Sunday, December 22, 2013

Why the Economy Could Grow: the Peace Dividend

Contrary to the expectations of many economists and financial market professionals, the U.S. economy seems to be growing reasonably well.  In the third quarter of 2013, growth was 4.1%.  For a mature, industrial economy, a 4.1% rate is good.  The Cassandras among pundits warn that it can't last.  They could be right--but they also could be wrong.

When one looks at what would impel further growth, many of the usual suspects don't seem to be helping much.  Business investment is tepid.  Income growth in the aggregate is even more tepid.  Only the the top few percent have no fear of the Grinch this Christmas.  The federal government is reducing its spending growth--primarily due to sequestration, but even the new budget deal doesn't offer major spending increases.  U.S. exports have been an economic bright spot the last few years, but America isn't an export driven nation and exports can't turn the economy around by themselves.

What, then, could be producing the growth?  The Federal Reserve's accommodative policies no doubt play a role, although much of the case for reducing quantitative easing is that its marginal impact is diminishing, and very possibly evaporating.  The Fed hasn't done anything lately to produce a growth spurt.  Its primary role has been to keep a thumb in the dike until other forces cause the economy to perk up.

But one factor to bear in mind is that America may be starting to enjoy a peace dividend.  The end of major wars is almost always followed by a period of prosperity.  The Civil War was followed by the rapid growth of the Gilded Age.  World War I was followed by the Roaring Twenties.  World War II was followed by decades of prosperity.  And the conclusion of the Cold War in 1990 was followed by the prosperity of the 1990s.  Only the end of the Vietnam War wasn't followed by a growth spurt, and that might well be attributable to the oil price shocks administered by OPEC, which transferred a great deal of wealth to oil producers and away from the consumers who comprise two-thirds of the U.S. economy.

Even though America remains embroiled in seemingly never-ending conflict, we have a peace dividend in the offing.  The war in Iraq is over.  The war in Afghanistan is winding down.  Although U.S. military and security personnel continue to confront challenges in the Middle East, Africa, Asia and Latin America, none of them involve the expenditure of hundreds of billions of dollars, as did the recent Iraq and Afghan wars.  Large amounts of America's wealth that were being spent on weapons and fighting overseas can now be shelled out for double bacon cheeseburgers, big screen TVs, three-quarter ton pickup trucks, smart phones, Legos sets, kitchen re-modelings, really big cups of soda in New York City, vacuous tattoos, frisbees, pre-mixed cocktails, trips to Graceland, and doggie pedicures.  And a lot of other stuff as well.  Giving peace a chance could be the best federal economic policy of the times.  Even though there surely will be ups and downs in the economy in the coming years, the peace dividend offers a powerful reason to hope for the best.

Wednesday, December 18, 2013

Beginning the Taper: What Fed Policy Change?

The Federal Reserve announced today that it will begin to taper its purchases of Treasury securities and mortgage-backed securities.  Starting in January, it will purchase each month $40 billion of Treasuries and $35 billion of mortgage-backs, instead of $45 billion and $40 billion, respectively.  A $10 billion drop from $85 billion per month. Whoop-de-do.  That's barely a drop in the bucket.  Yet, after the announcement, the Dow Jones Industrial Average jumped almost 300 points.  A 1.84% increase in the Dow because of a reduction in central bank accommodation?  Financial news stories attributed the stock market rise to a belief that the Fed was signalling that the economy was improving faster than expected.  But there's a much simpler explanation for the exuberance in stocks.

The Fed said that it was likely to keep short term interest rates at zero for "well past" the time when unemployment fell below 6.5%, its previously announced benchmark for starting to raise short term rates.  This is a significant change from previous statements.  It means that the Fed will keep short term rates at zero for a really long time, and it's not saying how long.  Could be forever, since the Fed didn't announce a new unemployment benchmark for raising rates. 

The promise of ultra cheap money indefinitely is to stocks like pouring gasoline onto a fire--instant exuberance.  What the Fed did today was give back with the right hand what it took with the left, and then some.  It's fair to say that the Fed increased net central bank intervention today.  The sharp jump in stocks is consistent with that view.  The relatively minor change in bonds is as well.

But are we surprised?  Did we really think the Fed was going to step out of the picture in a meaningful way?  American businesses and investors have become addicted to heavy doses of monetary methadone from the central bank.  If the Fed began to actually step back, the market would have tanked. 

What happened today is the Fed switched from wearing a blue tie to a paisley tie.  But the change was cosmetic, and net result was more Fed accommodation.  Oh, well. Plus ca change, plus c'est la meme chose.

Tuesday, December 10, 2013

Barack Obama's Curious Redistribution Ideas

President Obama recently spoke critically of the gap between the rich and the poor.  He has endorsed an increase in the federal minimum wage, from $7.25 up to $10.10.  He has argued for stronger enforcement of the labor laws.  He seeks universal pre-school.

Predictably, Republicans stood in opposition.  More government spending isn't the answer, they contend.  Economic growth is the tide that will lift all boats, they say.

Republicans, whether they are right or wrong, have nothing to worry about.  Barack Obama, whatever he may say, isn't really serious about changing the distribution of income or wealth.  He favors reducing the cost of living adjustment for the Social Security, military and federal retirement benefits that tens of millions of Americans depend on.  Cutting back on retirement benefits worsens the distribution of income and wealth.

There were some federal tax increases that took effect this year.  But the income tax increase on high level earners was accompanied by an increase in Social Security taxes (which are regressive).  So what was the net effect?  Most likely, very little or no redistribution.

The Affordable Care Act would have a redistributive effect because of its health insurance subsidies for low income participants.  If only people could enroll  . . . .

Barack Obama has serious credibility issues.  He drew a line in the dust over the use of poison gas, and Assad stepped over it.  Obama squirmed, complained, and then let the Russians broker a deal.  He didn't have the management skills to implement his signature legislative achievement, the Affordable Care Act.  He negotiated some sort of deal on nukes with Iran, although that deal seems to have implementation issues as well.  As negotiators talk, Iran continues to enrich.  If you're looking for action from the White House on redistribution of income or wealth, don't hold your breath.  Keep saving and investing, because you're on your own.

Thursday, December 5, 2013

A World of Foreign Policy Gambles

It is almost axiomatic that when a political leader faces domestic problems, he or she will turn to foreign relations as a way to divert disgruntled constituents from their daily travails.  Appeals to national pride easily tap into the often reflexive patriotism that many people have.  Folks tend to rally 'round the flag whenever there's a dustup with some bunch of dang foreigners.  Since foreign relations tend to be largely in the domain of Presidents, Prime Ministers and other national executives, legislative interference is less of a problem and credit for success can be hoarded.

With essentially all of the world's major economies unimpressive, sluggish or even tending toward torpid, it's hardly a surprise that some world leaders are indulging in cross-border shenani . . . , well, activities.  China has a slowing economy, with a real estate bubble, a debt bubble, increased competition from lower wage nations around the world, growing unemployment, a lack of high-value innovation, and a demographic demon of too many elderly and way too few young workers that's far, far worse than America's social security issues.  So what does China do?  Make noise about territorial claims in the East China Sea and South China Sea.  America responds by flying B-52s into an area claimed by the Chinese.  The Japanese, with a sludgy economy and a recently elected Prime Minister, Shinzo Abe, who appears to be of a nationalistic bent, contest the Chinese claims with their military aircraft, sabre-rattling as good as they've been rattled at.  Japan and China are quietly drifting into an arms race, while the U.S. military is expanding its presence in Asia.  And of course, there's North Korea, an economic dead zone, which engages in virtually nonstop sabre-rattling to legitimize its autocracy. 

Meanwhile, in the Middle East, a newly elected Iranian leadership faced with a sanctions-hammered economy that's circling the drain, are suddenly open-minded about a deal to slow down their nuclear program.  An American President, crippled by the virtual non-launch of his showcase domestic health insurance program, decides it's okay to let Iran continue to enrich uranium up to the 5% level, even though this isn't exactly a complete freeze of Iran's nuclear program.  (Even though Iran says it wants to have 5% uranium to develop nuclear power, since when does a country with gobs of petroleum reserves need to develop nuclear power?)  This deal could be seen as an effort by the U.S. to reduce its presence in the Middle East (so it can increase its presence in Asia).  Does that make war in the Middle East less likely?  Or will the increasingly nervous Israelis act on their own, as they have in the past?  And if they do, will America be militarily dragged into the consequences?

Over the past century and a half, foreign policy adventurism has tended to end badly.  Sometimes, very badly, with 20 million dead in World War I and 60 million dead in World War II.  This isn't to suggest that America and other nations should become isolationist.  The world is interconnected and some degree of international engagement is necessary.  But citizens should be skeptical of their leaders, who often have much to gain by stepping up their rhetoric and actions.  The recent popular outcries against American and British military action in Syria over its use of poisonous gas is an example of how the levelheadedness of the citizenry can cool the jets of a handful of very powerful people who may spend too much time talking to each other.  If a nation's leader seems to have a gambling problem in the foreign policy arena, citizens should stage an intervention.

Tuesday, November 26, 2013

Are We Stuck With a Powerless Government?

Despite its image as an overbearing ogre, the federal government may be largely powerless these days.  The President has managed to undercut himself with an astonishingly bad non-launch of the federal health insurance exchange.  Is there anyone in his administration with executive or management ability?  Could anyone in his administration succeed as evening shift supervisor at the local McDonald's? 

