Corona Virus: May 2

Not much new.  Henderson County continues to see outbreaks at senior housing.  I am beginning to think we made the wrong decision re testing when it was (and probably still is) limited.  What we could have done was that if someone was symptomatic and had none of the risk factors they should not have been tested.  They should have been told to assume they were positive and act accordingly.

Instead we should have pro-actively tested all of the staff in senior housing along with random testing of the seniors.

For most folks who are positive there is no reason to get any health care.  Most will recover with or without seeing a doctor or going to a hospital.  Some will die with or without health care.

Data points

- Overall US cases remain flat.  No sign of either a spike or the downhill slope.  Doesn't look like we are any where near stressing health care capacity (see above).

- NC continues to be under stay at home orders.  Number of cases continue to increase linearly (not exponentially).

- GA relaxed stay at home orders and there trend line is down.  That is if you believe their numbers.

- HVL had a spike this week

I did some bargain hunting last week.  Purchased F.  Risky but seems like there is more upside than downside.  My other buy of SBUX has worked at well.

Daily life

- Yard work
- Walks at Kellogg
- Watch 2 hours of TV at night (This is Us and Little Fires Everywhere)
- Reading The Civil War
- Using the stationary bike while watching The Last Dance
- Listening to the 2008 Spong lecture
- Listening to Bloomberg Surveillance podcast
- Watching the great courses lecture on Modern Political Tradition
- Reading Sherlock Holmes to Karel at bed time.
- Trying to catch up on the Economist.

Corona Virus: April 23

Earlier this week our neighboring states of TN, SC and GA announced they would ease "stay-at-home" orders.  This led to a long email thread where someone I know predicted doom and gloom, the end of the world as we know it.

I remain solidly in the middle.  Every day there are new data some positive, some negative.

Another 4 million joined the ranks of the unemployed.

The stock market moved sideways.

Congress is debating the fourth rescue package.

I'll stick with my prediction that we start easing here in WNC in mid-May, and with another prediction with much less conviction that we've seen the stock market bottom.

I'm bargain hunting tomorrow.

Corona Virus: Part 3

The date for easing restrictions here in North Carolina is coming into focus.  I am predicting May 15th.  I am assuming that over the next two weeks the we continue to see declines in the number of new cases, number of hospitalizations, and number of infected.  

We need additional data on the number of hospitalizations,  capacity of health care system and data on test kits.  How many test kits will be needed vs. availability.  Very little data on these as of today.

There is growing pressure to ease restrictions earlier.  If that happens we plan to maintain our stay-at-home until May 15th regardless.

I have goals for our isolation time:

- finish Shelby Foote's The Civil War.  Just started the fourth volume.
- finish the Great Course on Modern Political Theory
- finish the Spong lecture
- catch up on back issues of the Economist
- catch up on back issues of Foreign Affairs
- complete all spring yard work; all leaves mulched, all limbs collected and burned
- maintain weight at 160 or less

Corona Virus: Part 2

I am now getting a sense of the framework for the conditions that must be satisficed to end the stay-at-home orders.

Three assumptions:
a) No effective treatment is discovered
b) Stay-at-home orders will be ended either at the state or local level - not national.
c) Even after stay-at-home orders are ended there still will be restrictions and limitations.

1)  The health system must be able to handle new cases with normal resources, i.e. a non-emergency basis.  For example, the health system must be able to handle non-emergency surgeries, normal cases loads, etc. without the need of staff working overtime.

2) The state or locality must have the resources for "test and trace".  Anyone who is symptomatic must have access to a test.  The state or locality must have a system in place to identify and notify those who have a high probability of being in contact with anyone who has tested positive.

Corona Virus: April 10

I will try to capture my thoughts on a regular basis.  I'm curious to see how my perspective changes as the pandemic evolves.  I regularly follow the economic and financial market news so I want to see how my understanding of that evolves as well.

Seems to me the best way to start is to think about the various models.  In economics as well as in markets experts are called upon to make predictions about economic factors like GDP, unemployment, inflation, etc.  In financial markets the predictions are about the equity markets, interest rates, corporate profits, stock multiples, etc.

The pandemic models try to predict both number of folks infected and number of deaths.

What all these models have in common is that they are usually represented as a cartesian graph where the X-axis is time.

