‘O unhappy citizens, what madness?
Do you think the enemy’s sailed away? Or do you think
any Greek gift’s free of treachery? Is that Ulysses’s reputation?
Either there are Greeks in hiding, concealed by the wood,
or it’s been built as a machine to use against our walls,
or spy on our homes, or fall on the city from above,
or it hides some other trick: Trojans, don’t trust this horse.
Whatever it is, I’m afraid of Greeks even those bearing gifts.’
Virgil, The Aeneid Book II
So warned Laocoön to no avail, and that was with Cassandra’s corroboration. As reward for his prescient prudence, the Trojan priest and his twin sons were crushed to death by two sea serpents. It would seem the Greeks had no intention of relinquishing hold of ancient Anatolia, a critical continental crossroad where Europe and Asia’s borders meet, a natural target for conquering civilizations.
Thankfully, history has made history of menacing machinations crafted with the aim of undermining the opposition. If only… History is rife with exceptions starting with most politicians on Planet Earth and more recently, central bankers.
In what can only be characterized as Mission Creep raised to the power of infinity, the Federal Reserve’s last Federal Open Market Committee Minutes warned that “equity prices are quite high relative to standard valuation measures.”
Let’s see. Where does the stock market fit into Congress’ statutory requirements that the Fed’s objectives be: “maximum employment, stable prices and moderate long-term interest rates”? You neither, huh?
The Minutes also indicated that, “equity price indexes increased over the intermeeting period.” Is it the slightest bit alarming that monetary policymakers are nodding to a phenomena that’s been in place since March 2009 as having just occurred to them? Are we pondering pure coincidence or is this exactly what it appears to be — political pandering?
This from CNBC: FOMC Minutes have unleashed the word “valuation’ as it pertains to equities six times since Alan Greenspan, a self-described obsessive observer of the stock market, first uttered the words, “irrational exuberance.” In every instance, stocks were hit over the next 12 months.
Could it be that Janet Yellen, who in 2008 said the Minutes should be used, “to provide quantitative information on our expectations” knew exactly what she was doing, that she planted the word ‘valuation’ to send the President a pointed message with nothing less than perfect precision?
You may be thinking our new leader has more than enough on his agenda to be worried about a threat to the stock market from the likes of academics he not so long ago publicly derided. If Trump cares about staying in the good graces of those who put him in office, he will fight the temptation to pivot on the Fed. He’s been in office long enough to have made a move to begin filling the three open seats on the Federal Reserve Board.
More to the point, in the event Trump hasn’t been apprised, the Fed has the economy by the short hairs. And, yes, it was, is, and will be about the economy, at least among those who voted him into office, many of whom remain angry and anxious, but not stupid.
They are still waiting for an advocate who sees through the average data right through to the galling truth that absent executive pay, incomes remain in decline. They pine for a leader who can like debt all he wants to get deals done, but doesn’t force it down the economy’s throat to generate economic growth of the most fleeting nature. They may not be able to identify the enemy within by name but they have every right to expect their President does, that he has the gumption to stand up to the Fed and deliver his People from the shackles of indentured servitude.
It might even be a good thing, for working Americans who’ve long sensed the economy has abandoned them, that Trump has a beef with the media and two savvy guys from Goldman Sachs helping steer the economy. Together they should be able to glean the facts from the data the Fed insists are so much “good news.”
Consider, if you will, a fresh report on the state of consumer finance released by the New York Fed. At $12.73 trillion, household debt sits at a record high. We’re told to look the other way, that it’s a nominal figure and more importantly that debt as a percentage of gross domestic product (GDP) is nowhere near where it was back in the bad old days of 2007.
‘Tis true that household debt is no longer 95 percent of GDP which was the case when it peaked in the fourth quarter of 2007. Before resuming its climb to its current 80-percent level, it got as low as 78 percent of GDP. But let’s hold off on the austerity bubbly for the moment. Since record keeping began in 1952, when the record low of 23 percent was recorded, debt-to-GDP has averaged 56 percent.
As for the red herring that households have tightened their belts, while that is the case for a minority, the bulk of deleveraging that’s taken place has been the result of the past decade’s 10 million and counting foreclosures. (For those of you still keeping count, some 91,000 individuals had ‘foreclosure’ added to their credit reports in the first three months of this year, an uptick from 2016’s fourth quarter.)
The deleveraging, by the way, ended years ago. Aggregate household debt is 14 percent above the low it hit in the second quarter of 2013. And we’re not talking about mortgages here.
Drawing hard conclusions is a bit of a stretch as it really depends on your perspective. You make the call. How secured by anything of value is the type of debt households have taken on since mortgage lending standards tightened like a vise on would-be homebuyers? Credit card debt is an easy enough call. But what about that car loan? Checked your trade-in value lately? (Not recommended if you’ve had a bad day.) As for that festering $1.3 trillion mountain of student debt? Did someone say ‘perspective’?
The bottom line is we still have too much debt and precious little to show for it.
In return, we get this from the NY Fed’s President Bill Dudley: “Homeownership represents an important means of wealth accumulation, with housing equity being the principal form of wealth for most households.” (Isn’t that a good thing?)
He goes on to observe that, “Changes in the way we finance higher education, with an increased reliance on student debt, may have important implications for the housing market and the distribution of wealth.” (You think?)
And finally, out of the other side of his mouth, he has this gem of a recommendation to kick start the economy: “Whatever the timing, a return to a reasonable pattern of home equity extraction would be a positive development for retailers and would provide a boost to economic growth.” (Wait, wasn’t all that home equity borrowing what pushed debt up to its record highs and drove the economy into the Great Financial Crisis?)
It’s critical to note that Corporate America is also drowning in record levels of debt – nonfinancial corporate debt within a hair of $6 trillion. And though it was nary mentioned in the campaign by either party, at $20 trillion, Uncle Sam himself is up to his eyeballs in hock.
Hopefully you can see Trump’s once in a century chance to reshape the warped thinking inside the Fed. He has the tremendous power to redirect the meme by draining the debt swamp that makes our government beholden to foreign lenders, our corporations less competitive on the global stage and our households seething at their inhibited upward mobility. Talk about Making America Great Again, for ALL Americans.
Without a doubt, this will be one of Trump’s toughest tests, and yes, the Fed can easily take down the stock market in retaliation; they could even follow through on threats to shrink the balance sheet. It would be as if someone flipped a switch and we veered from Quantitative Pleasing to Quantitative Plaguing.
And what politician in their right mind wants plague visited upon their economy on their watch? Ask any of Trump’s predecessors and they’ll shoot you straight. Passing legislation with ultra-easy monetary policy and fluffy stock prices on your side sure as heck beats the alternative.
But in the end, it just buys time, not Greatness.
Artificially low interest rates might be as alluring as that Trojan Horse was to the people of Troy. But let’s put their experience to better use and not dismiss Laocoön’s words as the tragic Trojans did. Let us all Beware of Central Bankers Bearing Gifts.
What has the power to turn a right of way into a rite of passage?
Might it be that the mighty hand of time plays a role? Any buffed historian worth their weight in tapas will tell you the most glorious bull run of all time is grounded not in pageantry, but rather pragmatism and perseverance. Nestled on northern Spain’s Basque seashore bordering France, the heat of summer brings with it the promise that Pamplona will once again host its famed San Fermin Festival, so named for its patron saint.
History has it that Middle Age cattle herders and butchers would venture out into the night to guide bulls from their barges to bovine barricades. And while legend suggests the tradition dates back to the 13th century, from whence the mid-night marches morphed into the festivities that today are called the Running of the Bulls, its true beginning remains an unknown. The locals claim October 1776 marked the transformation to today’s annual adrenaline-rushed race through the cobblestone streets. But who establishes anything in unpredictable October? And 1776? In any event, the festival has since been moved to reliable July and aside from a few deaths (15 in all since 1924, when record keeping began) the running continues to run smoothly.
The same can be said of the modern-day bull run the world both celebrates and derides, trading day in and trading day out – it runs like silk on steroids. But unlike the practical birth of its Pamplonan predecessor, there was an overabundance of pomp associated with the grave circumstances that marked the advent of the current stock market run born in March 2009 from the beneficence of commandeered central bankers.