On the foreign policy front, the President managed to set his foot downrange and pull the trigger over Syria's use of poison gas.  Only an embarrassing intervention by Russia prevented the President from a real morass of a morass.  Now, the administration touts a deal with Iran to freeze its nuclear program, even though it can continue to enrich uranium to the 5% level.  Not very frozen, but perhaps global warming is having an impact.  One wonders whether this deal with Iran is a sign of strength or weakness on the part of the President.

Meanwhile, over on Capitol Hill, Congress remains essentially non-functional.  The Democratically controlled Senate was able to approve the appointment of a few judges by changing its rules, although scowling Republicans made many dire and threatening predictions that the Dems would be sorry for doing this.  Nothing like a love fest to make folks feel collegial.  As for the federal budget and the debt ceiling, they aren't likely to trigger new crises, but will be resolved by kicking the can down the road.

The only institution that seems to be doing anything is the Federal Reserve.  And even it may be losing some of its mojo.  The most recently released minutes of the Open Market Committee meeting in October have been interpreted to mean that the Fed may be thinking about pulling back soon on quantitative easing.  Antacid sales on Wall Street have jumped.  If the efficacy of Fed money printing is diminishing, we may find ourselves in a public policy Sahara with very few water holes.

A powerful government can be scary.  A powerless one can be scarier.  The problem is this isn't a horror movie and we can't get up and leave the theater if we don't like the show.

Thursday, November 14, 2013

How the Federal Reserve Defies the Laws of Economics

For an agency run by economists, the Fed seems non-economic.  Its quantitative easing program--now snarfing up bonds at the rate of $85 billion a month--defies one of the basic premises of economics:  the concept of scarcity.  Scarcity is crucial to establishing price.  If something is available in infinite amounts, it has to be priced for free because there's no limit to supply.  Scarcity acts as a constraint, forcing prices up as demand increases.  Price increases in turn compel actors in the market to think and rethink the utility of the thing that's getting costlier, and adjust their use of it.

The problem with the Fed's QE program is that it's paid for with printed money.  In other words, to get the $85 billion it needs each month, the Fed simply makes a few electronic entries into its computer system and, voila, money blossoms.  There is no scarcity.  The Fed doesn't have to get the money from anywhere.  Unlike taxes or borrowings, no one else has less money when the Fed prints some. 

In times past, when central banks pulled such financial alchemy, inflation would flare.  By reducing the value of the currency, buying power would become scarcer and discipline would be imposed.

But today, there is very little inflation--and, indeed, central banks seem to want more.  Thus, there are no constraints on money printing.  And, by all indications, the Fed governors whose voices count intend to keep the printing presses rolling.

Numerous skeptical observers haven't been able to complete the journey to Wonderland and believe that there will be no cost to all this.  And the truth may be that there has been and will be costs.  At the first hints of tapering earlier this year, a number of emerging markets began tanking and some have tanked hard.  Real estate sales have slowed dramatically as longer term interest rates have risen and the real estate recovery may have stalled out.  Gold and silver have fallen sharply, and other commodities prices have eased back. 

The Fed seems to have not really noticed that monetary policy now affects asset values more than consumer prices.  The tech stock boom and bust, the real estate and mortgage boom and bust, and the 2008 financial crisis can all be traced in part back to very generous Fed easy credit policies.  Central banks may be unable to foster inflation, perhaps for reasons that aren't fully understood yet.  But they can foster asset bubbles, and that's a strong reason for easing out of the QE business.  The last thing we need is to again have more government sponsored asset bubbles.

Monday, November 11, 2013

How Do You Invest in a Market That's Fearful and Greedy?

To paraphrase Warren Buffett's aphorism about investing, be greedy when others are fearful and fearful when others are greedy.  In other words, buy low and sell high.

But what do you do when the market is beset by fear and greed?  Market indexes rise to new heights almost every day.  But many investors are increasingly stepping back and hoarding cash.  Indeed, the greedier some get, the more fearful others get. 

There's no established strategy for a pishmi-pullyu market like this.  The fearful, greedy market's bipolar movements defy logic and rationality. 

Much of the market's wackiness comes down to the fact that asset values today are determined as much by government policy as anything else.  We live in the era of the Great Central Bank Accommodation, spiced up with bailouts of one sort or another as ad hoc government policies are slapped together in response to the crisis du jour.  Even though the central banks mutter disquietingly about withdrawing accommodation, they don't really get around to it, because they remain the only show in town when it comes to economic stimulus.  Investors know that government intervention is likely to continue indefinitely, so some invest.  They are also fearful because they know that government support cannot continue forever.  So some hoard cash. 

You can't rationally invest on the political process or government policy.  You can diversify.  That's simply another way of admitting you don't know what's happening or what's going to happen.  Then again, no one does.

Thursday, October 24, 2013

McResource And Your Tax Dollars

McDonald's, it seems, has a hotline called McResource that helps employees get food stamps and other public assistance.  See  Apparently, McPay is so low, McDonald's knows that many employees will need help from government programs.  So they have institutionalized for employees the process of getting public and charitable aid.

It's nice to know that our tax dollars support McDonald's personnel costs.  What could be a better use for our hard earned tax payments than burnishing the shine on the golden arches and boosting the company's earnings?  Even the private charity McD's employees get is indirectly subsidized by taxpayers, since contributions are likely to be deductible.

One wonders if Micky D's ought pay its employees better.  But, no.  Perish the thought.  Executive bonuses don't increase if employee costs go up.   All the better if the government subsidizes the company.

As for right wing proclamations about cutting back on welfare programs, well, forget it.  Poor people have essentially no political power.  But when public assistance subsidizes Corporate America, there's no chance that those with political power will allow the programs to be substantially reduced.

Monday, October 21, 2013

Are Stock Prices Real Any More?

One wonders if stock prices are real.  Consider the evidence.  Due to political obtuseness, the U.S. barely avoided defaulting on its debt.  The economy continues to expand at a disappointing rate.  Employment growth is tepid.  Middle class incomes are falling, on average.  Consumers are gloomy.  The Federal Reserve Board is gloomier.  Businesses hold back on investing cash.  But, last week, the S&P 500 reached record heights.  When you encounter cognitive dissonance in the financial markets, be careful.  Every time in the past 20 years when things seemed out of whack, it eventually turned out that, in fact, they were out of whack.  In other words, if it looks too good to be true, it probably isn't true.

Could investors be wearing their stupid hats again?  Their 401(k)'s got clobbered in the 2000-01 tech stock crash, and after adjustment for inflation, stocks still haven't recovered.  Investors' 401(k)'s and homes got clobbered again in the financial crisis of 2008, and many haven't recovered from those losses.  What does it take to move up the learning curve?

Maybe, however, the problem isn't investors.  Over 50% of the trading volume in the stock markets comes from high-speed computerized trading.  This activity isn't based on human judgments.  It flows from algorithms and formulae.  Some of the computerized trading is dynamic--it changes based on what it observes in the market.  Since the activity it is often observing is computerized, we now have computers reacting to the activity of computers, which could be reactions to activity by other computers. 

When stocks were valued by humans, we had some idea of what we were dealing with.  Even if things seemed irrational or even bubbly, we could understand what was happening, albeit with a frown.  Now, with stocks being priced by "thought" processes that are impenetrable to the average investor, the market not longer reflects the collective judgment of humans.  Instead, it is an amalgamation of valuation processes that often aren't based on human judgment.  The things that people are concerned with--lousy economy, sluggish jobs growth, falling incomes, dim view of the future--may not be finding their way into stock valuations, at least not in the ways that they historically did.  If so, we can't be sure stock prices are real because we have no idea what the computers will do next.  Caveat emptor.

Thursday, October 17, 2013

The Fiscal Crisis: Can Kicks Are All We Can Expect

Tonight (Wednesday, Oct. 16, 2013), Congress has temporarily "fixed" the fiscal and debt crises by re-opening the government until Jan. 15, 2014, and raising the debt ceiling until Feb. 7, 2014.  In other words, the government will resume operations and not default on its debt until early next year, when we return to crisis mode again.

Can kicking is all we can expect.  The government that the voters elected in 2012 isn't capable of decisive action on divisive issues like government spending.  With the House held hostage by a small but very loud group of Tea Partiers, and the rest of government controlled by the Democrats, dysfunction is baked into the cake the voters made last year.  Maintaining the status quo--a/k/a can kicking--is the only thing a sharply divided government can do.

Early next year, when Congress and the White House revisit the fiscal and debt crises, they will again kick the can through the end of the 2014 fiscal year (which ends Sept. 30, 2014)--because they won't be able to do anything else.  Maybe they'll make minor tweaks, but nothing big will happen.  Come late September or early October 2014, with the 2014 Congressional elections imminent, they will kick the can again past the election date, perhaps into early 2015 for the next Congress to deal with.

To end can kicking, voters need to elect a functional government next fall.  Yes, the idiots in Washington are to blame for behaving like children.  But the electorate put them in office.  Democracies function by compromising.  If narrow-minded, uncompromising fanatics are elected, expect the can to be well-kicked for years to come. 