The dependency seems to be; the health care/pandemic model which will determine the economic model which in turn will determine the financial market model.   The unknown is all of these cases is the X-axis.  My current understanding is that the longer the pandemic model stretches out the greater the impact to the economy and hence the market.  The best case scenario is that the stay-at-home orders begin to ease in early May.  This is based on the expectation that the pandemic will peak in the US within a week - say by April 15th.

What remains undetermined is that are the other conditions that need to be satisfied before work can resume.   I am making the assumption that no treatment is found in April.

Here's the current status:
- number of new cases is 30,000/day
- number of deaths is over 1,000/day

I would think that we would need to see the numbers reduced to something like <1000 new cases and < 100 deaths with many states at zero for both.

The second condition would be the availability of mass testing capability.

A few words about the economy.  Over the last 3 weeks 15,000,000 people have filed for unemployment.  Current estimates are that we will get to 15% unemployment rate by end of April.  The other current assumption is that a return to work will be gradual.  Some industries especially travel and leisure may remain at low level of employment for months.  No one knows how consumer behavior will change once the stay-at-home order is rescinded.  Putting people back to work impacts the supply side but the consumer demand side is unknown and unpredictable.

All this leads to is market uncertainty.  I am looking at opportunities to increase my equity holdings and scale back my bond holdings but right now there are too many unknowns.  The biggest unknown is the X-axis.

Part 1: Personal Finance

If your goal is simply financial security or financial abundance in retirement the most important thing is not how you invest your savings. 

The main idea is to spend less than you make while you are working.  Once you make that a habit then the rest is easy. You do not need to know much about investments to achieve financial security. 

If you spend less than you make you allocate your savings according to the following priorities.

1. Pay down all credit card, installment credit.  Home mortgages are okay.  Car payments should be avoided but they are also okay.  Lease payments are no good. 
2. Put aside some money for a rainy day fund.  If you are starting out it can be as little as $1000.  The rainy day fund should be liquid - meaning bank account, money market or a bank CD.
3. If you have a 401K save at least up to your companies match.  In fact if your company has a match this might move up to #2 in priority.
4. If you've achieved 1 through 3 then you can either add to your rainy day fund.  The amount you add depends on your job security.  If you're confident in your job situation enough money to cover 3 months of unemployment should be sufficient.
5. If you get this far you now should add to your 401K to the max allowed even if there is no match form your company.
6. If you still have surplus then invest in a non-retirement account. Open up a brokerage account at Vanguard or a discount broker.  I'll cover how to invest in the next post.

That's about it.  As long as you spend less than you make you'll be adding to your savings each month.  

Recap and restart

It's been a long time since the last post.  Time to restart a new set of posts on personal finance, markets, investments and economics.  But before I begin I need to do a short recap.

The last post was about the Fiscal Cliff of 2012.  Pres. Obama was finally able to get the GOP to increase taxes on the wealthy.  The Bush tax cuts on the wealthiest families did expire. 

Over the next 4 years there was little fiscal policy to help the economy.  The Fed kept interest rates at 0 until Dec 2015 and then raised it a mere 25 basis points.  The inertia of the fiscal policies including the 2012 changes were enough to keep both the economy as a whole and the labor market in particular on a path to steady improvement.  But Dec 2016 the unemployment rate was 4.6 and wages were growing.

Obama was content not to avoid the big mistakes.  With the help of the Senate Dems the GOP was prevented from screwing things up.   Obamacare started to kick in and as predicted by some was actually a boon to the labor market.  Folks now were in a better position to change jobs.

In addition the energy market improved dramatically.  The combination of increased US production, a slow down in the global economy and conservation and alternate energy policies all lead to the price of oil/gas tumbling in 2015/2016.

By the end of Obama's second term:
- stock market up
- unemployment down
- wages up
- interest rates low
- inflation under 2%
- gas prices about 2.50 gallon

My hope is that now that the GOP 'controls' the federal government they don't screw things up.  There is hope that the GOP will remain divided between the fiscal hawks and traditional conservatives and Trump who is neither.

Fiscal Cliff - part 2

The year end deadline only produced 3 of my optimistic outcomes.