Being as it is, the second-longest artificially-turbo-charged bull market in modern market history, the rally has garnered more than its fair share of detractors. These wall-of-worry scalers suffer from a post-traumatic-stress-disorder that only the twin architects Greenspan and Bernanke could conceive. They simply refuse to be thrice burned. And who with a straight face can blame them? And yet these stalwart prudes have nevertheless been engulfed in the flames of shame of the roaring rally that’s left them behind. In some cases, once again.
Have these unrequited bears lost money in the process? It is said, even insisted, that is the case. But all they’ve really done is lost face, not money. The bears have sat bitterly idle while their full-bull counterparts have racked up massive paper gains. As sure as salt finds an open wound, some of their professional peers will even be nimble enough to monetize their handsome profits and go off, as it were, into the wild blue yonder, or at least the Hamptons, which is a lot closer.
But history also dictates that most of today’s bulls will be fried to a crisp and lose it all. Such is the nature of the beast. Why else would he be called bestial?
In the meantime, the bulls have become belligerent, boastful and bloodthirsty. Naysayers in their pathway are as good as ripe for the picking to the bone as so many hyenas on the hunt would be innately inclined. If only there was some assurance that comeuppance was forthcoming!
Yes, stock market valuations are richer than at any other time since 2000 (in the case of you-name-the-bond and commercial real estate, well, no precedent exists). But let’s focus here. Yes, the yield curve is flattening. Yes, share buybacks have peaked and rolled over. Yes, unchecked leverage lurks in the shadows. Yes, the critically compromised Federal Reserve is threatening to unleash balance sheet Beelzebub. Yes, it is even the case that the real economy has peaked for the current cycle, in both the United States and China, for those inclined to see through bubblevision’s delusional depictions. No, as much as you’d like to believe, absent war, oil prices will not stage some robust rebound that rescues the junk market. And finally, yes, you are not imagining that the political and geopolitical backdrop have never been as tenuous as they are today, to be polite in shared company. At least in our lifetimes. And so justice commeth?
Afraid to be the bearer of good news, but NO, stocks are NOT poised to crash, at least not imminently.
The confluence of factors converging to bring stocks down are precisely what will keep them levitating for longer than any logical person could surmise. And God help the poor soul who endeavors to maintain a bet against stocks without withstanding magnificent losses. You may as well be shuffling razor blades blindfolded in the dark.
For all of you who’ve grown accustomed to analytics at this juncture, hit that ‘x’ at the top right of your screen. Stop reading now. This one comes from anecdotes, history’s brutal lessons and the gut.
Lesson number one is melt-ups have little to do with reason and everything to do with emotion. Where to start on measuring today’s mania?
If it was kosher to passively invest in a pre-Trumpian world, it’s downright patriotic to do so today. Bet against a future led by someone with no axes to grind, no special interests to whom to kowtow and a businessman at that? You call yourself an American? Buy the index! Long-term index investing always pays in the end.
As for the feckless Fed, futures are betting less than even odds of a rate hike after we see June 14th come and go. So rates are not at zero. But conditions are anything but tight and the market is telling us they’re as bad as they’ll get for the current cycle, within a quarter-of-a-percentage-point, that is.
Lest we forget the other inevitable that’s priced into the markets, DC is poised to stand and deliver. While that may or may not be the case, Congress-folks cannot recuse themselves from the lens of laudable lawmaking until a year from now when they hit the campaign trail for the midterm elections. And if nothing of note is passed? Oh you naïve nabobs, what’s at play is our playing along, nodding our heads in agreement that the smoke-in-mirrors routine amounts to anything more than a token tax repatriation that funds share buybacks (oh, the novelty of it all!)
But surely there’s that outlier of outliers to fall back on, that of the sadistic seed of demonic dictatorial despots? While abundant in their presence, you may note that absent the nefariousness of a nuclear nature, the markets could give a damn. Don’t expect that to change any time soon.
Not to get technical, but the technicals are poised to be the cherry on the bulls’ sundae. Bets are piling up that certain stocks are poised to fall. Those savvy souls placing their money where their mouth is include none other than the Big Short’s Steve Eisman, who almost lost it all, but lived to make it big betting against toxic subprime mortgages back in the day.
In the here and now, at least in his most recent CNBC interview, Eisman talked up his decidedly two-way book, one in which he’s long Amazon and short Simon Properties. Smart guy. Malls bad. E-commerce good. The only problem is, he won’t be alone in being long for long.
Crowded trades that are banking on a stock’s decline, especially when they begin to multiply as the macroeconomic backdrop deteriorates, oftentimes have a way of backfiring in splendid fashion. They’re called short covering rallies and can be a hairy to maneuver, to say nothing of escape, unscathed. As sound as the logic may be, extrapolating the idiosyncratic to the whole has made many an idiot investor.
How to put the mechanics succinctly? The slightest hint of not-awful news on a stock, or even the space it’s in, can trigger a mad dash to exit a negative bet. One investor covering their potential loss by buying a stock back necessarily propels that given stock upwards, which works in a vacuum. Except that shorting is akin to a plague in how quickly the contagion can spread. More often than not, others are forced to follow suit to contain their damage.
Recall that owning a stock, or being ‘long’ has finite downside. The flip side is that betting a stock will decline carries the potential for infinite theoretical losses, a truth to which many bloodied veterans who’ve lived to tell can attest.
More than any one factor, though, the one that is the least satisfying, the most vexing, for bears to bear, is that of gravity, or better said, the lack thereof. Though a challenge to quantify, upward trending markets are inclined to keep pushing into the stratosphere in search of weightlessness. Like a tantrum-pitching toddler whose headache has long since settled in, this tendency’s impetus to infuriate bears knows no bounds.
It will all come down to a race against time, a test of reality’s resolve to refute recession. But that’s the very nature of mindless melt-ups. They are what make bubbles unfathomable. The siren song of foregone fortunes is the very elixir that lures little investors into the lurch, lengthening the rally’s legs for one last leg-up.
If there is one saving grace, it is the gracelessness with which the bulls have begun to comport themselves, though comportment might be a bit generous in this application. Perhaps it’s better said that nasty is as nasty does. Reading the schadenfreude-fueled vicious barbs being spewed at the ‘loser-bears’ leaves one with some sense of the delayed justice to come.
To think these forked-tongue keyboard abusers embrace their mothers at holidays with the same claws that scratch out the multitude of inappropriate rants in public spaces. One is tempted to ask if someone can please get these bullish haters a puppy already. For the here and now, like it or not, the odds are the bullish cabal will keep running the Street, continuing to disappoint violently-disposed voyeurs by staying one step out of reach of those honed-sharp horns.
There are some predictions you just don’t want to come to fruition. As bad as things have been for retail, they just seem to be getting worse. It’s beginning to look as if the operating environment will assist in expediting the ripping-off-the-bandaid solution to what ails retail, that is resolving the overcapacity scourge that’s become the new retail reality, seemingly overnight.
If you’re into connecting the dots for fun during trading days that seem to stretch into an infinite sea of complacent calm, consider the value of the land under the malls that won’t be with us in the near future. These malls of our collective past may today be rendered irrelavent, labeled as they are ‘B’ and ‘C’ properties. But many are in pristine locations.
Viewed through this cold prism, you’ve got to give credit where it’s due. Gleaning value via preemptive store closers salvages what little there is to be had from the wreckage. This will work for those nimble first movers.
In such fluid environments, though, wrinkles set in fast. Enter auto dealers, who are also waking to the reality of requiring smaller physical footprints to maximize profitability. (Yes, Virginia, you can shop for a car on the World Wide Web.) The question is, what happens when shrinking dealers’ real estate listings collide with the supply of primo real estate coming onto the market via mall razings?
The short answer is anyone who tells you they know the end result is lying. We are sailing into uncharted waters as Columbus did way back when. Oh, and by the way, concluding the exercise of connecting of dots requires you incorporate oncoming record supplies of multifamily and lodging properties. Starting to get the fuzzy picture?
For more on the potential for the retail meltdown to converge with peak autos, please enjoy my latest weekly Bloomberg Prophets column: Car Sales Will Be Key to Job Creation — The renewal of the auto industry has been a major driver of economic growth in recent years.
If that’s not uplifting enough and you’re hankering to hear how I really feel about the latest economic developments and where my former employer, the Federal Reserve, fits into the equation, please listen to to a recent interview with Bloomberg’s Pimm Fox:
Signing off from Norfolk, VA where business has carried me and I’m happy to report, crabs are in season.