Friday, October 11, 2013

Why the Republicans Blinked

The Republicans, especially those in the House of Representatives, are rapidly giving ground in their fiscal battle with the Democrats.  A resolution is pretty likely within a week or less.  It will probably provide a short term delay of the debt ceiling and re-open the government, while the parties negotiate over long term fiscal issues.

Why did the Republicans blink?  Because they tried to manufacture a crisis out of a non-problem and a long term problem.  The non-problem is Obamacare.  The truth is that Obamacare offers valuable benefits to millions of people.  The huge traffic jams on health exchange websites demonstrate that lots of people understand Obamacare's value and want to participate in the program.  The Republican attempt to de-fund Obamacare would take away something millions of people want, and that's usually a very poor political strategy.  The Republicans seem to have belatedly figured this out, but not before forming a circle and firing volleys inward.

The long term problem is the federal deficit.  It is a serious problem.  But it's not an immediate problem.  The Republican effort to create a crisis at this moment over something that will play out years and decades from now is too obvious a political ploy.  The minority party wants to call the shots by gratuitously inflicting damage on the economy with a government shutdown and coercing an unnecessary default on the most important financial instruments in the world, U.S. Treasury securities.  Political parties thrive by winning over a majority of voters, not by wrecking economies and financial systems.  The fiscal deficit is not an immediate crisis.  It needs to be addressed, and will be, over the next years and decades as it becomes more pressing.  But the Republican tactic--give us everything we demand or we will destroy your government and wreck your finances--is bound to, and in fact did, alienate a majority of the electorate. 

After Barack Obama's re-election last year, the Republicans launched a process of reflection and reconsideration.  It's unclear that they made much progress, and the fiscal brawl of the past few weeks has surely left the party more damaged than before.  The Tea Partiers have prevented the Republicans from doing the thing that's necessary to political domination--shifting toward the middle.  Since political power abhors a vacuum, the Democrats have easily moved into the breach. 

Wednesday, October 2, 2013

Upsides of the Shutdown

The federal government shutdown isn't all bad.  Some of the good things that resulted include:

White supremacists had to cancel their rally at Gettysburg National Park, because National Parks have been closed.  Poor knuckleheads.

Federal spy agencies have been cut back 70%.  We now have a lot more privacy than we had just a day ago.

Spying on pandas halted, as the National Zoo's panda cam has been cut off.  A lot of people are disappointed, but consider the pandas' point of view.  Wouldn't it be creepy to have a camera focused on you for hour after hour after endless hour?  Aren't pandas entitled to some privacy and dignity?

School lunches and breakfast still being served.  Or maybe, from the kids' point of view, this isn't so good.  Many of them might have been hoping for an excuse to binge on junk food.

Free and discounted food and drinks are being offered to feds and sometimes non-feds by many Washington, DC area bars and restaurants.  Theaters, museums, gyms and other businesses are also advertising free or discounted admissions, goods or services.  Close the government and what do you get?  Party central.

Stock market up.  The S&P 500 rose about 0.8%.  If this is what a shutdown does, there are probably a lot of market players rooting for more government dysfunction.

Tuesday, September 24, 2013

The Key To Obamacare's Survival?

Even though the House of Representatives has just voted to use the budget bill to defund Obamacare, its chances of survival are pretty good.  Not just because the Senate will delink the defunding from the budget bill, but also because Obamacare suddenly seems to have some powerful supporters.

Not that these supporters are speaking openly.  But here's the scoop.  Major American corporations are moving their workers or retirees to the private exchanges.  Wahlgreens, Sears, and Darden Restaurants (think Olive Garden, Red Lobster, Longhorn Steakhouse, Capital Grille and more) have announced that employees will move to the private exchanges.  IBM and Time Warner are moving retirees to the private exchanges.  Apparently, these companies will pay employees or retirees subsidies to reduce their premium costs.  But these companies, and others making similar moves, are offloading a very important risk--the unpredictability of health care costs.  They provide fixed subsidies, thus stabilizing their costs.

Businesses love predictability and certainty.  Profits are more likely if you can control major cost items like health care coverage for employees and/or retirees.  In essence, Obamacare is on the verge of becoming an important subsidy to big business.

Experience teaches that government subsidies are virtually impossible to eliminate.  Long after the Great Depression and Dust Bowl, agricultural subsidies that make no public policy sense persist.  Even after being nationalized just before they could bring down the entire U.S. economy, Fannie Mae and Freddie Mac roll along, now more centrally positioned in the financing of residential real estate than ever before.  Virtual giveaways of access to minerals on federal land continue unabated even though the settlement of the West was effectively complete by 1890.

With Obamacare in the process of becoming a potentially really, really important subsidy to really, really big corporations, do we really think that it's going to be eliminated?  The Tea Partiers in the House make a lot of noise, but can they take on the political firepower that big business lobbyists can bring to bear?  Recent polls indicate that a majority of Americans support Obamacare, and politicians in a democracy eventually have to pay attention to the polls (see Obama-Syria-poison-gas-response for more on this point).  But, just as importantly (or more so), powerful business interests can arrange the survival of big subsidies no matter how loud some people in the House of Representatives scream.  This may reflect poorly on the nature of the political process, but it's the truth.  And Obamacare may well now have the backing of some highly influential lobbyists who will speak softly (to stay out of the cross-hairs of the Tea Party) but will wield big sticks to keep their clients well-subsidized.

Sunday, September 15, 2013

How To Stop the Too Big From Failing

Congress, and financial regulators in America and other nations, have struggled endlessly with the problem of financial institutions too big to fail.  Capital requirements have been increased, and regulation has been tightened (somewhat--much of the implementation of the Dodd Frank Act remains unfinished).  But the problem remains.

There is a simple way to seriously reduce the possibility of another taxpayer-funded bailout.  If a financial institution needs a government bailout, force the CEO, COO and CFO, and the members of the Board of Directors, to pay to the government the value of their entire compensation for the preceding five years.  This would include salary, bonuses, stock options, restricted stock, fees, country club memberships, company cars, and all other perks and compensation.  This payment would be required without regard to whether or not the executive officer or director was proven to have participated in any wrongdoing or neglect.  It wouldn't be a penalty for misconduct.  It would be an incentive to avoid sticking the government with the costs of mismanagement.

Any such proposal would, of course, provoke howls of outrage from financial institutions and their free-roaming packs of mouth-foaming running dog lobbyists.  Such a measure would be unfair if the officer or director hadn't been shown to have engaged in misconduct, it would be argued.  However, the SEC already has the legal authority to force a company's CEO and CFO to pay out all their compensation for the 12 months following the issuance of financial statements that are subsequently modified (in a form called a restatement)--see Section 304 of the Sarbanes-Oxley Act.  The SEC isn't required to show that the CEO and CFO did bad things.  They can be forced to make this payout simply because the original financial statements were wrong and needed to be restated.  The courts have upheld this authority.  There's nothing unfair about requiring senior executives to get important things right in the first instance.

Banks and other financial institutions might also object that they couldn't recruit the executive talent they need if this financial Sword of Damocles were to hang over their heads.  But, when we consider the geniuses at some financial institutions in the recent past who steered their firms right over cliffs and into government safety nets, this argument loses its persuasiveness.  Executive compensation arrangements at the too big to fail seem to incentivize risk-taking, even if it might entail unmanageable complexity.  There needs to be a disincentive--and a strong one.

The government has been criticized for not penalizing the high and mighty for the financial crisis of 2008.  Remember, however, that the statutes and regulations governing financial institutions are complex.  Proof of violations can be difficult.  A simple measure like a penalty of five year's compensation for a government bailout offers a way to nail the top dogs for signing a chit the taxpayers have to pay.

Sunday, September 8, 2013

One and Done in Syria, Right? Right? . . . Come on, right?

Once upon a time, there were some nasty guys known as al Qaeda.  In August 1998, they bombed the U.S. embassies in Kenya and Tanzania.  Over 200 people were killed, including 12 Americans.  In order punish the baddies, President Clinton order cruise missile attacks on al Qaeda training camps in Afghanistan and a pharmaceutical factory in Sudan which supposedly made chemical weapons.  Dozens of cruise missiles were fired and hit their targets.  After that, al Qaeda was never heard from again.

Unfortunately, the last part isn't true.  Al Qaeda, as we all know, survived in Afghanistan, killed some 3,000 Americans on September 11, 2001, and triggered wars that have turned out to be America's longest military conflicts.  Over 4,800 Americans died in Iraq, and more than 2,000 in Afghanistan.  American personnel are now engaged in fighting al Qaeda or its affiliates in South Asia, the Middle East, the Arabian Peninsula, North Africa, and who knows, maybe even Southeast Asia (there are Muslim insurgencies in Indonesia and the Philippines).   There is no end in sight for America's war against violent Islamic radicals.

President Obama and his supporters seem to think they can conducted a limited strike in Syria to punish Bashar al-Assad for using chemical weapons, and then be done with it.  Who are they kidding?  The bad guys in this scenario grow beards on the other cheek; they don't turn it.  Iran, Syria and Hezbollah are all promising retaliation if America launches cruise missiles.  Americans and American facilities in Iraq, Afghanistan, and probably other places are likely to be on the hit list.  American allies like Israel, Turkey, and other nations may be attacked.  Sooner or later, Assad or one of his allies will do something that will require further American action.  That's what happened with al Qaeda 15 years ago.  The 1998 cruise missile strikes on al Qaeda's training camps led to the 9/11 bombings, which then led to a war we're still fighting.