1. Increase marginal tax rates for the wealthy
2. End payroll tax holiday
3. Fund extended unemployment

The good news is that the tax revenues were increased without any reduction in spending.  The bad news is that the debt ceiling was not increased.

There now are two more deadlines and it is not clear where the bargaining leverage is.

One the spending side especially with respect to the sequester across the board cuts that were part of the 2011 budget deal I think Pres. Obama has the leverage.  He does not need to accept any spending cuts that will specifically hurt the economy or the working and middle classes.  He can negotiate for a balanced set of spending cuts and/or additional revenue through closing tax loopholes for the wealthy and for large corporations.   I don't see that he needs to put Medicare, Medicaid or SSN on the table for this next round.  I believe the target debt reduction for the sequestering cuts is 600 billion over 10 years.  That should be achievable without touching the "entitlement" programs.

The debt ceiling is another matter.  Not sure who has the leverage here.  Pres. Obama is correct that in that Congress should pass a "clean" debt ceiling extension.  If he allows Congress to negotiate terms for this it will not only hurt the economy it will hurt the office of the Presidency.  I think Presidents in their second term begin to think more and more about their personal legacy and about protecting the integrity of the office.

Will big business pressure the GOP to pass a clean bill?

Will the Democrats negotiate with the GOP to pass a debt ceiling bill along with some concessions?

Will the GOP not pass a clean bill and force a government shut down?

Anything but a clean bill is very bad for the economy.  Some of the other outcomes could be disastrous for the world economy.  
 

Hopeful prediction on the fiscal cliff

Here's an optimistic prediction

1. Raise Income Tax rates on those making more than $250,000 in taxable income
2. Eliminate or reduce Payroll Tax Holiday
3. Reduce defense spending
4. Reduce discretionary domestic spending (these last two in equal parts)
5. Raise the debt ceiling
6. Eliminate or reduce extended unemployment benefits
7. Agree on a framework for broader, longer term fiscal remedies which would include
• reduction on tax "spending" (special deductions or loopholes),
• further reduction on defense spending
• Medicare and Medicaid program cuts

Points 1-6 would deal with the tactical issues related to the expiration of the Bush era tax cuts and automatic sequestering.

Point 7 would be some loose agreement in principle to deal with the longer term fiscal issue.

If this is accomplished the economy will continue to grow albeit slowly in 2013.  Contrary to Speaker Boehner's ideas raising taxes on the wealthy in order to do lower the debt and fund some critical spending will create jobs.

Gini coefficient

I just finished reading a special report in the Economist on the trajectory of wealth and income distribution on a global basis.  The data show that the US has become more and more unequal primarily at the top 1% and the top 0.01%.  The US social safety net ensures the poor haven't lost as much ground as the lower middle class.  Those folks without a good education are steadily losing ground.   The broad trends of globalization and automation are key drivers behind this trend.  I have discussed these here before.

In addition to those broad trends that impact all low skilled workers in the developed world, in the US we have two additional factors, one social factor and one government policy.   The social factor is that more and more working class children live in one parent households and with that comes a slew of educational and development disadvantages. The government policy issue is that the US spends much less on the poor  as a percentage of  GDP - especially in education - than most development nations.

One of the conclusions of the Economist is that as income and wealth inequalities become too extreme than the nation's overall growth and prosperity will suffer.  Ironically this essentially is in agreement with the socialist perspective.

So this all reinforces my thesis that the government policy that promotes even modest  wealth and income "redistribution" will be a  job creation policy.  

The Presidential election debates had little substance.  But it seems to me that Gov. Romney ran on  decreasing income tax rates across the board while Pres. Obama has now run two victorious national campaigns on the policy of increasing tax rates for those making more than $250,000 or more in taxable income.

Let's see if Pres. Obama holds firm.  I don't think it will make much difference but at least it would be a step in the right direction.

Income inequality and jobs

Once again it's been a few months since I last posted. As expected the macro-economic situation has changed very little in that time. At the outset of the financial crisis I predicted that the job recovery would be very slow and that an unemployment rate over 8% may last a decade.

Nothing has happened in the last four years to change my view on that. Yesterday we had the US jobs report for July. More jobs were added again but once again not enough. Unemployment went up a tick to 8.3%. Even if job growth rises to 250,000 jobs per month, the unemployment rate could still be 8% or more. There are plenty of sources that describe how the official unemployment rate is misleadingly low so I won't go into that here.