What’s the next best thing to heaven?
Ask any Texan. Or better yet, try Tanya Tucker, born in Seminole, Texas in October 1958. She might just answer you by belting out the first stanza of her smash 1978 hit, “Texas When I Die,” in that gravelly voice of hers:
“When I die, I may not go to heaven
I don’t know if they let cowboys in
If they don’t just let me go to Texas
Texas is as close as I’ve been”
The point of the song is to glorify the Lone Star State as no other. And make no mistake, true Texans of all ages know and love the song. An out-of-state foreigner might venture that Texas has an ego. Yes, the state, replete with its own rallying cries. Remember “Remember the Alamo!”? Or if you prefer, the modern-day version, “Don’t Mess with Texas!” That last one may or may not have started out as an anti-littering campaign. But Texans cannot be one-upped in the adaptation department.
More recently, a crop of bumper stickers has blanketed the state’s highways and byways. Though state shapes are employed for illustration purposes on said stickers, you see the translation in the title: “Don’t CA my TX!” Ask any Texan about optionality if our taxes (let’s leave it there) even flirt with California’s. They’ll share with you the latest word bandied about: “Texit!”
Let’s use Forbes as the arbiter to explain the corporate and middle class mass departure out of California and into Texas in recent years. In 2016, Texas ranked fourth in Business Costs; California 43rd. Though there are a myriad of contributing factors to the relative unattractiveness of the Golden State, deeply underfunded pensions sit high on the list.
According to one CA resident and close friend, who also happens to be a crack economist, the back-of-the-envelope math works out as such: Stanford figures the state’s liabilities are in the neighborhood of $1 trillion, or $78,000 per household. Narrow it down to her county level, the local liability if you will, and there’s another $2 billion to consider, or $10,000 per household. Now here’s the rub. Double that $88,000 to account for the fact that various groups estimate upwards of half of CA residents don’t pay taxes. For the record, my friend is grappling with moving to a low-tax cold or low-tax warm state. Answer seems obvious but go figure.
The irony is recent headlines might cause her to steer clear of Texas given that the nation’s building pension tension first broke in Texas’ two biggest cities. Legislation is making its way through the Texas State Legislature to overhaul Houston’s firefighter and municipal employee pension. The zinger: the fix involves a cool $1 billion pension obligation bond that would require voter approval. Not to be outdone, subsequently, the Texas House voted unanimously to approve a rescue of Dallas’ Police and Fire Pension, which will also put taxpayers on the hook for a $1 billion, give or take. News that there’s been a run on a pension apparently has a stimulative effect on politicians.
The question is, will Texas begin to lose some of its appeal as the low-cost alternative to just about any other state in the nation? More to the point, are there other states out there that also appear to be dirt cheap but have pricey pension promises that will present themselves the next time markets swoon?
So much for judging low-tax-rate states by their covers. The good news is there’s a somewhat neutral intermediary to help conduct your analysis. You know, the rating agencies. Before you reach through your screen and try to land a knuckle sandwich, consider first that Moody’s and Standard & Poor’s have long been in the business of rating plain vanilla municipal bonds. We’re not talking about securities comprised of toxic mass that’s sliced and diced into credit sainthood. Plus, recent revisions to accounting rules require the agencies to visibly incorporate pension underfunding when scoring credits.
According to a recent Wells Fargo report penned by Wells Fargo Senior Analyst Natalie Cohen, over the last twelve months, this shift in accounting rules has triggered state-level downgrades of Alaska, Connecticut, Illinois, Kansas, Kentucky, New Jersey and West Virginia.
One caveat, especially at the local level, involves termination costs that can be triggered by a downgrade and accelerate payments. Detroit is a classic case in which ‘swap terminations’ tipped the city into bankruptcy. Moody’s, in particular, has devised a methodology to appraise stress using a uniform corporate bond rate; it’s called the “adjusted net pension liability (ANPL)” calculation. Included among those that lost their top credit rating because they had prohibitively high ANPLs are Evanston, IL, Minneapolis and Santa Fe along with a handful of highly-rated Ohio school districts.
It shouldn’t shock that many of the shakiest local credits reside within the weakest states. On a list Wells comprised using Merritt Research Services data, weak pensions contributed to 11 local government downgrades in Illinois, 10 in New Jersey and six in Connecticut. In what can only be described as fiscal hot potato, some states are also increasing the funds school districts are required to contribute to state retirement funds. One case in point: Local districts in Michigan previously contributed 16.5 percent of payrolls to the Michigan Public School Employee Retirement System; that has since been upped to 27 percent. Cohen calls it the ‘State-Local Trickle Down’ effect.
They say that the best laid plans cannot account for random molecules bumping around the universe. The rub is there’s nothing random about the rot spreading across the municipal landscape. The buck will eventually stop somewhere, even as states and municipalities endeavor to shift their growing burdens from here to there to anywhere. If you just squirmed in your seat, you know where this is going.
The theory is taxpayers will take the tax hikes of the future required to rescue pensions lying down, forcing the actuarial armies’ math to finally work out in practice, not fairyland theory. Let’s just say the jury isn’t even hung on such an outrageously optimistic outcome. Targeted residents are much more apt to follow in Cook County’s fleeing population’s footsteps, that is, pull up stakes and move to lower tax states.
Carry this inevitable, albeit eventual, process to its logical end-point and it’s easy enough to envision the United States having a periphery of its own consisting of shallow-tax-base, budgetary-basket-case, junky high-yielding municipal borrowers. Preening at the opposite end of the spectrum are states that have prudently managed their affairs and prevented unions from ruling the pension roost – pristine and pure investment grade municipals.
An aside if you’ve got the ‘G’ in PIIGS on the mind (remember the acronym for the European periphery?), don’t sap your synapses. There will be no Prexit. The Constitution doesn’t allow for it.
As for tax reform, that’s another story. John Mousseau, Cumberland Advisors’ in house municipal maven, recently published a one-pager titled, “Quick Take on Munis and the Trump Plan.” In the report, Mousseau calculates the math behind the lower tax rate that stems from the elimination of the ObamaCare tax on investment income for families making over $200,000 combined with the nixing of the alternative minimum tax. The first blush take is that taxable equivalent yields of 5.30 percent for the today’s 39.6-percent top federal bracket taxpayers will fall to 4.61 percent as the top bracket declines to 35 percent. That slippage, however, is offset by the closure of the loopholes and deductions proposed.
But what about rendering nondeductible state and local income taxes? Mousseau uses the high-income-tax state of California, where the top state tax rate is currently 13.3 percent on income over $1 million, to illustrate the impact of the proposed changes to the tax laws. Under existing tax law, that rate effectively declines to 7.5 percent. Eliminate both the federal deduction for state income taxes and the Obamacare tax and you land right back at 13.3 percent.
The result would be twofold: 1) demand rises for in-state tax-exempt bonds in high-tax states (prices up, yields down), and 2) major resistance on the parts of state and local governments against tax increases and a push to roll back tax rates as state taxes will abruptly and significantly rise from their current levels.
Mousseau’s bottom line:
“From today’s vantage point, we feel that muni bonds, particularly in the intermediate and longer maturities, should face little adjustment under the proposed plan and that the demand for municipal bonds in high-tax states should advance smartly.”
While a wash for municipal bond holders in general, the implication is that high tax states, especially those with deeply underfunded pensions, will find politicians struggling in their efforts to insure escape eludes essential taxpayers.
The next recession will only serve to expedite the exoduses. That will put the onus on DC politicians to ponder the profound, as in how does the country meet the aggregate challenge pensions present? At some point, clinical calculations will clash with the still-angry citizenry. Making matters worse, both pensioners and punished taxpayers are within their rights in feeling as if they’ve been wronged.
Who will represent taxpaying Californians who prefer to grow old enjoying their perfect vistas of the Pacific? For that matter, who will stand up for Texans who darkly joke that the real wall that will be eventually erected will rise up along the state’s northern border?
The closest thing to winners in this war of states are Texas real estate agents who have never had it so good. Loaded with sales proceeds courtesy of ostentatiously overpriced homes, California transplants tend to buy two homes instead of one, so flashily flush are they when they cross over the Red River. While that extra spacious back yard (of course they raze one of the two!) is all good and well for the eager emigrant jet set, the traffic is worse than ever.