There is no chance--as in zero percent--that a U.S. cruise missile strike against Assad's forces will be the last word.  President Obama has yet to explain how he will deal with the many retaliatory responses from the bad guys, all without putting boots on the ground in some distant place and without entangling us in another endless war against people who can outlast us because it's their home.  In all likelihood, he has no explanation, because there is no way to contain America's involvement in Syria once we cruise in. 

As Americans know from hard experience, the road to Hell is paved with good intentions, and President Obama has the road we're now on very well paved.   Good intentions aren't the only thing that counts.  Competence and diligence matter, too.  You have to have a strategy to win--convincingly and quickly.  If you don't have such a strategy, don't dive into a war.  Ask the 58,000 Americans who died in Vietnam and the 4,800 who died in Iraq about this point.  There doesn't seem to be much strategic thinking going on in the White House; just political maneuvering in the hope of preventing the President from losing credibility for shooting from the hip.  Some of the U.S. troops in Afghanistan today were seven or eight years old at the time of the 9/11 bombings.  Today's parents of elementary school students should pay close attention to the discussion of U.S. military action in Syria.

Tuesday, September 3, 2013

How Does Obama Define Success in Syria?

Barack Obama has flinched.  Not once.  Not twice.  But three times in the last year or so.  Each time, he rattled the saber at Syrian President Bashar al-Assad, Assad called Obama's hand, and Obama flinched.  Now, evidently rattled himself by the unexpected rejection of military action by the British Parliament, Obama seems to be looking around for someone to offer a fist bump.  French President Francois Hollande has been supportive, but Obama has called for Congress to pass a resolution endorsing a military response to Assad's use of chemical weapons on Syrian civilians.

The Democrats, who control the Senate, are feeling queasy, but may support a narrowly crafted resolution.  The Republicans, who control the House, are skeptical and may reject the resolution. 

The Administration has offered a variety of negative reasons for striking Assad's forces, arguing that bad or negative consequences will ensue if the U.S. does not strike.  Chemical weapons are horrible and are prohibited by international law.  The United States, and especially the President would lose credibility.  The Iranians would be emboldened in their quest for nuclear weapons.  The North Koreans would be emboldened to pull more septic content.  The Russians would be emboldened in any number of ways. 

Chemical weapons are horrible.  But does the President see himself as a referee, seeking to penalize Assad for face masking?  Is the President's plan to throw down a yellow flag, move Assad back a few yards, and then let the slaughter continue?  Is it okay for Assad to continue his nationwide massacre if he just limits himself to conventional weapons?  Why don't we issue striped uniforms to the U.S. military and give them whistles to blow along with cruise missiles to fire?

As for credibility, Assad is in a fight for his very life.  He couldn't give a rat's left ear what Obama does, because Obama won't put U.S. boots on the ground and hasn't even provided military support to the Syrian rebels that he promised months ago.  Obama doesn't present a significant threat to Assad.  Maybe Assad's forces will refrain from obvious use of chemical weapons for a while and employ more conventional but plenty lethal weaponry to kill many more Syrians.  But nothing Obama is contemplating will make him more credible to anyone who matters.

The Iranians are, if the vaguely sourced information published by the press over the past few years is accurate, hellbent on building nuclear weapons on the fastest possible schedule.  It won't matter a bit what Obama does in Syria.  A U.S. military strike there will only lead the Iranians to more comprehensively disguise their activities.  But it won't dissuade them in the least from halting their nuclear program.

The North Koreans are constrained by the presence of 26,000 U.S. troops stationed along the demilitarized zone in the Korean peninsula.  North Korea can't do anything substantial to South Korea or any other nation without affecting these troops.  As long as those troops are there, what Obama does or doesn't do in Syria isn't significant.

As for Russia, Prime Minister Vladimir Putin is ex-KBG.  If there was an intelligence service that knew how to spot and exploit human weakness, it was the KGB.  Putin surely has Obama figured out--the man isn't bold.  He's not a risk taker.  He wants to be on the winning side no matter who that is or what happens (this is how the U.S. wound up being detested by everyone in Egypt--we tried to be everyone's buddy and ended up no one's buddy).  Obama is like the political equivalent of Microsoft--very successful, but not so likely to continue that success in the future because of an aversion to taking real risks.  Whatever carefully calibrated and narrowly focused military strike Obama now orders isn't going to convince Putin that Obama is anything except a smart, but cautious man trying to stay on his feet in a back alley brawl.  The smartest man in the alley might win the brawl, but the meanest man is the one you have to watch out for.

To persuade Congress and the American people that military action in Syria is justified, President Obama has to present positive reasons.  We need to know how we succeed, how we win.  Waging war for the purpose of stopping bad people from being bad isn't likely to work, unless one is prepared to wage total war and completely conquer the enemy, as America did to Germany and Japan in World War II.  No one has suggested that America conquer Syria.  For the past fifty years, America has dived into military adventures for poorly conceived reasons, and not surprisingly done poorly.  The only clear case for offensive military action--the 2001 invasion of Afghanistan-- was thoroughly botched by the second Bush Administration when it failed to deal definitively with Osama bin Laden after trapping him in late 2001 at Tora Bora.  We're still suffering the consequences of that failure.  If President Obama wants our support for a strike in Syria, he should tell us how we attain victory.  If there is no victory that can be defined or attained, we should hold our fire.

Saturday, August 24, 2013

The Hidden Inflation

The Federal Reserve assures us that inflation is modest, and can point to measures of inflation it prefers (the PCE price index) or doesn't prefer (the CPI), both of which tend to be modest--in the 2% range or less.  But if you ask a lot of people out in the real world, they'll tell you inflation is worse than that.  And they are right, once you take account of what inflation really means.

The ultimate problem created by inflation comes up when price increases exceed income increases.  If your real income is falling, your standard of living will drop.  That's cause for concern.  When incomes rise faster than price increases, people complain but then dig into their steaks and lobster. 

Incomes today are, in real terms, falling for a lot of people.  Workers on average earn less, net of price inflation: see and  Median household incomes have fallen since the beginning of the Great Recession:  While the fall in household income may in part be due to higher unemployment, it would also reflect the drop in worker earnings. 

Once you look at earnings and household incomes, you can see that inflation in the broader sense isn't so modest.  Since the Great Recession began in 2009, government statistics show that real average weekly pay for full-time workers has fallen 3.5% from 2009 to the second quarter of 2013.  (See  The social discord and turmoil that can come from inflation is rooted in falling real incomes, not nominal price increases.  Despite all the statistical soothing the Fed may offer, many Americans today are hurting from this hidden inflation. 

There is little the Fed can do about falling real incomes.  Its monetary tools and bond purchases have little connection to wage and salary levels.  They may boost household income to the extent they promote greater employment.  However, because they significantly reduce interest income for savers, they may also exacerbate the problem of falling incomes. 

As for Congress and the Administration, they're on August recess right now.  And they won't do much about this problem when they get back.  Fights over a budget for the next federal fiscal year (beginning Oct. 1, 2013) and the looming debt ceiling will provide photo ops and Sunday morning talk show invites for the high and the mighty.  The dreariness of ordinary life is likely to get lost in the shuffle.  Talk at the state level about raising the minimum wage may have some impact.  But falling incomes is as much a problem of the middle class as of lower income persons.  Minimum wage laws won't help the middle class very much. 

The overall structure of American society, with its exceedingly generous corporate compensation practices to tax laws favoring the 1% to the decreasing degree of upward social mobility to the astonishing growth in the cost of college educations and more, is thinning out and pushing down the middle class.  No nation has gone on to its greatest days with increased social stratification and top-heavy distribution of wealth.  But nothing is happening right now to change the trend.  This story won't end well.

Monday, August 19, 2013

Why No Great Rotation?

A popular view among market aficionados is that, with bond prices falling while stocks have been rising, money would shift from bonds to stocks.  Stocks and bonds have historically often moved inversely.  When stocks rose, bonds fell, and vice versa. With bonds falling now, it would seem reasonable to expect investors to rotate their money into stocks.  But there has been no rotation.  Why not?

First, for the past five years, we've had a brave new Fed which has manipulated asset values in ways beyond historical experience.  Since early 2009, central bank easy money has helped to spur a stock rally accompanied by a bond rally.  Both asset classes rose simultaneously, instead of moving inversely.  With their traditional relationship out of whack, it is hardly surprising that they don't cha-cha when they're supposed to.  Investors would be understandably suspicious of stocks in a market that is seemingly dependent on the Fed's methadone program, especially when the Fed is talking about easing out of its role as Dr. Feelgood.

Second, the Great Rotation is an investment strategy for the medium to long term.  Today's stock market is dominated by high-speed, computerized trading, where the holding period for stocks is measured in milliseconds.  The long term human investors that might consider rotating greatly have mostly been supplanted, and many have chosen to invest on autopilot, buying index funds and throwing salt over their left shoulders.

So whither the markets?  That's the $64,000 question, and in truth nobody knows the answer.  With both stocks and bonds having enjoyed years-long bull markets, logic and experience, especially recent very painful experience, tell us that when markets can't keep rising indefinitely, they won't.