This post is about how income and wealth inequality eventually result in economic stagnation and unemployment. My primary source is The Great Financial Crisis: Causes and Consequences. Unlike many of the books written about the bubble and meltdown this book focused less on the proximate causes and much more on a long term view. 

Here's that view.

Over the long term capital (wealth) will become more and concentrated.  The growth of the middle class in the US after WWII and subsequently in the other industrialized nations was an aberration.  This historical anomaly lead to economic growth in all of these countries.  Starting around 1980 the situation began to revert to its historical norm - which is concentration of wealth which leads to stagnation.

The data is somewhat misleading because of the bubbles and one time conditions.  In the late 80's and early 90's there was a peace dividend as the cold was ended.  The dividend was physological as well as fiscal.  This was followed in the next 15 years by two bubbles in the US that temporarily produced unstainable GDP growth and unstainable employment levels. After the financial crisis and "recovery" we are back on our path to long term stagnation.

The reason that concentration of wealth and income leads to stagnation is straight-forward.  Wealthy individuals spend less of their income and save and invest more of it.  If there are no investment opportunities in industrial or commercial investments then capital flows to financial assets or even bubbles.  We know how that story ended last time.  Low and middle income workers on the other hand spend more of their income which leads to more economic activity and possibly more jobs.  Remember though that globalization and automation still play a drag on job formation.

The evidence that there is a surplus of capital is all around.  Investments in money market or savings accounts pay less interest than the currently modest inflation rate.  Capital in these asset classes are 100% guaranteed to lose purchasing power.  10 Year US Treasuries are yielding less than 1.5%.  Unless there is a deflationary cycle the massive investments in US Treasuries will also lose purchasing power over the life of the investment.

Why then has capital not flowed into commercial and industrial assets?  Businesses invest capital for only one reason - maintain or grow income.  Investments can do this in two ways, increase revenue or decrease costs.  In a slow growth and low inflationary cycle it is hard to increase revenue by simply raising prices. The other option is to sell more goods and services.  But once again we get back to low overall demand due to sluggish consumer spending.  The second investment opportunity is to lower costs.   These opportunities do not depend on demand; innovation, application of new technology, or simply moving production to lower labor costs are all effective ways to invest.  Unfortunately the cost-saving investments may lead to more unemployment not less.

Additionally the large US corporations have generated so much cash that many do not need outside capital for their investments.  Instead they are contributors to the excess capital conditions we have today.  They form part of the Giant Pool of Money and contribute to the concentration of capital into fewer hands.

So here we are and here we will stay.

As long as politicians, pundits and policy makers insist that higher taxes on high income individuals will cost jobs here we will stay.  As long as politicians, pundits and policy makers propose government austerity here we will stay.

I am not sure there is a solution.  The best try would be to significantly increase taxes on high income individuals, increase taxes on the upper middle class, eliminate tax loopholes, allow corporations to treat dividends as a business expense and at the some time tax personal interest and dividend as wages - including the payroll taxes of Social Security and Medicare.  The government then has to use that additional revenue to actually create jobs by the most direct and cost-effective means - hire people.

Right now we need more public sector jobs - teachers, fireman, librarians, construction and maintenance workers, and yes - regulators.

Greece: How to leave the Euro

The giant credit bubble spilled over to Greece with the help of Goldman Sachs and a whole host of commercial banks in Europe. Greece was able to borrow way more than they will be able to repay. The private lenders have taken a hair cut already which is fair since they made the bad lending decisions. However the austerity program forced on Greece by the IMF and the EEU has, of course, led to a recession. The drastic cuts in government spending caused the recession as predicted by Keynesian economics.

So Greece will still be unable to pay down its existing debt or to borrow more money.

The typical long term solution is to devalue the currency. Imports become more expensive. Consumers suffer an immediate hit on their standard of living. Usually you would expect a steep decline in the units of imported goods especially any discretionary consumer goods. On the other hand exports become cheaper. For Greece, olive oil, wine, cheese become cheaper in the world markets which can increase demand and help grow all export industries. Tourism is an a sense a service industry export and for Greece a significant one. Presumably services purchased as part of the tourism industtry - hotels, restaurants, events, guides, transportation become cheaper for the foreigner visitor. After devaluation Greece could become a very, very popular destination.