So, is there a Texit in the cards? The late Supreme Court Justice Antonin Scalia assured us the answer is no: “If there was any constitutional issue resolved by the Civil War, it is that there is no right to secede.”
Try telling that to a tenacious Texan. As worthy residents of the state, who find themselves belting out Tucker’s gravelly-voice timeless hit racing down a dusty country road with the windows open will tell you, it’s not bond math that defines the allure of life in the Lone Star State. To the many, the proud, such a futile approach is akin to trying to put into words what the wind feels like to someone who has never felt a warm breeze against their face. Why bother? To borrow from another legendary bumper sticker: “I may not have been born in Texas. But I got here as fast as I could.”
So lamented Styx lead vocalist Dennis DeYoung in a song he wrote and recorded in 1980. To listen to the lyrics, the ballad would seem inaptly titled “The Best of Times.” But then, love conquers all. That’s where the ‘best’ part comes in, as two star-crossed lovers find in each other their salvation from a world turned cruel.
The song was the first release from Styx’s 1981 triple-platinum album Paradise Theatre. That first release suggests the album could just as well have been named Paradise Lost. It’s impossible to say without asking DeYoung directly but perhaps his somber tone was simply a reflection of the times.
The oil crises of the 1970s had left the country mired in stagflation and veering headlong into a double recession. Inflation and unemployment were both high leaving many so miserable an index was conceived in their name. And crime, well, it was at least perceived to be rampant and televised for good measure.
The fact is public pensions are an intractable issue that is growing as a factor of time and worryingly, increasingly ignored. And these are the best of recent times for pensions, without question. This from Bloomberg: U.S. state and city pensions posted median gains of 4.1 percent in the first three months of this year, the sixth consecutive quarter of positive returns, the longest winning streak since 2014.
While this moment in time will alleviate some of the $2 trillion in underfunding, it cannot be enough to make up for lost time given that the depth of the hole was less than $300 billion in 2007. As is plain, a whole heck of a lot of damage was exacted in the short space of a decade. Obviously, there was blood in the Street during the crisis years. But that dark chapter was followed by a magnificent rally in risky assets.
The means by which pensions find themselves bound by Gordian’s knot is simple: time.
For today’s older folks, the miracle of compounding interest is a simple and beautiful phenomenon. In addition to the income you gather on the principal you’ve invested, time sweetens the pot if you leave your earnings be. Your interest also earns interest, more is more. The growth is a sight to behold. That is, if your age begins with the number ‘6.’
Central bankers, in their infinite wisdom, have consciously robbed generations plural of such an ideal. Zero on zero gets you zero. No beauty there.
Unluckily, pensions have been allowed to exist in a parallel universe where zero interest rates don’t exist. Why discount future liabilities by zero, or even insanely low rates, just because the powers that be slam rates to the floor? That level of realism invites nasty side effects, as in an immediate tripling of pensions’ underfunding. Could any state or municipality shoulder such a heavy burden? (Answer: few to none.)
Instead, pension fund managers have traveled from one parallel universe to the next, to that of amplified assumed rates of returns to compensate for what reality simply cannot provide.
Think of it as the opposite of compounding interest. The insidious interplay between fancifully assumed discount rates and the unicorn returns we pretend managers can conjure on pension assets is where the word ‘damage’ comes into play.
In the same way compounding interest escalates the growth of your original investment, double denial in pensions renders the damage inflicted permanent.
While that four percent racked up in the first quarter sounds great, ask yourself this: can it compensate for the average annual return of 1.5 percent chocked up in the fiscal year ended June 30, 2016? Well sure, except for one glaring detail – the rate of return assumed was north of seven percent, again, on average.
It is THAT gap, repeated year in and year out, that cannot and will not be made up as a factor of time. Returns have been too low for too long, as have interest rates, to rectify what ails pensions. To compensate, as has been more widely reported by the media, to its credit, pensions have been making investments in illiquid, expensive private equity funds. We’re talking $350 billion since 2007.
To be clear, a pension fund manager is fiduciarily responsible to ensure that adequate funds are on hand to meet the obligations promised to beneficiaries, that assets are on hand to satisfy future liabilities. Period.
Why on earth, mandated by that seemingly simple tenet, would any pension manager in their right mind, or with the best interests of their entrusted pensioners at heart, be investing in a distressed real estate or illiquid credit fund? And at this juncture in the cycle?
Before the arguments begin – that we’re at the precipice of some new paradigm, that tax cuts will reignite growth, that stocks are dirt cheap when adjusted for inflation, can we just agree on one thing? Can we answer one question please: Do recessions occur, eventually?
If you can acknowledge that there is cyclicality in the business cycle, there are deeper issues to discuss.
Consider that every (remaining) California household is on the hook for $93,000 to cover the state’s public pensions, at least as of the end of 2015 according to Stanford University. That gap will never be rectified, at least on planet earth, not without eviscerating what’s left of the state’s middle class. Sorry to rain on the Golden State, but good luck. Middle-income-earning, tax-paying Californians will continue to do what they’ve been doing, along with their cohorts in Cook County, Illinois. They will continue to vote with their feet and relocate to states with better tax climes. And why shouldn’t they?
Economists like to gloat about inflation and unemployment hovering near record lows. But the truth is, a vast majority of Americans today are subject to a different kind of misery index, one that could be a kissing cousin to that of the late 1970s. Call it the bondage index. Buying a new starter home and renting your first apartment are so prohibitively expensive the homeownership rate among Millennials is the lowest on record for their historic age group. And while the unemployment rate is near record lows, it’s nothing to write home about, at least for the millions upon millions who’ve been forced to work part-time or take on two jobs just to make ends meet.
In other words, the statistics may not lie but they sure as hell don’t tell the whole truth. As one astute Twitter follower commented following fresh data on rising car repossessions, “Between losing their transportation to their job and unaffordable housing, expect the bottom 20 percent who have lost out to get desperate.” Economic bondage will do that.
Maybe you can help connect the dots. We’re in the third longest economic expansion in postwar history. Stocks have enjoyed their second longest bull run ever. Public pensions are loaded up to their eyeballs in risky assets because there are no alternatives aside from the alternative investments they’ve piled into that will give them no cover in a downturn. How exactly does this story have a happy ending, for pensioners and 401k-holding taxpayers alike?
Some arbiter from some corner will have to rise up to resolve this dilemma. The judiciary will certainly play a lead role in setting precedents. Strong leaders will also have to make tough calls knowing full well that unions will stage a rebellion. It won’t be easy to convert future public employees to the same retirement reality the rest of us rely on.
But what other choice is there? Cutting public services to such an extent that taxpayers take to the streets? Or worse, that we lock our doors and hide inside?
Teddy Roosevelt once said that, “People don’t care what you know until they know that you care.” We must ask ourselves how the barely-contained anger manifests itself when the masses wake to the knowledge that the most knowledgeable cared the least.
How do you take your plaque?
C’mon, we all have our victual vices that risk turning the gourmet in us gourmand. Those naughty nibbles that do so tempt us. Is it a bacon, cheese, well…anything? Maybe a slice of pie – pizza or otherwise? Or do you take yours scattered, smothered and covered? As in how you order your late-night hashbrowns at Waffle House – scattered on the grill, smothered with onions and covered with melted cheese. That last order is sure to do the trick if clogging your arteries is your aim. Too exhausted to trek inside? Hit the drive through. It’s the American way.
Enter Morgan Spurlock. In 2003, he had grown so alarmed with the ease with which we can go from medium to jumbo (in girth) he conducted a filmed experiment. For 30 days, Spurlock consumed his three squares at McDonald’s, a neat average of 5,000 calories a day, twice what’s recommended for a man to maintain his body weight. Fourteen months later, Spurlock managed to shed the 24 pounds he’d packed on.
Released in 2004, Super Size Me garnered the nomination for Best Documentary Feature.
And since then? A freshly released paper finds that more than 30 percent of Americans were obese in 2015 compared with 19 percent in 1997. Of those who were overweight or obese, about 49 percent said they were trying to lose weight, compared to 55 percent in 1994.
One must ask, where’s that “Can Do!” spirit? Why acquiesce given the known benefits of restraint? Perhaps we’d be just as well off asking that same question of the world’s central bankers who seem to have also thrown in the towel on discipline, opting to Super Size their collective balance sheet, the known hazards be damned.