Thursday, August 8, 2013

Why an SEC Victory Counts More Than an SEC Loss

Since the SEC won a jury verdict against former Goldman Sachs VP Fabrice Tourre last week, the financial press has published semi-snarky commentary about how the SEC has lost more financial crisis cases than it has won.  This game of statistics misses an essential point.  Wall Streeters, corporate executives and directors, and their attorneys are cautious folk.  You might not think so from some of the inexplicably risky things they occasionally do, but on the whole they are more concerned about downside risk than upside potential.  (Even good hedge fund traders look first at how much they can lose before they focus on how much they might make.)

A high profile SEC win, like the Tourre case, makes the risk averse pause and reflect all the more so before taking the plunge.  It's better to settle and hide behind your PR person who repeatedly declines to comment to press inquiries than to be photographed outside a federal courthouse wearing a nice suit and a gloomy expression.  People will remember that expression for a long time.  Tourre didn't have to do a perp walk, but there's nobody--absolutely nobody--on Wall Street, Main Street or anywhere else in the corporate world who wants to wear his suit. 

When the SEC loses in court, the defendants have a day in the sunshine.  But then their cases are largely forgotten.  Major SEC victories are remembered.  The SEC's cases against notorious insider trader Ivan Boesky and junk bond king Michael Milken still receive public mention, even after 25 or so years.  Who remembers the cases the SEC lost in the 1980's?

In the plush conference rooms and offices where corporate lawyers and their clients under SEC investigation discuss the risks of settling versus litigating, you can be sure that the SEC victory in the Tourre case is getting a lot of attention.  The SEC's losses are probably mentioned as well.  But no good attorney wants to be caught making, or even implying, a promise s/he can't keep, and the story of Fabrice Tourre is likely being presented as a cautionary tale.  People with a lot more to lose from an SEC victory than they have to win from an SEC loss may well see the merit of capping their downside risks.

Thursday, August 1, 2013

SEC 1, Tourre 0, Goldman 0, Financial Press -1

Today's jury verdict finding Fabrice (the "Fabulous Fab") Tourre liable on six of the seven civil counts against him represents a major victory for the SEC.  That's not simply because of the prominence of the case, which involved the sale of a controversial motgage-backed derivatives investment and is the highest profile SEC enforcement action to come out of the 2008 financial crisis.  It's because the agency's very efficacy has been under attack for the better part of a decade.  Widely viewed as ineffectual, the SEC has re-established its presence as a cop on the beat.  While one victory doesn't win the war, a victory this big will make a lot of corporate and white collar defendants think harder about settling, even if the price involves admitting to making bad choices.

Fabrice Tourre rolled the dice and lost.  Litigation is a gamble, and some bets turn out to be losers.  Perhaps he chose to fight instead of settling up front because he was angry about being a lower level guy who was singled out as a named defendant.  But anger doesn't equate to victory in court.  Above all, what matters is the evidence.  Tourre may have been his own worst enemy, seemingly adding insouciance as too much of a fillip to his e-mails.  Most likely, his attorneys will soon make motions for this and that, and perhaps later file appeals.  But now that the jury has spoken, Tourre faces an uphill battle.

Goldman Sachs wasn't a party to the case.  But it reportedly financed Tourre's defense.  And perhaps it has reasons beyond loyalty to a former employee.  Goldman faces potential liability in private civil lawsuits involving charges similar to those in the SEC case.  If Tourre had won, Goldman might have negotiated more favorable settlements in those cases.  Now that he's lost, GS has shifted closer to the 8-ball.  But that's all just a matter of money, of which GS has a fair pile.  GS isn't going to be kicked out of the securities business, as Tourre might be, because GS already settled with the SEC, thereby capping its regulatory liability.   Now that he's been held liable by a jury, Tourre not only faces SEC sanctions, but perhaps demands for payment from the plaintiffs' attorneys in those private civil lawsuits as well.  Poor Fab.  Not so fabulous any more.

The financial press ends up looking silly.  Not one publication of any prominence, to this writer's knowledge, predicted the SEC's victory.  Many expressed serious doubt about the SEC's case.  The coverage during the trial was frequently skeptical of the SEC's evidence and efforts.  It might be interesting to know why the press coverage was so imbalanced.  Whatever the reason, the press was scooped by the SEC staff, which convinced the jury to announce the real story. 

Tuesday, July 30, 2013

From the Fed: Short Term Gain, Long Term Pain

As the Fed's ultra low interest rate policies grind on for a fifth year, we can see ever more clearly that there is no such thing as a free lunch, even when it comes to central bank policies.  The benefits of the Fed's low interest rate policies were easy to see at first:  cheap credit, stimulus to housing, a boost to the economy.  The costs didn't seem so great. 

However, by persistently favoring borrowers and heaping mulch on income-seeking investors for five years, the long term costs of the Fed's policies are emerging--and painfully so.  Detroit is in bankruptcy, and other cities teeter on the brink. Corporate defined benefit pension plans are becoming less common than the ivory-billed woodpecker. It's no wonder why.  Pension funds rely on safe long term investments that provide solid returns.  U.S. Treasury notes and bonds used to be crucially important components of pension fund portfolios.  AAA-rated corporates, which would have to pay slightly better than Treasuries, also were favored investments.  But pension plan returns came under stress as the returns on these low-risk investments nosedived.  And pension fund deficiencies, calculated on the basis of long term returns, balloon when returns fall.  Plan sponsors have to increase contributions--sometimes enormously--to keep the plans solvent.  Corporate executives intent on making the big score with their stock options see little upside to signing off on these contributions.  Shrinking cities like Detroit have little ability to make them.  Something has to give, and pensioners seem to be doing a lot of giving these days.  Detroit's problems go well beyond low long term interest rates.  But the city really didn't need the Fed to push it closer to the abyss. 

Neither did a lot of corporate employees whose retirements are less secure after losing their defined benefit pensions or seeing the plans capped.  Most people aren't skilled at managing their finances.  When fewer have defined benefit pensions, more are likely to end up with just Social Security, even if they start retirement with good-sized 401(k) account balances.  When people have fewer or no private resources, cutting benefits from the government becomes political anathema. 

Low interest rates hurt older folks in other ways.  As income from their interest-bearing investments dries up, fear drives them to become serial economizers.  That's a hard habit to break even after rates rise again (assuming they do).  Consumption may be impaired for a long time.  In addition, long term care insurance is getting scarce and expensive.  While poorly conceived estimates by insurers of the cost of care have much to do with that, the inability of insurers to obtain decent, safe returns on investments has added to the problem.  Fewer people are able to afford such policies.  So we have a ticking demographic time bomb, with lots of uninsured elderly likely to need Medicaid in a decade or two or three instead of being able to rely on their own resources.  Low interest rates are beneficial to the federal government's borrowing costs right now, keeping the budget deficit lower.  But positioning a lot of people to need Medicaid in decades to come means we'll have pressure toward an increased deficit in the long term.

 The Fed is taking a page from corporate America:  focus on short term returns at the risk of increasing long term costs.  The great corporate success stories don't follow this plot line.  But there's not much chance the narrative will change.  The Fed's easy money merry-go-round keeps the stock market buoyant.  With mid-term Congressional elections coming up next year, the Obama administration needs to keep the market feeling chipper.  Ultimately, everything in Washington happens for political reasons.  And politics dictates that Janet Yellen, a monetary dove, will be Obama's nominee as the next Chairman of the Fed.

Wednesday, July 24, 2013

Managing Personal Risk

Modern businesses put a lot of effort into managing risk.  They take risks, because that's how they might make big money.  But they also work to mitigate the downsides of their risks, because employee stock options don't pay off real well if the CEO, or someone or something else, blows up the business.

Individuals need to manage risk as well.  Bankruptcies most often result from unexpected problems, like a medical crisis or job loss.  If you don't deal with the ways that life can fall apart, the chances of your life fallling apart increase. The need to manage personal risk may be one of the most under-appreciated aspects of financial planning. While there's no perfect or complete way to analyze personal risk, here are some things to think about.

Age.  As you grow older, reduce risk.  If anything goes wrong, you will have less time to recover, and less ability to recover as your value in the labor force declines (and it eventually will).  There are variety of ways to reduce risk discussed below.  The important point is that as time passes and you accumulate more gray hair, reduce personal risk.

Occupation.  Your occupation can be a major risk factor.  Some types of work can't be performed by older people.  This would include construction, law enforcement, military service, fire fighting and other jobs that demand physical strength and endurance.  It could also include jobs that don't demand physical strength, but do require certain abilities that deteriorate with age, such as flying, working as an air traffic controller, or performing surgery.   If your job has a relatively limited time span, start building wealth at an early age and persist.  You may be able to have a second career when the first one ends.  But then again, maybe not.  Don't count on what's highly uncertain.  Assume your first occupation is all that you'll ever have and base your financial planning on it.

Employment stability.  If your job security is unstable, build up a large pool of savings to tide you over the rough spots.  A year's worth of living expenses, or more, in an emergency fund would be a good idea.  If you work in a boom-bust industry, like construction or oil and gas drilling, or an unpredictable job, like entertainment, your savings account is your best friend.  If you have to take on debts, or lose a car and/or house, because you didn't prepare for a layoff, your long term financial future may be cloudy.