The problemis of course that Greece does not have its own currency.

So how does it get there.

All bank deposits need to be converted from Euros to drachmas. All goods and services are prices in drachmas. Day One - it is a one-to-one conversion. After one month - Euro currency is no longer accepted. After a few months the drachma is devalued so that one drachma equals 0.7 Euros. All bank deposits and all Drachma in currency now have lost 25% of their purchasing power. The Greek government is now able to issue new bonds in Drachma and have the central bank buy them - essentially printing money. Inflation would probably be in double digits but now the economy is growing again. Through economic growth, slow reduction in government spending and inflation Greece will be able to balance its budget and pay down its debt.

Greece will simply default on their existing Euro bonds.

This is the scenario worked out over time by many other countries. The savers and investors take a big hit. The bond holders take a hit. Consumers take a hit. Private borrowers may get a break.

The unique challenges for Greece is that bank deposits can be moved to other countries. Why would anyone leave their Euro deposits in a Greek bank and subject themselves to this devaluation. No one will. That's why when this is done it has to be done "overnight" even if "ovrrnight" means a one week bank holiday to allow the banks to fix their bank deposit accouting and payment systems.

The run on Greek banks has already started. With the massive withdrawals already undeway most Greek banks are insolvent. The government will likely need to nationalize the banks for some time.

Bubble and Meltdown - Jobs again

I haven't added to this thread in awhile but nothing much has changed so I can pick up where I left off. We are back in an election cycle so the conversation about policy is pretty much over. For the next 11 months the conversation will be about politics and personality not policy.

Much of the political discourse on jobs and the economy is not focused on what is actually happening.

1) US jobs are being lost due to automation and globalization. Nothing can stop this trend.
2) The largest percentage of US GDP is consumer spending. It is about 70% and it is growing very, very slowly.
3) Businesses do not need tax breaks to create jobs they need demand for their products and services.
4) The biggest uncertainty that businesses faces is not tax policy or the health care insurance reform. The biggest uncertainty is whether there will be demand for their products and services. On the global basis the biggest threat to demand is the Euro crisis. European governments are adopting "fiscal reforms" and "austerity budgets" that will likely result in a recession in Europe in 2012.
5) US consumer spending can only increase on a sustainable basis when personal income increases. The credit bubble allowed consumer spending to increase but spending more than you earn is not sustainable.
6) Accumulation of wealth and income in the US hampers job growth.
7) The conversation about the POTUS "managing the economy" or "creating jobs" is surrealistic. The federal government is powerless to do either one.

So what it the way forward?

A slow recovery. Eventually consumer spending will increase as people who work continue to first pay down their debt and then slowly increase spending. I expect unemployment to be over 8% for years and years.

The US fiscal problem will eventually be sorted out by:
- increasing taxes especially on the affluent
- inflation
- massive cuts on defense spending
- reducing health care costs by expanding on the health care reforms already passed
- economic growth

This will all take time.

Bubble and Meltdown - Jobs, Jobs, Jobs

I have been meaning to write this for sometime. One of the most underreported aspects of the American economy is the loss of jobs and the decrease in middle class wealth and income. These are long term issues that preceded the bubble and still exist today.

Let's start with the loss of jobs. The reasons are obvious. Technology and globalization. It would be possible to write an entire book about how technology in the long term eliminates jobs. Some argue that technology increases productivity and therefore wealth and income and it has from time to time and in some parts of the economy. But the long term trend is inescapable. From small manufacturers, to farming, to large scale agriculture, and now to services.

The impact on globalization on US jobs is obvious to us all. Impacts started with manufacturing and have extended to low value services and now extends to professional services such as accounting and computer science.

Next combine the loss of jobs with loss of wealth and income for the middle class. The main drivers of this are also long term. First the competition for jobs due to job scarcity drives wages down. The reduction of the power of organized labor has hurt all US workers. Some claim that the unions were too powerful but that was clearly not the case. The unions never had that much power. But while they were viable they supported wages and benefit levels for non-union workers. Almost all gone now.