At the opposite end of the over-indulge-me spectrum sits one Harvey Rosenblum, a central banker and my former mentor who sought to push his own discipline to the limits throughout his 40 years on the inside, to take a stand against the vast majority of his peers. Consider the paper, co-authored with yours truly, released in October 2008 — Fed Intervention: Managing Moral Hazard in Financial Crises.
In the event your memory banks have been fully withdrawn to a zero balance, October 2008 is the month that followed the magnificent dual implosions of Lehman Brothers and AIG.
To speak of insurers and quote from our paper: “Moral hazard, a term first used by the insurance industry, captures the unfortunate paradox of efforts to mitigate the adverse consequences of risk: They may encourage the very behaviors they’re intended to prevent. For example, individuals insured against automobile theft may be less vigilant about locking their cars because losses due to carelessness are partly borne by the insurance company.”
As it pertains to central banking, we had this to say: “Lessening the consequences of risky financial behavior encourages greater carelessness about risk down the road as investors come to count on benign intervention. By intervening in a financial crisis, the Fed doesn’t allow markets to play their natural role of judge, jury and executioner. This raises the specter of setting a dangerous precedent that could prompt private-sector entities to take additional risk, assuming the Fed will cushion the impact of reckless decision-making.”
What a redeeming difference eight years can make?
If you’ve read Fed Up, you’ll recognize these words, which open Chapter One: “Never in the field of monetary policy was so much gained by so few at the expense of so many.” Every chapter of the book begins with a quote, most of them ill-fated words straight out the mouths of Greenspan, Bernanke and Yellen, chief architects of the sad paradox that’s benefitted “so few.” Those prescient words were written in November 2015 by Bank of America ML’s Chief Investment Strategist Michael Hartnett, before Brexit was on the tips of any of our tongues, before the anger of the “many” erupted at voting booths.
Chapter One goes on to recount the Federal Reserve’s December 2008 decision to lower interest rates to zero. According to the Bernanke Doctrine, the Fed’s purchasing securities, quantitative easing (QE) could not commence until interest rates had hit their lower bound. To suggest the chairman’s blueprint was arbitrary requires a vivid imagination. Few appreciate the Doctrine was conceived in August 2007 in Jackson Hole, in the tight company of his chief architects. But one can breathe a sigh of relief his models did not necessitate negative interest rates.
We know it’s been over two years since the Federal Reserve stopped growing its balance sheet to its current $4.5 trillion size. And yet, investors are anything but alarmed, comforted in their knowledge that Liberty Street stretches round the globe. There are plenty of corners on which moral hazard dealers can ply their wares, luring animal spirits out of their lairs. QE is global, it’s fungible and it feels so good.
As Hartnett reminds us in his latest dispatch, global QE is, “the only flow that matters.” Add up the furious flowage and you arrive at a cool $1 trillion central banks have bought thus far this year (note: it’s April). That works out to a $3.6-trillion annualized rate, the most in the decade that encompasses the years that made the financial crisis “Great.”
“The ongoing Liquidity Supernova is the best explanation why global stocks and bonds are both annualizing double-digit gains year-to-date despite Trump, Le Pen, China, macro…”
As so many sailors fated to crash onto the rocky shores of Sirenuse, investors have complied with central bankers’ biddings. And why shouldn’t they?
As Bernanke himself wrote in defense of QE in a 2010 op-ed, “Higher stock prices will boost consumer wealth and help increase confidence, which can also spur spending. Increased spending will lead to higher incomes and profits that, in a virtuous circle, will support further economic expansion.”
What a relief! This won’t end as tragically as the Greeks would deem fit. It’s the wealth effect, a different myth altogether, protected by virtue herself.
Investors are excelling at obedience in such rude form they’ve plowed fresh monies into emerging market debt funds for 12 weeks running. As for stocks, forget the fact that it’s a handful (actually two hands) of stocks that are responsible for half the S&P 500’s gains. Passive is hot, red hot. According to those at Bernstein toiling away at tallying, within nine months more than half of managed US equities will be managed passively.
As if to celebrate this milestone, Hartnett reports that an ETF ETF has completed its launch sequence. What better way to mark a decade that’s seen $2.9 trillion flow into passive funds and $1.3 trillion redeemed from active managers? In the event you too need a definition, an ETF ETF is comprised of stocks of the companies that have driven the growth of the Exchange Traded Funds industry. But of course.
In the event you’re unnerved by the abundance of blind abandon in our midst, it helps to recall the beauty of moral hazard. Central bankers know what they’re doing in encouraging moral hazard and they’ve got your back. If they can’t prevent, they can at least mitigate the future economic damage they’re manufacturing.
As Bernanke said in a 2010 interview, “if the stock market continues higher it will do more to stimulate the economy than any other measure.” If that was true then, isn’t it even truer today? More has to be more. Why diet when it’s so much more satisfying to indulge to our heart (attack’s) abandon?
No sequel. No Part II. No Redux. 1981’s smash hit Arthur is a classic example of what happens when well is not left alone. There was never going to be a way to replicate the hilarity born of sublime scripting and delivery to say nothing of the perfectly unconventional combination of casting and direction. Upon reflection, the only question is what sort of prig it takes to award the movie anything but five full stars – Amazon has it as 4.5 stars. (We’ll leave that one for another day, but you know who you are and you clearly need to get out more.)
Who, after all, could fault Dudley Moore’s best moments portraying Arthur Bach, cinema’s most darling drunk? A smattering of the film’s snippets:
When Susan, his fiancé by way of an arranged-marriage, suggested that, “A real woman could stop you from drinking,” Arthur rebutted that, “It’d have to be a real BIG woman.”
Or his description of his day job: “I race cars, play tennis and fondle women. BUT! I have weekends off and I am my own boss.”
Then, of course, there’s the farcical exchange between Arthur and his proper aunt and uncle when he’s caught out with a spandex-clad prostitute. Endeavoring to render his “date” passable, he claims she’s a princess from a speck of a country: “It’s terribly small, a tiny little country. Rhode Island could beat the crap out of it in a war. THAT’s how small it is.”
One beat later when it (re)dawns on him that his arm candy is actually said prostitute? Well, that’s the best of the best: “You’re a hooker? Jesus, I forgot! I just thought I was doing GREAT with you!”
In 1981, the audience was naturally attracted to Moore’s spoiled, over-the-top coddled character and to the sheer novelty of just imagining being him — breakfasted-in-bed, butlered, chauffeured and indulged in every conceivable way. A good many of those caught between the moon and New York City these days might not see the movie as so much comedy, but rather a droll performance, or better yet, dare one venture, autobiographical.
Welcome to the sequel to America’s Gilded Age. Fair warning, like Arthur 2: On the Rocks, it’s gauche, tacky and vulgar all at once. And for far too many angry Americans, this follow-on to one of history’s most raucous chapters is as unwelcome as was that of Arthur’s sequel to the original movie’s purist fans.
The dirty little secret the ostensibly wealthy consider to be indelicate cocktail conversation is that this second era of insulting inequality is rather old news. Inequality has been on the rise since 1987 when Alan Greenspan took the helm of the Federal Reserve. It was then the Maestro began his crusade to indemnify investors’ portfolios against any nasty side effects risk-taking might invite.
By 2012, the top one percent of U.S. earners were commanding 19.3 percent of household income, burying once and for all the prior record set in 1927. In other words, it’s been five years, people! At this point, the subject is borderline blasé. Can we move on to another subject already?
Plus, the runaway stock market has managed to benefit the ‘rest’ of Americans – OK, the top 20 percent — who owned 92 percent of the stock market in 2013.
One thing is for certain, that other eighty percent of Americans who controlled that other eight percent of stocks notwithstanding, the trickle-down effect to the top quintile is undeniably conspicuous in its overabundance.
A recent foray to the local posh mall (where else to see Boss Baby?) was all the show-and-tell required to illustrate the point. So lengthy was the valet line, one wondered if the intended task of shopping would ever be properly addressed. Forget the Ferraris. This is the mall folks, land of the SUV, as in the Bentayga, Bentley’s answer to every delusional soccer mom’s dreams. It is what it is if only the best will do. Besides, it’ll only set the hubby back a cool quarter of a million.
If only that had been what was ‘remarkable.’ No, that preserve was reserved for the three – count ‘em – three Rolls Royces queued up to be whisked away, for a smart tip, to be sure.