Health.  Factor into your financial planning your health problems, especially any chronic ones you have.  There is no way to avoid having health problems, especially as you get older.  That's why having health insurance is so important--you will definitely use it.  Also have some savings available for health care expenses not covered by insurance--these expenses are one of the leading reasons for personal bankruptcy filings.  If your health is good, save plenty because you may need to finance a long life span. 

Debts.  Debts are one of the most dangerous risks.  Jobs may not be secure, but debts, once incurred, are a certainty.  If you're poor, but debt free, you won't end up in bankruptcy.  Poverty doesn't lead to bankruptcy; unmanageable debts do.  But debts are also one of the most controllable risks.  Avoid taking on debt unless it's really necessary.  Pay off debts as quickly as possible, especially as you get older.  A mortgage-free house is better than a sleeping pill.  There are some financial planners who will tell you to have a mortgage and invest your cash in stocks.  Well, if stocks maintained a nice, steady upward trend all the time, this might well be a smart move.  But if stocks are sometimes volatile--well, some people do manage to eat dog food.  Avoid debt and you avoid risk.

Moral and voluntary obligations.  Lots of people help their kids pay for college--and then help some more when the kids rebound home after graduating.  Many help their aged parents.  Quite a few help siblings, nieces, nephews, friends and so on when the going gets tough.  If you are likely to accept these obligations, manage your finances to be able to meet them.  Being nice can be a major financial risk factor. 

Riskiness of your assets.  This isn't quite the same as asset allocation.  This is preparing for things to go wrong with your choice of assets.  Don't think your allocation is necessarily right.  Almost no one predicted the financial crisis of 2008 and hundreds of millions of savers worldwide got a big tummy ache as a result.  If you really think that you and your financial planner have it all figured out, contact me about buying a very nice bridge in Brooklyn, and at a bargain price, too.

But back to the first point.  Stress test your investments (see  If you are uncomfortable with the potential losses you could incur, change your allocation.  Of course, no matter what you do, you'll end up with some kind of allocation.  The important thing is to end up with something that you can live with on good days and bad.  

Insurance.  Only Congress is less popular than insurance companies.  But having some insurance coverage is important to mitigating risks.  We've already covered health insurance.  Have homeowners or renter's coverage.  Maintain plenty of liability coverage on your auto policy, and buy an umbrella policy if you have a significant net worth.  Get disability coverage (first check to see what your employer offers, and supplement it if appropriate).  If you have dependents, like minor children, buy life insurance.  Think about long term care coverage if you have significant assets.  Granted, writing a check to an insurance company feels like eating sawdust.  But if life takes a u-turn, it's comforting to be able to forward the bill to an insurance company.

Boost your benefits.  Work as long as possible to build up your Social Security credits and any pension benefits for which you are eligible.  Okay, Congress, the White House, City Hall, the boss, or somebody is always threatening to trim or take away these benefits.  But they will very likely survive in one form or another, and you benefit from maximizing them because they may offer the best shelter available when cold economic winds blow.

Sunday, July 14, 2013

Is the Fed Losing Control?

In the past two weeks, we heard from Chairman Hyde and then Chairman Jekyll.  A couple of weeks ago, Ben Bernanke made allusions to gradually winding down the Fed's bond buying program, called quantitative easing.  Up to this point, the market had perceived the current round of QE as infinite, a perception that Fed had encouraged by placing no time limts on the program, and offering only the vaguest of guidance as to when QE might end.

But two weeks ago Chairman Hyde frowned and cleared his throat, and the bond bulls began running.  In their panic, they gored many an investor who had drank the Kool-aid however reluctantly and bought risk assets like long term Treasuries, corporate bonds and junk bonds.

Within days of Chairman Hyde's hint that the punch bowl might be taken away, the ten year Treasury note was yielding over 2.5% (up from 1.6% in May) and 30-year mortgages popped up about 1% to 4.5%.  Stocks quivered, but didn't belly flop like bonds.  Alarmed, various governors of the Fed and presidents of Federal Reserve Banks chimed in and suggested that the punch bowl wouldn't be withdrawn any time soon.  Stocks perked up, but bonds continued to pout and mortgage rates kept rising. This was emphatically not what the Fed wanted, since the Fed is resorting to its old trick of trying to revive the economy by bubbling up the housing market.  Even though this is what got us into trouble in 2007-08 with the mortgage crisis, the Fed evidently has an abiding faith in its old tricks.

With the housing rally now threatened, Chairman Jekyll spoke up this past Wednesday (July 10) and made nice nice.  The little toddler of a recovery would need propping up for a long time, he said, before he'd expect it to walk on its own--a very, very long time.  He also said he was sending the senior Fed staff out for a late night booze run to stoke up the punch bowl.

Stocks did a cheery little conga and stepped up to new heights.  This might produce a bit of a wealth effect to boost the economy.  But it will be hardly a smidgen, if the bond market doldrums continue. Bonds barely budged after Chairman Jekyll's attempted love fest.  The ten-year Treasury dallied briefly with the 2.53% level, but then went back up to 2.59%.  Mortgage rates continue to cloud the skies over the housing market. 

Is the Fed losing control?  This is really two questions.  What message is the Fed trying to send?  The most recent minutes it released indicate sharp divisions within the Open Market Committee, and the truth may be that a highly mixed message would be the most accurate.  Bernanke's initial statements two weeks ago may have been an attempt to be transparent and let the public know what the Committee really thinks.  But the Fed got what it perceived as an over-reaction from the market, and has been trying to cover its tracks ever since.

But did the Fed get an over-reaction, or an accurate reaction?  The sharp sell-off in bonds and rise in mortgage rates may have reflected the erstwhile rationality of betting on a continuing rally in fixed income.  Central banks worldwide have joined together and danced the most accommodative bunny hop in the history of banking.  Anyone who anticipated a reversion to the mean in the money markets has been just about rendered CIA-style. Much of the flash crash in the bond markets may have been hedge funds and other big players unwinding leveraged positions betting on more booze for the punch bowl.  Now that the Open Market Committee may be going wobbly on the idea of giving a drunk yet another pitcher of Martinis, bond pros evidently are becoming wary of the hair of the dog that just bit them.  If so, the Fed may have lost control of the long end of the yield curve.

If the Fed no longer has a clear message to send, and can't maneuver the long end of the yield curve any more, it may lose control of the economic recovery.  But perhaps it never really had that much control.  Maybe things looked good for a while because people wanted to believe, and the Fed provided the only federal economic policy they could believe in.  With Chairman Bernanke now a short timer, courtesy of President Obama, it's unclear what anyone can believe in.  And that won't be good for the market or the economy.

Wednesday, July 10, 2013

Regulatory Challenges of the Bond Market

The Great 2013 Bond Market Chain Saw Massacre has probably caused trillions of dollars of losses.  On May 1, 2013, the yield on the U.S. Treasury 10-year note went as low as 1.61%.  Since then, it has vaulted as high as 2.72% and most recently closed at 2.63%.  Such a jump in yields is, as kindergartners would put it, ginormous. 

The inverse math of the bond market would dictate that when yields jump this much this fast, the principal value of bonds will fall painfully and nasty losses will be incurred.  While precise numbers aren't readily available, losses in Treasuries may reach a trillion dollars.  And when you add in corporates, munis, junk bonds, and mortgage-backed securities, the losses could be multiple trillions.

The game of musical losses is now in progress.  Through short positions, derivatives contracts and other hedges, the losses are flowing through to wherever they will end up.  The challenge for regulators is to find out, and quickly, where that end will be.  What must be ascertained is whether the losses are spread out and landing in places where they can be absorbed without too much fuss.  Or whether the losses are concentrated somewhere and could have secondary and tertiary rippling effects (i.e., cause a run on one or a few major financial institution(s)).  Well within living memory (2008, to be exact), sharp losses in the mortgage markets triggered tsunamis in the financial markets that washed over Bear Stearns and Lehman Brothers, and threatened to wipe out AIG, Fannie Mae, Freddie Mac and Merrill Lynch.  Bailouts and regulator-encouraged acquisitions barely prevented an abrupt, loud, low-flow flush of the entire financial system.

Regulators should be proactively trying to pin down where the bond market losses will fall.  Complicating their task is the likelihood of speculators who used leverage to make derivatives bets on a fall in interest rates.  Since there is no prohibition on speculating with derivatives, as opposed to hedging, it is possible (and probable) that some players in the financial markets made such a bet.  That wouldn't be intrinsically different from the bet that John Paulson made in mortgages shortly before the mortgage crisis that sweetened his net worth by billions.  It's also not intrinsically different from the gold bets that John Paulson's gold fund has likely made, which reportedly has sustained losses in excess of 60% (ouch).  Any such speculative bets in the bond markets could exacerbate the game of musical losses, and make the regulators' tasks all the more difficult, since many of the speculators might be trading through entities chartered in off-shore locations that might frustrate U.S. government oversight.  But the Feds will have to do their best, because the alternative would be what happened in 2008, when they waited until things blew up and bailouts were just about the only option.

There's more.  The yield curve has been steepening during the last two months.  The short end remains squashed by the Fed's scorched earth policy on short term interest rates.  But the long end, as we noted above, has been rising meteorically.  This steepening makes attractive a type of carry trade.  It's possible to make a lot of money by borrowing short term and investing long term.  

