be valuable, money has to be spent wisely. There's no requirement for wisdom attached to the printed money the Fed is pushing off its loading dock.

Friday, August 6, 2010

How Can the Economy Recover If Bad Must Become Good?

The path to economic recovery, it would seem, requires bad to become good.

We're told consumer spending must rise. Instead, it's stagnant or dropping as consumers save more and pay down their debts. Improving balance sheets is good for consumers, because they can't spend with confidence if they're swamped in debt. When they try, we end up with a credit crisis, like the one in 2008-09. But policy makers want consumers to spend more even though it would be bad for them.

The Fed keeps lowering interest rates. The economy is growing, yet there is a good likelihood the Fed will resume buying longer term bonds after its August 10 meeting in order to rates. The effect is the same as printing money. Somehow, the concoction of dollars out of thin air is considered good even though it defies any common sense notion of value. Monetary relaxation hasn't spurred the economy because the banks aren't lending. Even though ultra low interest rates subsidize banks, they don't produce much of anything for the rest of us. Holders of capital are punished for their thrift. It's no surprise even the well-to-do are spending less. Lower rates will only discourage them more, but the Fed seems to believe that bad is good.

Conservatives want to reduce federal deficits while keeping in place the Bush 2001 tax cuts. Those are the same cuts that, along with President George W. Bush's foreign misadventures, produced the monumental deficits we have today. Why repeat Bush the Younger's errors? But conservatives think bad is good.

Liberals never see a spending bill they don't like. The most recent is a $26 billion bailout of the states that has passed the Senate and will probably pass the House next week and be signed by the President. This bill is couched as a measure to prevent more layoffs of teachers, police officers and firefighters. But money is fungible. If states didn't get this money, they wouldn't necessarily lay off more teachers, police officers and firefighters. They might make other cuts to keep important personnel on the payrolls. The $26 billion bailout allows the states to avoid facing problems of their own making. It's one thing to bailout unemployed people who were laid off through no fault of their own. Even bailing out Wall Street banks in order to save the financial system is defensible on some level. But providing a bailout to states that can raise taxes if they want to keep spending or cut their budgets, simply pushes the costs of state government political miscalculations and profligacy onto federal taxpayers. This bailout is bad, even though it's couched as good.

So, we can see that bad must become good for the economy to improve. If we can just bring ourselves to believe six impossible things before breakfast, everything will be all right.

Sunday, August 1, 2010

Will the Bond Market Sandbag the Fed?

Improbably, bonds have rallied for the last 30 years. When Ronald Reagan was elected president in 1980, rates on 30-year Treasuries were in the range of 15%. Today, they pay about 4%. Economists have estimated that real interest rates (i.e., rates net of inflation) run around 3%. Buying a 30-year Treasury today is like gambling on 1% annual inflation for the next thirty years. That's a riskapalooza if there ever was one.

The corporate bond market is also glowingly optimistic about inflation. Recently, McDonald's sold $450 million of 10-year bonds bearing interest of 3.5%. That's like gambling on 0.5% inflation per year for a decade. Then again, if you bought 10-year Treasury notes, which today pay under 3%, you'd be speculating that there will be deflation for 10 years. One would have to go back to the Great Depression to find a time when these investments would have been winners. Reality is we've got a huge bond bubble.

The Fed is desperately seeking inflation. It's keeping interest rates (short, medium and long) ultra low in an effort to stimulate growth, hoping that a little inflation will be like a round of cocktails before dinner that gets the party going. While neither prices nor GDP are cooperating, the Fed persists, in the belief that manipulating the money supply will somehow work a miracle when consumers are scared, corporations are cautious, and Wall Street finances speculations in derivatives rather than production of goods and services.

Here's the catch: if the economy revives, the Fed will have to raise rates. That could pop the bubble in the bond markets, clobbering yet another asset class. If that happened, holders of capital, already pummeled by the 2000 tech stock collapse and the 2008 stock market crash, real estate crash, auction rate securities collapse, etc., would suffer aggravated battered investor syndrome. They'd pull back from risk and consumption. The stagnation the Fed so publicly fears would follow.

But if the Fed doesn't raise interest rates after the economy revives, inflation would flare, ravaging the value of bonds as borrowers repay creditors with cheaper dollars. The bond bubble would pop in this scenario as well, producing severe battered investor syndrome and stagnation.

Thus, the potential for lasting recovery from the Fed's monetary policies may be capped by the bond bubble. There are other reasons why monetary policies may well fail (banks refusing to lend, consumers too scared to spend). But we've got a built-in booby trap set to spring if the economy revives.

The Fed surely knows this, and will probably hold off on raising rates as long as possible. Forget about the widely accepted view that the Fed should raise rates before inflation rears its ugly head to nip the problem in the bud. By incentivizing borrowing as much as possible, short, medium and long term, the Fed faces the possibility of injuring a constituency, creditors, it has tried to protect 100 cents on the dollar since 2008.

The Fed is damned if it does and damned if it doesn't. It has statutory responsibilities to promote full employment and economic growth. But if it succeeds in promoting growth with a little inflation fillip, it will likely pop the bond bubble and produce potentially large investor losses and a renewal of stagnation. Only a slow, agonizing, years-long recovery, with interest rates barely crawling up, would allow creditors to adjust to a rising interest rate environment without sharp losses. But unemployment would have to remain painfully high in such a scenario. Millions of unemployed Americans would pay the price for easing the bond market out of its current dilemma.

The Fed has yet to pop an asset bubble before it became a systemic threat. No doubt, it won't pop the bond bubble now. But it's laying the foundation for painful choices in the future.