Pardon the urge to submerge your pleasurable 12-cylinder fantasy. But do you see anything wrong with this picture? Two questions (should) come to mind: Can this many people afford to be driving these beyond-luxurious vehicles? Much more critically, are their means so meaningful they’re licensed to brazenly brandish their wealth? Or is a fair bit of financial feigning at work to paint the impressive impression?
At the risk of being daft, it pays much more in mental dividends to ignore so much of the hyperbolic, hysterical ‘news’ spewed about by the shock-and-awe contingency whose sole aim is to scare the tar out of us. Pardon the interruption, but the stock market does not crash at appointed dates and times.
And yet, the devilish details demand our attention. It’s easy enough to dismiss the blaring headlines about subprime car loans blowing up. They don’t amount to a hill of beans in the aggregate compared to their mortgage predecessor, so move on. But what of the news that prime losses on securitized car loans had risen while recoveries had fallen in February, a month when seasonals tend to flatter the data? That one garnered an eyebrow raise.
And then there’s that pesky data on bankruptcy filings. In all, some 81,590 commercial and consumer bankruptcies were filed in March compared to 78,372 in the same month last year. The American Bankruptcy Institute’s Executive Director Samuel Gerdano sounded the following note of caution, “Distress in the retail sector is pushing up the total number of business filings, and we’re also seeing an uptick in consumer filings from previous months.” OK, so there’s that.
Oh, yeah. What about the recent front-page Wall Street Journal article on record levels of margin debt? Did those figures give you a little itch that was hard to reach? Did it bother you more that analysts chided your “naivete,” insisting this was no cause for alarm? That always ends well. To wit, we have this gem to file away, as we would any other embarrassing and awkward teenage photos saved for future parental blackmail:
“This isn’t a signal to me that markets are reaching an exuberant level like they did in the 1920s or 1990s, when speculation was rampant,” said Jeff Mortimer, director of investment strategy at BNY Mellon Wealth Management. “What our clients are doing is borrowing against their portfolios because interest rates are so low. They’re not leveraging up because they see the market exploding to the upside; they’re using leverage because they can pay it off at any time.”
Is that so? Aspirational investors are borrowing against their brokerage accounts at an unprecedented pace because they’re savvy, not because they feel there’s easy money to be made in a stock market that knows no upper bound. And they’re just sitting on some other pile of cash that can be used to square these same margin accounts…just in case? How exactly, then, have they also managed to tack on that multi-million-dollar mortgage and tuck into that car lease payment that exceeds most Americans’ monthly rent?
Could it be that the top 20 percent is living larger than ever, aspiring to flaunt and taunt as any one-percenter would? How else does one square the desire to lease a Rolls Royce in the first place, mind you, for $1,795 a month? While the ability to finance a Rolls explains the 42-percent spike in the brand’s sales since the election, it also induces an impulse to go shower off that one data point.
Do these aspirationals begin to appreciate the condemnation their affectations attract?
A recent conversation with an executive and long-time friend at a multi-generational luxury goods purveyor was more telling than any data set. His observation was that we have full-circled back to 2006. Many of his clients are new faces to him. They are leveraged to the hilt, living in more home than they can carry, driving more car than their incomes begin to justify and whipping out their credit cards with utter abandon to finance the purchase of his sparkly trinkets. They’re behaving as if they’ve time traveled into the future and know their margin account will cover what they’ll never be able to in cold, hard cash.
He too had seen so many Rolls Royces of late that he’d caught himself trying to make sure he wasn’t seeing the same one rounding the block. He confirmed that was not the case and relayed the same wonderment I’d felt at the mall. In what was almost an afterthought, my friend added that he could never bring himself to drive a Rolls Royce, even if he could afford one (he can).
But that’s the point. He was raised better than that and retains a healthy appreciation for how harshly history has treated pretentious pretenders.
“Let’s put it this way,” Arthur Bach explained of his immense and real (fictionally-depicted) wealth, “I wish I had a dime for every dime I have.” These cinematographic carefree one-liners were a delight to the ear in 1981 and remain so to this day for those of us with good memories and a solid sense of self. But the truth is, far too many in our midst mime a real-life version of Arthur in such cavalier fashion as to invite the fates to exact their unique form of revenge. Do you think they’re conscious they’ve been warned?
While it’s true the next downturn will ravage those on Main Street, that sad reality will always represent the wicked way of the world. Trickle-down economics is a fantasy at best during good times; it’s a real bitch when the economy turns south. The real question is will those who aspire today join the ranks of those they’ve disparaged, even pitied, tomorrow? In the end, will they too be forced to ask their brothers and sisters if they can spare a dime?
Quizzically-inclined quantum physicists quench their intellectuality by quoting philosophers first, then their fellow scientists.
It is in fact questionable whether quantum physics would have come into being if not for George Berkeley’s 1710, “A Treatise Concerning the Principles of Human Knowledge.” Berkeley’s most famous saying is, ‘esse est percipi,’ or, ‘to be is to be perceived.’ He elaborated using the following examples:
“The objects of sense exist only when they are perceived: the trees therefore are in the garden, or the chairs in the parlour, no longer than while there is some body by to perceive them.” So matters of matter exist only in our mind. It is critical to note that Berkeley never posed a question but rather he made a statement of the world view through his metaphysical personal prism.
It was not until the June 1883 publication of the magazine The Chautauquan that the question was put as such: “If a tree were to fall on an island where there were no human beings would there be any sound?” Rather than pause to ponder, the answer followed that, “No. Sound is the sensation excited in the ear when the air or other medium is set in motion.”
A vexatious debate has ensued ever since, one that eventually stumped the great Albert Einstein who finally declared “God does not play dice.” In recognizing this, Einstein also resolved himself to the quantum physics conclusion, that there is no way to precisely predict where individual electrons can be found – unless, that is, you’re Divine.
Odds are high that the establishment, which looks to ride away with upcoming European elections, is emboldened by quantum physics. The entrenched parties appear set to retain their power holds, in some cases by the thinnest of margins. What is it the French say about la plus ca change? Is it truly the case that the more things change the more they stay the same?
Is this state of stasis sustainable, you might be asking? Clearly the cushy assumption is that the voices of those whose votes will not result in change will be as good as uncast, unheard and unremarkable.
Except…and this is a big ‘except’ – time is on the side of the castigated and for one simple reason – they are young. Consider Great Britain’s majority decision to leave the European Union (EU). An un-astonishing 59 percent of pensioners voted to leave the EU while only 19 percent of those between the ages of 18 and 24 supported Brexit. The aged see the EU as a cash drain at just the wrong time, and for good reason while the young view those 28 member states as the land(s) of opportunities.
With the caveat that polling has been revealed to be anything but reliable, young voters in France see things a might bit differently. Nearly half of surveyed French youth say they will vote for far-right candidate Marie Le Pen. At the opposite end of the spectrum, the dark horse far-left candidate, Jean-Luc Melechon, has enjoyed a late-stage surge in the polls by vowing to increase wages and shorten workweeks. Both insurgent camps view the lead contender, former banker Emmanuel Macron as the epitome of elitism, their ‘Hillary.’
Polls show the initial round of voting, which takes place on April 23rd, will make Macron sweat, but that he will survive to stand as the strongest contender in the second round. The status quo thus prevails, which for many represents continued economic stagnation and evasion of fiscal reforms.
Now factor in the rising recognition of the fallibility and limitations of central bankers. Mario Draghi, encouraged shall we say by the Germans, looks set to begin tapping the brakes on Europe’s answer to quantitative easing. Let’s be clear. Draghi has made it plain that he won’t go down without a fight. Nonetheless, it appears monetary policy will slowly become less accommodating, dragging on growth in the peripheral countries.
And then there is the matter of the refugee crisis, the cost of which few in the United States fully appreciate. Faced with impossible living conditions and no access to work in Jordan, Turkey and Lebanon, hundreds of thousands have opted to risk the journey to Europe. In 2015, 1.3 million asylum seekers landed in Europe, half of whom traced their origins to Syria, Afghanistan and Iraq. That number plunged in 2016 to 364,000 owing mainly to a deal between the EU and Turkey which blocks the flow of migrants to Europe.
The cost, not surprisingly, is enormous. Europeans spend at least $30,000 for every refugee who lands on her shores. By some estimates, the cost would have been one-tenth that, as in $3,000 per refugee, had the journey to Europe NOT been made in the first place.