All of this would eventually lead to a reduction of consumer spending. This was avoided for awhile. First wives entered the work force in the 70s and 80s. In the 90's there actually was a peace dividend and the subsequent economic growth and asset appreciation (housing and stock market) supported consumer spending.

By 2000 all of these short term influences had been spent. Jobs were still being lost and wealth and income was beginning to become concentrated. But we had two bubbles in the 2000's that disguised the longer term trends. After the Internet bubble we had a jobless recovery. We would likely have fallen into a long recession but then we had even a bigger bubble. The bubble was not just housing. It was an overall asset bubble, a credit bubble and a leverage bubble. All of this excess spending saved or created jobs.

Now that's over and the longer term trends have re-emerged.

I would not be surprised if the unemployment rate stays over 8% for 5 to 10 years.

I would not be surprised if we had a Depression with offical unemployment at 15%.

There are government policies that can improve this situation but they will seem so radical to the American voter that they will not have a chance for success until it gets much worse.

Macroeconomics - a political science

Before I continue on the remaining topics let's pause to talk about the field of macroeconomics. Macroeconomics is a political science. It is not a scientific body of knowledge where there are truths, facts, theorems, or problems with correct answers. It is a body of knowledge about values not truths and in this regard it is like other areas of philosophy such as morals and ethics. It is unlike related areas that are often lumped in with macroeconomics like microeconomics or finance which do contain certain facts, theorems and valid, proveable equations.

When you hear an pronouncement or opinion from an economist ask yourself whether the speaker acknowledges that their views or based on their values.

One tell-tale sign is their terminology. If the speaker talks about economic growth or GDP as the measure of a countries economic well-being then the speaker is likely a conservation economist. If the speaker talks about unemployment, poverty levels or middle class income as a measure of a nations well-being then the speaker is likely a liberal economist.

Since the two sides have basically different values they will measure the economy in different ways using different tools and different statistics. They can barely have a conversation since they don't see the world the same way at all.

Bubble and Meltdown - the agency problem

The agency problem was best explained in Stiglitz's book Freefall. In general the agency problem occurs when a economic player is making decisions with other people's money. The agent may not make the same choices as the priniipal who actually provides the money.

In the mortgage mess it seems that everyone was an agent.

• The buyer obtained 100% mortgages and therefore had little or no money at risk.
• The mortgage broker sold the mortgage to a Wall St. bank. Their risk was limited to the short time they held the mortgage.
• The Wall St. bank combined the mortgage into securities and sold the securities. Their risk was limited to the short time they held the mortgage.
• The rating agencies had no money at risk.
• Often the buyers were fund managers, pension fund managers, bond fund managers, hedge funds, etc. They had little or none of their own money at risk. In fact some of the bond fund managers were obligated to buy high yield bonds.

The "invisible hand" of Adam Smith assumes that prices are set by the market forces of supply and demand. There are free market fundamentalists that still believe that this "invisible hand" actually works to set prices so that supply and demand reach equilibrium. And this does work fairly well for consumer commodity products and services.

But it assumes that the buyers and sellers are rational actors, they are making rational decisions in their own best interest and that they both buyers and sellers have the same information. The agency problem is that if the buyers and sellers are agents and are not making decisions in the interest of the real buyer or real seller then the invisible hand simply isn't there. This is only one problem with the invisible hand. There are others which we may get to.

Contrast the players involved with the housing and credit bubble with the Bailey Savings and Loan system. In this system a local bank lent money to a developer - as a construction loan. Some of the money came from their depositors but some of the money was the bank's own money. The ratio between the depositors money at risk and the bank's own capital is leverage and the leverage was probably around 10 to 1. The banker would make the construction loan based onthe developer's past performance, their credit worthiness and the bank's assessment that the housing that was built could be sold. The developer had to put some of their money at risk as well.

When the contruction was complete the developer would sell the homes. The home buyers would get mortgages from the same bank. The bank would assess the value of the house, the credit worthiness of the buyer and would expect the buyer to put some money at risk - at least 20%. The homes are sold and the construction loan is repaid.

The banks hold the mortgage, collect fees and interest and pass on some of the interest (always at a lower rate) to their depositors. The difference in the interest rates results in profits to the bank less reserves for the possibility of some defaults. But even in the case of default the bank is protected since they assessed the value of the house and the buyer had 20% of their money in the house. Only if the value of the house decreased more than 20% was the bank at risk.