Fed policy makes this carry trade all the more enticing.  The Fed's intent, as far as it can be discerned from the entrails currently visible, is to begin cutting down on bond purchases (i.e., QE) within months, but to keep short term rates at zero until unemployment reaches 6.5%.  Although employment has been rising, the unemployment rate has been static for several months.  While no one really knows when unemployment will reach 6.5%, it's not uncommon to read predictions of mid-2014 or so for that level to be acheived.  If so, the carry trade could be profitable for a while, especially if the Fed's reduction of bond purchases push long term yields even higher. 

To paraphrase P.T. Barnum, or Mark Twain, or somebody, there's a smarty pants who shows up in the financial markets every minute. Some--and perhaps many-- will surely indulge in this carry trade, most likely on a leveraged basis (because leverage boosts profits, assuming the trade works in your favor).  But if the unemployment rate unexpectedly drops quickly to 6.5%, the partakers of this carry trade might wonder if they aren't living in a septic tank. 

Either way, the regulators have to keep an eye out for the possibility of mounting risks from this sort of carry trade.  It could look like easy money to banks, hedge funds, insurance companies and other important players in the financial markets--after all, with the Federal Reserve at least momentarily anchoring their borrowing costs while pushing up their profits, the government is on their side.  But borrowing short to invest long is the E. coli that has poisoned many a would-be financial marvel.  Regulators need to be watchful not only for bond market losses from risks that have already materialized, but also for the growth of more risk from the changing landscape of the market.

Friday, June 28, 2013

Tale of the Magic Dragon

Betrayal.  The Vietnam War was full of betrayals.  And they didn't come from the enemy.   In Tale of the Magic Dragon, men who knew too much were sold out. 

Officially, the patrol never happened and nothing was said about the men left behind.  But former Green Beret Frank McTigue, a struggling private investigator, learns the truth when he agrees to protect pretty Lia, who had witnessed the murder of his former commanding officer.  A voice from the past dredges up unfinished business from his tour of duty in Southeast Asia. He can't let it go. Outnumbered and outgunned, he teams up with his Special Forces comrade at arms Odell Franklin.  They end up in a desperate fight where secrets are dear and lives are cheap--and find a glimmer of hope for redemption.

 Rated 5-Stars on Amazon and Barnes & Noble.

Available at

Available on Amazon at

At the iTunes bookstore at

At Barnes and Noble at

At Smashwords (for downloads onto laptops, tablets and similar devices) at

Also available at a number of other online booksellers; check your favorite one.

Friday, June 21, 2013

Why Did Obama Fire Bernanke?

Okay, President Obama didn't actually fire Federal Reserve Chairman Ben Bernanke.  But it felt like that when the President strongly hinted a couple of days ago that he wouldn't nominate Bernanke for re-appointment.  The stock market followed up with a two-day belly flop of almost 560 points.  Much of that drop was because the Fed announced that it would indeed, contrary to infantile market expectations, eventually take away the quantitative easing punchbowl.  But the backdrop to this announcement was Ben Bernanke's short remaining term as bartender-in-chief.  That creates enormous uncertainty.  The financial markets love Bernanke, even though not all market players will admit it publicly because he was a policy pragmatist (read heretic in the eyes of many purists).  He gave the markets lots of sweets and never let them pout or fuss for long.  He never met an asset class he didn't like and tried to puff them all up.  (That's why virtually all asset classes are dropping now--Sugar Daddy is leaving town.)  With Ben's helicopter thumping away toward the horizon, it gets a lot harder to predict what investments might have actual economic value, so investors renew their love affair with cash.

But why did Obama choose this moment to put Bernanke on the stagecoach going out of town?  Obama is no economist, so it couldn't have been for an economic reason.  The President is a consummate politician, though, so one has to entertain the sneaking suspicion that he did it for political reasons.  A not uncommon reason for pulling the rug out from underneath an incumbent is because you foresee the need to blame him or her for something.  Maybe the President was concerned that the eventual end of QE would cause the markets to fall, and he wanted to be able to blame Bernanke and say he didn't re-appoint him.  But the very act of leaving Bernanke behind in the dust aggravated into prophecy fulfillment the markets' inclination to swan dive.  So, if this was the President's thinking, he may have contributed to the problem he foresaw and could end up taking some of the blame for the market's hissy fit.

The President is having second-term hiccups in a variety of ways--the IRS, NSA, State Dept., and DOJ come to mind.  Is he losing his grip?  Bernanke was the last man standing when it came to federal officials doing something to boost the economic recovery.  Why ax the most highly regarded civil servant in the country?

The financial markets hate uncertainty.  And they've gotten a belly full of it recently.  That's why the last two days have been bad for 401(k) accounts from sea to shining sea.  And the picture probably won't get brighter for months.

Sunday, June 16, 2013

How to Improve NSA Surveillance

Despite the uproar, there's little chance of changing the scope and extent of NSA surveillance of Americans.  No politician wants to be blamed if there's another Boston Marathon-type bombing.  So they'll hide behind the usual gridlock and do nothing. 

That being the case, we might as well make the most of NSA's surveillance.  After all, it's being done on the taxpayer's dime, and taxpayers ought to get their money's worth.  Here are some ways NSA can make 'round the clock surveillance a better experience for all of us.

Package Delivery.  Since NSA knows where you are at all times, it could run a great delivery service.  Let's say you're on the road and forgot to bring your cellphone recharger.  An NSA courier could be dispatched with a new recharger in a flash.  And they'd want to make this delivery.  After all, it's harder to keep track of you if your cell phone battery is dead. 

And if you're traveling with a small child and need is a package of disposable diapers and some wipes, NSA could deliver them for a modest fee, even to the highway rest stop where you discovered what you forgot to pack.  This would not only please many a distressed parental taxpayer, it would also give NSA a stream of fee revenue that could supplement its multi-billion dollar budget. 

Chatline.  There are many lonely people, and NSA may be among the few that care to listen in on their phone calls.  Perhaps NSA could operate chatlines, to help the lonely find companionship.  Maybe NSA will get lucky and a frustrated terrorist will unburden himself on a chatline, confessing to having fantasies about pressure cookers. 

Dating Service.  If you're single, NSA already knows how bad your personal life is.  They know everything about you--and everyone else.  Since they know so much, they might as well operate a dating service.  With all that they know, they should be able to find the perfect match for you in only three nanoseconds of processing time on their massive supercomputers.

Grocery Shopping.  NSA could doing your grocery shopping and bill your bank account, all without you having to do more than tell them your grocery list.  You can pick up the phone and say what you need.  No need to dial because NSA's monitors will pick up your request anyway, and they can send one of their personnel to the supermarket.  Billing your bank account will be a breeze, since they already know the number and track everything that goes on in it.  Indeed, there's no reason for NSA to stop with groceries.  It could keep you well-stocked with beer and wine, pick up and return your dry cleaning, and arrange for pizza to be delivered in time for dinner.  You'd have to pay fees for these services, but think of the convenience.

Concierge Services.  There's more.  NSA could offer the full range of concierge services.  They could get you movie tickets, make dinner reservations, call cabs, send personnel out to be your personal shopper, and so on.  They already monitor your credit card and banking activity, so they know what movies you see, where you have dinner, and what your personal shopping consists of.  Might as well make the situation a win-win by offering citizens some conveniences now available mostly to the 1%.

Rebranding NSA.  NSA has an image problem.  It's portrayed by its detractors as an intrusive ogre that laughs derisively while steam rolling over civil liberties.  A common strategy in the business world for such a problem is to rebrand oneself.  NSA could leverage its massive knowledge of every intimate detail of your life by offering services like those described above, and change its name to, say, NSA Deluxe Lifestyle Services.  After all, nothing pleases citizens more than seeing government work for them.

Friday, June 7, 2013

The Good Deficit

You already know we're in Oz.  The government manages the federal deficit by making across the board cuts everyone thought would be so extreme that both Democrats and Republicans would work together to find a more rational solution.  Ha ha ha.  The joke's on us.  The government manages the debt ceiling by kicking the can down the road every few months.  The can is getting awfully dented.  And most tellingly, a surprisingly large number of the members of Congress bear a distinct resemblance to the flying monkeys in the movie.

But even as there were bad witches in the movie, there were also good witches.  There are good deficits as well.  Government spending for things that government is particularly good at is generally desirable, even if it requires deficit spending.  For example, government is good at national defense, education, law enforcement, and building or subsidizing transportation systems.  Government is also very good at funding basic research.  Deficit spending to pursue these goals is money well spent because it fills gaps that the private sector leaves open.  These kinds of spending protect and enhance the national wealth and welfare.

There's another problem that should be tackled, even if it requires deficit spending.  The unemployment rate for Gen Y (a/k/a the Millenials) is much too high.  It's generally about twice the level for Baby Boomers, and the less educated Millenials have even higher rates of unemployment.  Those that are African-American and lack college degrees need not apply, especially if they are male.  Large numbers of the better educated Millenials are burdened with heavy educational debts.  The ones with debts of $100,000 or more could face decades of 21st Century-style indentured servitude to their creditors, whose claims they cannot oust in bankruptcy proceedings except in extremely distressed circumstances. 