Of course, aid money helps cover the cost of the crisis. Some $15.4 billion, about 10 percent of global aid monies raised in 2016, was directed to hosting and processing migrants in developed countries last year. While charity lessens the burden, it can’t staunch anger at headline-grabbing statistics claiming that Chancellor Angela Merkel’s ‘failed migrant policy’ will cost German and EU taxpayers $46 billion in the two years ending 2017.
Fear thee not, the consensus is that September’s elections in Germany will come and go with little to no fanfare; pro-Europe candidates enjoy wide leads in the polls. Many macroeconomists expect the year to end with the strongest ties in generations between Germany and the rest of the eurozone, led by France. Bullish analysts expect the euro to shake its jitters and end the year above €1.10.
The biggest obstacle to a happy ending, for the time being at least, comes down to Italy. General elections must take place by May 2018 but an early vote remains a possibility if the current prime minister of the eurozone’s third-largest economy does not survive the year. Investors, for their part, yawn at the mention of Italy. As the Wall Street Journal pointed out in a recent story, numbness tends to set in after 44 governments have come and gone in the space of 50 years.
The most recent survey revealed a record one-in-three Italians would vote the Five-Star Movement into power if elections took place today. The rebellious, populist party has tapped the anxieties of Italians whose per capita economic output has suffered the most since the euro was formed in 1999. Even the Greeks can claim to have suffered less.
Is an Italian uprising in the cards? The bond market certainly doesn’t buy into the potential for major disruption, grazie Signore Draghi.
At some point demographics will start to matter. The situation in France is no doubt grave, with youth unemployment at nearly 24 percent. But that pales in comparison to Italy where 39 percent of its young workers don’t have jobs to go to, day in and day out. Older voters determined to keep the establishment intact will begin to die off. In their wake will be a growing majority of voters who are increasingly disenfranchised, disaffected and despondent.
If there’s one lesson Europeans can glean from their allies across the Atlantic, it’s that bullets can be dodged, but not indefinitely. As we are learning the hard way, necessary reforms are challenging to enact. Avoidance, though, will only succeed in feeding anger and despair. The longer the voices of the desperate go unheard, as just so many silently falling trees in the forest, the more piercing their cries will be in the end.
Had it not been for the genius of Thomas Crapper, champion inventor of the water-waste-preventing cistern syphon, Victorians would have been left to make their trek to that malodorous darker place otherwise known as the Out House, or perhaps the crockery pot stashed under the bed for a while longer.
Born in 1836, Crapper was apprenticed to a master plumber at the tender (today) age of 14 and had hung his shingle in Chelsea by his mid-twenties. Such was Crapper’s renown and stellar reputation, that even the Royals themselves were early adopters. The Prince of Wales, later King Edward VII, is the first known to grace the invention with his regal rear. Windsor Castle, Buckingham Palace and Westminster Abbey would be appointed in short order ensuring safe and sanitarily stately relief as the royal “We” traveled from castle to castle.
Of course, it took rude Americans to nick his last name, giving future generations of boisterous boys endless joy at having a humorous potty word to reference the potty. Crapper took great pride in publicly peddling his patented products. Legend has it prim British ladies would faint upon happening upon his Marlborough Road shop, such was the shock at the sight of this and that model of the technological wonder behind huge pane glass windows.
By our very nature, we are nothing if not imperfect, Crapper included. One of his innovative inventions fell flat, or better put, jumped too high. It would seem his spring-loaded loo seat, which leapt upwards as derrieres ascended, automating flushing in the process, was too ill-conceived and thus ill-fated, to be purveyed after all.
No one likes a rude slap on the bottom, bond market investors especially. Perhaps that’s why there’s such irritability among traders who prefer clarity above all, even as bond yields flash danger ahead. Just a guess here but all that angst could reflect concerns about a different sort of plumber, of the central banker ilk.
It’s no secret the plumbers at the Federal Reserve are feverishly at work devising a way to unwind their $4.5 trillion war chest of a balance sheet. Officials claim their carefully devised maneuvers will nary elicit an inkling of a disturbance in the markets they’ve coddled all these years with billions of dollars of purchases, month-in, month-out. But one must wonder, at the timing, at the ostensive optics, if nothing else.
Fed Chair Janet Yellen insists that economic recoveries do not die of old age. But why chance it? Unless, that is, the motivations of shrinkage are less than magnanimous and dare one say, immoral.
Consider the Fed’s Commander in Chief herself. Back in December 2011, then Vice Chair Yellen pushed back against the majority of those on the Federal Open Market Committee (FOMC). The time was ripe for more cowbell. She argued that “a compelling case for further policy accommodation” could be made despite visible green shoots in the labor market and business spending. The consummate dove, she added that while they were at it, why not commit to the Fed sitting on its hands until late 2014 from what was then mid-2013?
Why yes, since you raise the subject, a presidential election was indeed a matter of months away.
Take a step back further in time if you will, to August 2011. Though it is maintained that the subject of politics at FOMC meetings is unseemly, as religion is to cocktail parties, the upcoming election was too front and center to ignore given the subject of debate among committee members.
At the time, the markets were interpreting the Fed’s pledge to keep interest rates tethered to the zero bound for “an extended period” as several meetings. For markets, that period of time was sufficiently brief to begin to price in an impending tightening cycle, an abhorrent assumption to the dovish coalition who had several years, not meetings, in mind.
How best to broadcast the Fed was anything but a commitment-phobe? That’s easy. Do what the Fed did throughout its foray into unconventional policymaking and guarantee results the best way econometricians can, with a numeric commitment, in this case through “mid-2013.”
God love St. Louis Fed President James Bullard for piping up with this following gem: “It will look very political to delay any rate hikes until after the election. I think that will also damage our credibility. I also doubt that we can credibly promise what this committee may or may not do two years from now.”
Score two for St. Louis! Political tinder and who the heck knows where economy will be in two years!
Dallas Fed President Richard Fisher (full disclosure – the man I once simply referred to as ‘boss’) concurred: “The ‘2013’ just looks too politically convenient, and I don’t want to fall back into people being suspicious about the way we conduct our business.”
According to the transcripts, former Fed Governor Daniel Tarullo offered a helping hand with the suggestion that perhaps Fisher would be happier with committing all the way out to 2014. Lovely. And this coming from an individual who sported his Obama bumper sticker for years driving in and out of the parking garage.
For the record, then Chairman Ben Bernanke sided with the doves, defending the move to make binding for a set period the promise to keep rates on the floor. In the end, Bernanke withstood three dissenting votes though not without a fight.
Perhaps what’s most noteworthy is that no fewer than 20 pages of transcripts are devoted to Bernanke’s best efforts to quash the dissents. That’s a problem in and of itself. Healthy dissent should make for a healthy institution. Plus, common sense tells you markets never give back what you give. The time committed was downright irresponsible and all but set the stage for future market temper and taper tantrums.
You may note that the dissenting voices of reason never prevailed, hence the aforementioned $4.5 trillion balance sheet. That’s what makes the doves’ dogged determination to tighten on two fronts so damning. It’s clear that politics got us into this monetary quagmire and that politics will also land us in recession.
To be fair, recessions are inevitabilities down here on Planet Earth where business cycles are permitted to be cyclical. Just the same, for a group of folks who’ve done backbends for years endeavoring to prolong the recovery at all costs, it’s plain odd that they’re even flirting with shrinking the very balance sheet that secures their power base as Type A monetary control freaks.
The good news, for those fearing having to enter monetary rehab, is that it’s going to take a mighty long time to shrink the balance sheet. The fine folks over at Goldman Sachs figure that getting from Point A ($4.5 trillion) to Point B ($2 trillion based on balance sheet contracting just over a tenth the size of the country’s GDP) will take at least five years.
(An aside for you insomniacs out there: Have a look back at Mind the Cap, penned back on December 16, 2015, released hours before the Fed hiked rates for the first time in order to raise the cap on the Reverse Repo Facility (RRP) to $2 trillion. (Mind The Cap via DiMartinobooth.com) Come what may, you can consider Goldman’s estimate of the terminal value of a $2 trillion balance sheet and the size of the RRP to be anything but coincidental.)
In any event, things change. As per Goldman, by 2022, “…changes in Fed leadership, regulation, Treasury issuance policy, or macroeconomic conditions could alter both the near-term path and the intended terminal size of the balance sheet.” Indeed.