Now compare that simple model with the model used during the credit and housing bubble.

Since most of the players were agents and not principals they due diligence of assessing the overall housing market, the specific home assessment, and the credit worthiness of the buyer, the developed, the mortgage broker and the Wall St. bank were all neglected.

The buyer borrowed money from the mortgage broker.

The mortgage broker borrowed money from the Wall St. bank. They paid the money back when they sold the mortgage to the Wall. St. bank.

The Wall St. bank borrowed money from institutional investors and the ratio of money at risk to their own capital wasn't 10-1 it was 35 or 40-1. They paid the money back when the sold the mortgage securities to their investors.

And the agents became rich by paying themselves large salaries and bonuses while they put their corporations and the shareholders - the real principals at risk.

So when it all fell apart the shareholders or Countrywide Financial, Citigroup, Lehman Bros, Bear Stearns, Bank of America all went south but the executives walked away with their bonuses intact.

Bubble and Meltdown - part 2

Been away for a couple of weeks. Before I move on to the other topics one more thought on the Giant Pool of Money.

One of the reasons given for a government policy of fiscal restraint is that huge government borrowing will "crowd out" borrowing by business. The idea is that as the deficit and national debt grows the US goverment will have to issue more and more T-Bills and Bonds and will soak up all available fixed income investment money. Over time the investors will require higher and higher interest rates not due to the risk of default but due to the risk of USD inflation. As the interest rate rises on US government bonds then it will also have to rise on all USD corporate bonds. USD corporate bond holders face the same risk of USD inflation plus the credit risk.

But after a decade of huge deficits it hasn't happened. Even before the meltdown US government bonds had low yields and after the bubble, the bail-outs, the 2010 stimulus and the 2011 tax deal 10 year bonds are currently yielding less than 4.00%.

Why?

I believe the answer may be the Giant Pool of Money. The supply of money available for fixed income investment continues to increase. The money is concentrated in foreign central banks, balance sheets of the largest corporations, US banks and the super-rich.

If interest rates on US government and investment grade USD corporate bonds stays low then this may be an indication that the Giant Pool of Money is a decisive factor. Stay tuned.

Bubble and Meltdown - chapter 1

Over the last year I have read 10+ books on the financial bubble and meltdown. Much of the story is well known but there are some aspects that I don't believe have received the attention they deserve.

Here are some under-reported aspects:
- The Giant Pool of Money
- The Agency problem
- How the bubble lead to misplacing of resources and lower rates of unemployment that were unsustainable
- How the wealth and income disparity leads to stagnation
- Repeal of Glass-Steagal
- Global imbalances in trade and savings

Let's start with the Giant Pool of Money. I can across this from a Podcast, This American Life, which is the number 1 podcast on Itunes. http://www.thisamericanlife.org/radio-archives/episode/355/The-Giant-Pool-of-Money. The basic idea is that there is a global Giant Pool of Money available for investing - much of it looking for fixed income investments, e.g. bonds. The Pool of Money is always increasing in the long term but in the years leading up to the bubble it really expanded. Part of this was due to the increased savings in Asia as millions of Chinese and Indian workers climbed out of poverty and saved a large percentage (at least compared to Americans) of their income. In addition the US trade deficit with China lead to the Chinese banks to accumulate billions in USD.

So we had a huge increase in money available for investing at a time when the fixed income investment of choice - US T-bills and Treasury notes had very low interest rates. So investment managers all over the world were looking for investments with a better rate of return and Wall St. invented new investments especially mortgage and asset backed securities that paid higher rates of interest. But even these new securites could not match the demand so Wall St. invented an alphabet soup of financial derivatives that we have all read about - CDO and CDS and then more deriviates based on the derivatives - synthetic CDOs.

We all know what happened next. In order to create more fixed income securities the mortgage brokers made very bad loans. They borrowed money from Wall St. to make the loans but then sold the mortgages back to Wall Street where they were packaged into asset backed securities and sold to global investors. Why did these supposedly well-informed investors buy securities that consisted of bad loans? One, they were rated AAA by the ratings agencies. Two, the feeling was that even if the loans went bad they loans were backed by strong collatoral, i.e. houses.