Millenials who are unemployed and underemployed represent wasted human capital. Modern economies are knowledge based, and human capital is the most important form of national wealth.  A vivid example of the overarching importance of human capital can be found in the aftermath of World War II.  Germany and Japan, the devastated losers (who deserved to lose), had only limited industrial capacity and not enough food to feed their populations.  But they also retained the advanced industrial knowledge they had acquired in building and supporting their massive and highly capable war machines.  Required by Allied occupation authorities to turn that knowledge to peaceful purposes, the two losing nations rebuilt their economies rapidly, and within three decades became industrial powerhouses.  Because they still had their human capital after the war, they could rebuild their tangible assets and prosper.

As a nation, we can't afford to let the human capital of Gen Y atrophy.  They are starting their working lives now, a crucial time for developing the skills of a self-supporting adult.  It's in your twenties and thirties that you learn how to apply all your book learning to the practical needs and purposes of the working world.  Learn those lessons well, and you'll be productive for 40 or more years.  Failing to learn them can result in permanent stunting of one's career.

Add a heavy load of school debt to the mix, and we can see how unemployed and underemployed Millenials could become a permanent economic underclass, unable to escape a shadow world of part-time jobs and episodic contract work, trailed by the baying of creditors hounding them at every turn. 

It's time to revive the Civilian Conservation Corps, 21st Century style.  The CCC of the 1930s employed some 3 million young Americans over the course of its decade of existence.  They were paid very modest wages, most of which were given to their parents (although the employees also received food and housing in addition to their pay).  They did mostly physical labor, as such work was integral to America's 1930s industrial economy.  The program was very popular with the American public, as it gave young people a chance to develop work skills and get a start in adult life.

A comparable program today could include jobs requiring manual labor.  America's highways, bridges and other infrastructure need a lot of maintenance.  America's cities need to be cleaned up, and abandoned buildings torn down, so that redevelopment can begin.  But there are many white collar jobs that need to be done as well.  Rural areas and inner cities lack physicians and other health care providers.  Many school districts are strapped for funding and need more teachers and staff for everything ranging from special education to music and drama.  Many jurisdictions have gravely inadequate funding for public defenders.  Criminal defendants, whom the law in its majesty presumes innocent until proven guilty, have little means to defend themselves and give their presumption of innocence tangible effect.  The poor need legal services for civil matters as well, such as battling indifferent landlords.  The list could go on.

CCC-21st Century jobs should be real jobs, not make work.  We can't ask taxpayers to pay people to dig holes and fill them up.  The pay should be low, because these aren't meant to be career jobs.  They are a way to give young people a start.  Part of the compensation should include generous provisions for government assistance in repaying school debt.  In effect, the government would help young people offload their school debt so they can get a fresh start in life.  Yes, yes, yes, there are countervailing considerations about holding people responsible for their debts and not bailing people out, etc., etc.  But we let egregious spendthrifts stiff their creditors for non-education debt as a matter of course in bankruptcy.  And we bail out really large financial institutions run by millionaire executives.  The burden of educational debt is getting to be too much.  As some guy put it about 400 years ago, the quality of mercy is not strained.  Let's be realistic instead of Puritanically moralistic.

Those CCC-21st Century employees who haven't gone to college could be compensated with the right to educational subsidies, akin to the GI Bill.  These young people could then go to college with less need for debt.  Their human capital would be enriched.

This isn't a perfect solution, and won't solve all the problems of Gen Y.  But it would give many of them a start.  And that's what they need.  Deficit spending for another CCC would be money well-spent.  The private sector isn't helping these people.  Government action is the only alternative.  We don't need more stimulus in the form of Federal Reserve money printing.  We could benefit greatly from stimulus in the form of deficit spending invested in our young adults.

Sunday, May 26, 2013

How Government Inflation Policies Would Smack the Middle Class

The federal government proposes to use inflation to smack the middle class.  The Federal Reserve has an inflation target of 2%, and some Fed officials, fearing that deflation is around the corner--have recently been openly grousing about how inflation--running just above 1%--is too low.  They want to take away your spending power faster.  One of their primary tools for fueling inflation is to obliterate positive interest rates--or, stated otherwise, to deprive you of interest income.  Your faint memories of the distant past, when interest income actually required you to fill out Schedule B for your tax return, will become entirely ethereal.

Meanwhile, the Obama administration has proposed to use a less generous inflation adjustment (the Chained CPI) for Social Security recipients and federal and military retirees.  The Chained CPI would also be used to adjust tax brackets, with the effect that taxes would be higher than under the currently used CPI.  In other words, the Fed wants to increase inflation, while the President wants less protection for retirees and taxpayers from the ravages of inflation. 

Those whose incomes are middle class or lower (i.e., $100,000 a year or less) tend to be vulnerable to inflation.  They have little discretionary income left after necessary monthly expenses, and consequently, not much of a buffer against increases in inflation.  Retirees are especially defenseless.  Add the heavier taxes resulting from the Chained CPI, and the federal government's inflation policies could effectively reduce middle class and retiree incomes in real terms.

With the sluggish U.S. economy 70% dependent on consumption, it makes no sense for the federal government to deploy inflation as a weapon against those with middle class or lower incomes.  Reduce incomes and people will consume less.  If these federal policies somehow stimulate greater economic growth, it isn't hard to figure who will benefit the most from that greater growth, and it ain't gonna be the lowest 80%. 

The Chained CPI hasn't become law yet, and not all Fed officials want to ignite inflation.  So the worst may not come to pass.  But the lowest 80%, already facing uncertain employment prospects and stagnant wages, really don't need to be squeezed by inflation policies that make sense only to those well-to-do people who are insulated from their impacts.

Saturday, May 18, 2013

News Flash: Republicans Don't Like Profiling

Well, it appears that Republicans don't like profiling after all.  At least, not when Tea Partiers are profiled by the IRS.  When the targets of profiling are black or Muslim, well . . . . 

Of course, the IRS should not have profiled Tea Partiers.  As liberals have been saying for decades, profiling is unfair and illegal.  But the level of outrage emanating from the right is pathetic, at best.  Profiling is all too common, and we shouldn't get any more outraged over the IRS's profiling of Tea Partiers than we do over the profiling of blacks, Muslims and other people.  Finding a conservative commentator who'd agree with this point would take longer than the IRS took to process Tea Party nonprofit applications.  And that's the problem with political discourse these days.  The point of view too often taken is "If it hurts me, it's bad.  If it hurts people I don't like or don't care about, it's okay."  Profiling is unprincipled.  But so are way too many participants in today's political mosh pit.

Wednesday, May 15, 2013

Beware of Overpriced Assets

The delirious exuberance of stocks today is reminiscent of the stock market just before its earlier peaks in March and April 2000, and in the fall of 2007.  Prices move up in defiance of risks and uncertainties.  Stock indices set records every week.  Bulls overrun the markets.  Bears have become a seriously endangered species.

Even as financial messiahs proclaim a brave new market in spite of the stumbling economic recovery in America and recession in the rest of the industrialized world, let us recall the sources of the last two market busts:  highly overpriced assets.  In the late 1990s, the bubble was in tech stocks.  In 2007-08, housing and real estate mortgages were grossly overpriced.  In both instances, the sheer quantity of inflated assets ensured that when the markets turned, losses would be enormous.  Given the dazzling rise of stocks over the past few years, it behooves us to ask if there is a comparable risk today?

The answer would appear to be yes.  Investors have poured vast amounts of money into bonds of every stripe and variety.  Bond valuations, even of junk bonds, have reached highly optimistic levels.  Bonds are priced for perfection.  If any imperfection appears, losses--and a lot of them--will follow.

The most obvious risk to bondholders is that the Federal Reserve and other central banks will step back from the extremely accommodative policies they have instituted.  This will happen sooner or later, probably sooner in America and later in Europe and Japan.  When it does, bondholders will incur losses, and those losses will be big simply because of the huge amounts of money that have flowed into bonds. 

The Fed seems to think it can manage the process of shifting from quantitative easing to unwinding its $3 trillion plus balance sheet (i.e., quantitative tightening).  Perhaps it can do so without causing severe short-term turmoil in the markets.  But it can't circumvent a basic problem:  when interest rates rise and bond prices fall, a lot of losses will be incurred.  These losses must land somewhere.  They might be shifted from one investor to another by means of derivatives and other hedges.  But someone, ultimately, has to take the loss. 

The fact that losses in the financial markets have to land on someone somewhere wreaked havoc on the world's major economies following the real estate crash of 2007-08.  Investors around the globe who bought mortgage-backed securities, CDOs, CDOs squared, and other such financial alchemy paid the price for drinking too much of the Kool-Aid du jour.  We live with the resulting economic pain even to this day.

The bond markets are like a coiled spring that presents a similar problem. Extremely high prices have been paid for bonds, and bondholders face serious risk of losses when rates rise.  The sheer quantity of potential losses is the scary thing.  Those losses will have to land on someone, somewhere, and that will be painful.  The Fed's quantitative easing program has only exacerbated the risks, and the Fed's near term success in preventing depression has burnished its image of competence, which may have blinded bond investors to the dangers of the market downturn that must take place eventually.  As history repeatedly has demonstrated, the Fed is fallible and its fallibility is accompanied by serious consequences for the financial markets and the economy.

By promoting ultra low interest rates for five years, the Fed has allowed a massive build-up of investment in overpriced bonds.  While central bank intervention in a crisis is to be applauded, a years-long distortion of market forces will surely do bad things, and bad things have been done.  The only question now is when and how we will suffer the consequences.