It is entertaining to watch market pundits shift in their skivvies trying to assure the masses that a shrinking balance sheet will be welcomed by risky assets. It was downright comical to read that the Fed’s strategically allowing only long-dated Treasuries to expire and not be replaced would prevent the yield curve from inverting, thus staving off recession.
Pardon the interruption, but domestic non-financial sector debt stood at about 140 percent of GDP in 1980. Today, it’s crested 250 percent of GDP and keeps rising. Interest rate sensitivity, especially in commercial real estate, household finance and junk bonds is particularly acute. Oh, and by the way, monetary policy is a global phenomenon. At last check, the European periphery and emerging market corporate bond market were not in the best position to weather a rising rate environment.
The best performance, though, was delivered by Chair Janet Yellen herself. In the spirit of giving credit its due, Business Insider’s Pedro da Costa highlighted this delightful nugget from testimony Yellen presented to Congress in February: “Waiting too long to remove accommodation would be unwise, potentially requiring the FOMC to eventually raise rates rapidly, which could risk disrupting the financial markets and pushing the economy into recession.”
Isn’t the rapidly flattening yield curve communicating that ‘removing accommodation’ today is one and the same with ‘pushing the economy into recession’? In Da Costa’s words, this preemptive philosophy is “dubious” and akin to, “a modern-day finance version of bleeding the patient to cure it.” Hope you’ll agree that leeching has no more place in modern medicine than outhouses do in our backyards.
Even as the Fed battles its own public relations nightmare, it would seem policymakers intend to follow through on their threat to tighten on two fronts, though not concurrently. Will President Trump pass the test and stand firm on reinstating leaders at the Fed who will transform it into a less compromised, more apolitical institution? Or will Trump fold, opting to keep the doves in command?
It’s just a hunch, but a less-threatened Fed could just as easily be expected to back down on shrinking the balance sheet. Given where the economy looks headed, newly empowered doves might even be inclined to grow the balance sheet anew. Stranger things or political posturing? You tell me and while you’re at it, ever noticed the word, ‘die’ is embedded in the word, ‘diet’? Let’s just say bulking up is easier done than slimming down.
Toro, toro? Hankering for Hamachi?
Have an urge for uni? In Midtown? Well then, head west, to 8th Avenue to be precise. And keep walking, west that is. But go easy on the sake if you’ve got a sushi crawl in mind. No fewer than six fine purveyors of some of the best raw fish on the isle of Manhattan await you. Clearly the law of game theory applies to more than just clusters of gas stations.
Not sure you’d agree, but game theory made the study of economics engaging. The brain teaser’s roots date back to the 1920s with the work of John von Neumann. His work culminated in a book he co-wrote with Oskar Morgenstern which delves into the oxymoronic theory in its most straightforward form – a ‘zero-sum’ game wherein the interests of two players are strictly opposed.
But it was John Nash who elevated the theory to fame. The eminent Nash Equilibrium added practicality to the theory and opened the door to nuance. The ‘players’ were numerous and shared both common interests and rivalries. Hence six sushi spots in one square block and a handful more a few steps in either direction.
But what happens when game theory hits reverse gear? Is such a thing possible? The answer may be coming soon to a mall near you, maybe even one with its theatre and Sears still standing. Huh?
Developed in 1973, Valley View Mall rose to be a retail darling on the 1980s Dallas shopping scene. Even its name worked well with an iconic mall-era film (Why Valley Girl, of course! (Retailing in America: Valley Girl (Interrupted) Foley’s, Macy’s Bloomingdale’s anyone? All of these icons anchored Valley View at one point or another.
But that was then, in a pre-Amazon world, when people clearly got out more and discretionary spending was more discrete. In December 2016, the mall literally began to be bulldozed, albeit with two tenants still operating amidst the dust storm – Sears and AMC Theatres. On March 21st, the world learned that it could soon be just the theater left standing.
Though the Valley View Sears will still be open today from 11 am to 8 pm, odds are the retailer will not be with us in a year’s time. On March 21st, Sears Holding Corporation submitted a filing with its regulators that it has “substantial doubt” it can continue as a “going concern.”
Don’t recall companies being charged with making their own death throes’ announcements from your Accounting coursework? You are correct. Meet the new and improved U.S. accounting rules that have just come into effect for public companies reporting annual periods that ended after December 15, 2016, Sears included. The change shifted the onus to disclose from a given company’s auditors to its management.
It was telling that the Sears news fell on the very same day discount retailer Payless announced it could soon file for bankruptcy protection. That same day, the less ubiquitous Bebe female fashion chain said it too was ‘exploring strategic options,’ typically code for that same ill-fated Chapter in the court system.
Did Sears strategically time its disclosure? Not in the least according to the retailer’s CFO Jason Hollar. The day after the disastrous disclosure, he blogged out that the ‘going concern’ reference simply complied with regulators’ requirements that investors be apprised of any risks looming over the horizon. Hollar went so far as to say that Sears is a, “viable business that can meet its financial and other obligations for the foreseeable future.” Don’t shoot the messenger, but selling Craftsman, the last valuable jewel in the once encrusted crown, certainly doesn’t suggest that much of a ‘future.”
Unless, that is, the reassurances come down to CEO Edward Lampert trying his level best to play game theory in reverse. That would entail capitalizing on the dying chain’s real estate holdings before the rest of the players on life support clue in to just how dire the situation will soon be across the full commercial real estate spectrum. Lampert does, after all, run a hedge fund that happens to be the retailer’s second-largest shareholder. You would agree, the best managers excel at games.
One does have to marvel at the degree of denial among retailers when websites such as deadmalls.com actively track shuttering structures.
At the opposite end of the denial spectrum sits Boston Fed President Eric Rosengren, who is and has been publicly worried about an entirely different sort of challenge facing the real estate market.
It’s no secret that apartment prices are soaring. Over the past year, prices have risen 11 percent, leading the broad market. While that increase may seem benign in and of itself, consider how the sector has fared over the course of the recovery: prices have recouped an eye-watering 240 percent of their peak-to-trough losses. In sharp contrast, retail has performed the worst; it’s only recovered 96 percent of its losses.
Rosengren is rightly worried that the “sharp” increase in apartment prices could catalyze financial instability. He went on to say that, “Because real estate holdings are widespread, and the monetary and macro-prudential tools for handling valuation concerns are somewhat limited, I believe we must acknowledge that the commercial real estate sector has the potential to amplify whatever problems may emerge when we at some point face an economic downturn.”
If you would indulge a translation: The bubble in commercial real estate (CRE) could trigger systemic risk, which of course, no central bank can contain.
The ‘macro-prudential’ tools to which Rosengren refers include rules and caps on banks’ exposure to CRE. Odds are, however, that the horse has already fled the barn. Over the past five years, CRE lending has been running at roughly double economic growth, a dangerous dynamic. The result: banks’ exposure to CRE has reached record levels. Last year alone, bank holdings of CRE and multifamily mortgages rose nine and 12 percent, respectively.
More worrisome yet is that the most concentrated cohort – those with more than 300 percent of their risk-based capital at risk – is banks with less than $50 billion in assets; most have assets south of $10 billion. How exactly will small banks confront a systemic risk conflagration? That pesky potential presumably is what’s robbing Rosengren of sleep at night. He might just remember that small German lenders called Landesbanks were where subprime bombs detonated unexpectedly way back when.
Beginning to connect the dots? All of this lending has led to massive amounts of building. After troughing at an annualized rate of 82,000 units in late 2009, multifamily starts hit a 387,000-annualized rate last year – a neat 372 percent rebound. Permits data suggest 2017 will push an equal number of units onto the market while 2018 looks to be about three percent below these lofty decade-high levels. There are similar supply stories in the hotel sector, which has led to the beginning of the end for lodging. Indeed, prices across the full CRE market have begun to fall for the first time since 2009.
Take all of these moving pieces into account and ask yourself, is it any wonder retailers are rushing the exits, all but falling over one another to accelerate announcements of thousands of store closures? As ugly as the situation is today, if widespread panic promises to present itself, prospects for retailers will get that much nastier. Demolition specialists will soon forget what it was to have down time and headlines screaming about malls sold for $1 will lose their novelty.
Is Sears’ Lampert craftily capitalizing on a trend he saw coming first, giving new meaning to ‘first mover advantage’? Is retail on the receiving end of reverse game theory? John Nash would be so proud.