Of course what most of us missed was that the home prices were based on a bubble.

If you read what those in the industry said at the time it was "housing prices never go down" (even though housing prices have gone down substantially in the past). Looking back it is easy to understand that housing prices in the long term have to be linked to income and income for most Americans was stagnating. If you plotted housing prices and growth in income you would see a huge and growing gap.

These securities were very vulnerable not just to falling housing prices but even if housing prices stayed flat the borrowers would be unable to pay off their mortgages once the teaser rates expired nor would they be able to refinance. Had prices remained flat there would have been a large amount of foreclosures but when housing prices fell the number of foreclosures increased exponentially.

What drove the market for mortgages was not demand by consumers for houses it was demand for fixed income securities from the Giant Pool of Money. So mortgages were offered with no consideration as to whether the mortgage could ever be repaid. More on that when I discuss the agency problem.

The Giant Pool of Money tells Lehman, Bear Stearns, Citi, Merrill Lynch, Goldman Sachs - find us more securities. Wall Street works with the mortgage originators and makes them short term loans to make mortgages. Local banks make short term loans to developers. Developers build more homes and work with the mortgage originators to find buyers. The house is sold. The developer pays back the local bank. The mortgage originators sells the mortgages to Wall St. and pay back their short term loans. Wall St. finances all of this with short term loans in the form of CD and loans from the large banks. The mortgages are packaged into securities and sold to the Giant Pool of Money. Wall St. pays back their bank loans.

Everyone gets paid mostly in fees. The risk has moved from the local banks, the developers, the mortgage brokers and Wall Street to the Giant Pool of Money.

Except that there are always more loans to be made. More construction loans, more houses, more bad mortgages, and more risky mortgage backed securities some of which are not sold to the Giant Pool of Money but are held by the Wall St. banks.

So where's the blame? Well kind of everywhere. Every one in this chain is making mistakes. It may be that the least informed about the risks are the consumers and the Giant Pool of Money. Everyone else is simply trying to skim off fees and trying not to be standing when the music stops.

More on the agency problem next time.

Ticket to Ride

Well, the NH primary was discouraging. Clinton won and Guiliani wasn't buried by Ron Paul so the dread Clinton-Guiliani race is still a possibility.

If that occurs we need an independent ticket and I have a better idea than Mike Bloomberg.


The 2008 Dream Team

President - Colin Powell, VP - Bill Bradley

They announce the following choices for their cabinet.

Secretary of Defense - John McCain
Secretary of State - Al Gore
Secretary of Treasury - Mike Bloomfield
Attorney General - John Edwards
Head of Homeland Security - Mitt Romney
Head of EPA - Ralph Nadar

We Didn't Start the Fire

Goose Gossage into the Hall of Fame, finally.

Boys and girls back before the days of the closer, back before Lee Smith, Dennis Eckersley, Mariano Rivera and Trevor Hoffman; baseball teams had relief pitchers who were Fireman. They came into the game - not in the beginning of the 9th inning, no on, no out, with their team ahead. They came into the game in the 7th, 8th or 9th with men on base and good hitters up and their job was to prevent not merely the batter at the plate from scoring, their job was to prevent the runners at 2nd and 3rd from scoring. They were call Firemen. They doused opposition rallies.

In this role no one was better than Goose Gossage.

In the beginning, pitchers pitched the entire game. Babe Ruth pitched 107 complete gamesi in 5+ seasons; Greg Maddux has completed 109 games in 22 seasons. Relievers were not that important before the 1960's.

There were a couple of successful relievers for a season or two but the first star reliever was Hoyt Wilhelm. He changed the game. He was a knuckleball pitcher and a relief specialist. He set the example for relief specialists who had one or two dominant pitches. In the 1960's the firemen role was established by guys like Roy Face, Ron Perranoski and Dick "the Monster" Radatz. This was the role that Gossage assumed in the 70's and 80's.

He came to the Yankees in 1978. In the previous year, 1977, Sparky Lyle was the Yankee fireman and won the Cy Young award. But everyone knew that Gossage was much, much better. Craig Nettles offered a famous and brilliant line that Lyle went from Cy Young to Syanora when the Yankees signed Goose.

He was that good. And, certainly better than Bruce Sutter who was elected into the Hall of Fame last year.