THREEofTHREE, Danielle DiMartino booth, Money Strong

Pricing in Perfection: Three out of Three?

We know two out of three ain’t bad. Does that render three out of three perfection itself? The history of the number three certainly suggests that to be the case. Little did we know that three is the first number bequeathed ‘all-encompassing’ status.

True Triads come in many familiar forms including the Father, Son and Holy Spirit; the beginning, middle and the end; the heaven, earth and waters; the body, soul and spirit; and last but certainly not least — life, liberty and happiness.

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Economy, Pensions, DiMartino Booth, Danielle DiMartino Booth, Money Strong LLC, Fed Up: An Insider's Guide to why the Federal Reserve is Bad for America,

Retirement in America: The Rise of the Velvet Rope

Before there was the One Percent, there was the velvet rope at Studio 54.

Gaining entry to the divine disco, with its adherence to a strict formula, was just as exclusionary. This from Mark Fleischman, the Manhattan haunt’s second owner in a memoir released to mark the 40th anniversary of the club’s opening:  “A movie star could bring unlimited guests, a prince or princess could invite five or six guests, counts and countesses four, most other VIPs three, and so on.”

Andy Warhol called it the, “dictatorship at the door.” Brigid Berlin, one of Warhol’s Factory workers and guests, once described to Vanity Fair how she, “loved getting out of a cab and seeing those long lines of people who couldn’t get in.” If beauty alone could sway the dandy doorman, famed for flaunting his fur, a different kind of cordon awaited you once you set foot inside the cavernous strobe-lit mecca, that is a screen hung across the dance floor to separate the chosen from the common. The scrim summarily dropped at midnight, but not a minute before, affording elites ample opportunity to make their escape to the VIP floors above.

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ICYMI.ddb, In Case You Missed It — August 4, 2017

In Case You Missed It — July 28, 2017

Dear friends,

Calling turning points can be a fool’s game. But there is something to be said for the deathly quiet we’ve seen in the jobs market. Jobless claims volatility is at a postwar low even as companies have begun to cite cost cutting as the major driver behind job cut announcements. Is that ‘something’ finally about to give in this recovery that has left so many behind?

I’d love your feedback on my latest Bloomberg Prophets column, linked here:

Bloomberg Prophets — Like Markets, Jobs Are Due for a Jolt
Volatility for labor has reached its lowest in postwar history. What’s next?

I was also in New York ever so briefly as it was the day Fed officials met. Janet Yellen et al took the opportunity of a lame duck meeting to toughen up their language on Quantitative Tightening despite there being np press conference to explain themselves.

Will the Fed begin to shrink its mammoth balance sheet as early as September? Will the opposite of Quantitative Easing have no effect at all on markets? We will all tune in to FedSpeak in the weeks and months to come. The debate will no doubt continue to rage on.

You may be asking why I included a Bill Gross segment. As I was informed shortly after I left the set, CNBC’s Brian Sullivan gave self-deprecation new meaning when he claimed he was not as smart as me. I can assure you after many interviews sitting to his left, Brian is one smart cookie and a might bit smarter than yours truly.

A Few TV Stops in New York on Fed Day

Expert: Fed Fires ‘Shot Across the Bow’ on Balance Sheet Reduction
CNBC The Fed — Danielle DiMartino Booth

No One Knows How the Markets Will React to the Federal Reserve’s ‘Quantitative Tightening’
The Street — Danielle DiMartino Booth

Fed is Shifting its Focus to Balance Sheet Reduction instead of Interest Rates
CNBC The Fed — Bill Gross

On a personal note, I am delighted so many of you have subscribed. Next Wednesday marks the onset of a new journey and I am gratified to have you along. Bottoms up, friends and new subscribers! I raise my glass to you!

If you have not yet subscribed, please email subscription@dimartinobooth.com and type ‘Subscribe’ in the title line.

This weekend and next, wishing you well,

 

Danielle

DiMartino Booth, Fed Up, Will Corporate Bonds Cross Over?

Will Corporate Bonds Cross Over?

It started out kinda ‘Crazy,’ in 1961 to be exact. A 20-something-year-old bass player by the name of Willie Nelson had written a song which he generously offered up to country singer Billy Walker. Walker, however, perceived the lilting lyrics to be a bit too feminine, so he passed. The late Patsy Cline would be forever grateful to Willie for ‘Crazy,’ which she sultrily sang to stardom, and in doing so, founded a movement.

We’re familiar with what followed, from the hobo portrayed as ‘King of the Road’ to the petulant moment, ‘The day my momma socked it to the Harper Valley PTA.” Even the most vacuous pop music acolytes couldn’t help but to let Olivia Newton John know they loved her. Did they ever let her know! And who didn’t want to emulate Glenn Campbell? Even those 1975 disco divas velvet-roping at Studio 54 dreamed of landing the perfect Rhinestone Cowboy.

Year in and year out, Crossover Country hits made traitors of pop purists. Even Willie finally got his mainstream due, with 1982’s No. 5 pop chart hit, “Always on my Mind.” It wasn’t until 1983, when Dolly Parton & Kenny Rogers met on “Islands in the Stream,” taking the hit all the way to No. 1 on the charts, that crossover crossed back over to strictly Country terrain.

And now there is Sam Hunt. Never heard of him? Chances are you can recite a line or two from ‘Body Like a Back Road,’ Hunt’s Crossover Country megahit that recently landed at No. 6 on the Billboard 100. Even if you choose to be obtuse about what the song is about, you can’t help but roll the windows down and sing about “Doin’ 15 in a 30.”

That is, unless you’ve recently hit our country’s byways and all but screamed at that infuriating Sunday driver who only adheres to half the law, that is, doesn’t comprehend Slower Traffic Keep Right (!)

Unbeknownst to unassuming corporate bond holders, they too will soon be forced into the slow lane. For the moment, the vast majority fancy themselves that equally exasperating driver who won’t get out of the fast lane, determined to bully their way to their damned destination. As for the perils of tailgating, they’re for the other guy, the less agile driver with rubbery reflexes.

That’s all good and well and has been for many years. Bond market fender benders are nearly nonexistent. The question is: Will central bankers worldwide turn placid parkways into highways to hell as they ‘remove accommodation,’ to borrow from their gently genteel jargon? That’s certainly one way to interpret Federal Reserve Chair Janet Yellen’s latest promise to shrink the balance sheet ‘appreciably.’

Care for a translation? How easily does “Aggressive Quantitative Tightening” roll off the tongue? Perhaps you’ve just bitten yours instead.

Enter the International Monetary Fund (IMF), The Institute of International Finance (IIF), The Bank of International Settlements (BIS), and by the way, the Emerging Markets complex including and especially China.

As a former central banker, it is with embarrassing ease yours truly can bandy about fantastic figures. No surprise that nary an eyebrow was raised at the latest figures out of the IIF that aggregate global debt is closing in on $220 trillion, as touched on last week. Consider that to be the broad backdrop.

Now, narrow in on the IMF’s concerns that financial stability could be rocked by a rumble in US corporate debt markets. Using firms’ capacity to service their debts from current earnings as a simple and elegant yard stick, the report warned that one in ten firms are failing outright.

The last two years of levering up have exacted rapid damage: earnings have fallen to less than six times interest expense, this during an era of unprecedented low interest rates. And as record non-financial debt as a percentage of GDP quickly approaches 50 percent, the share of income required to service this mountain is at a seven-year high. Should financial conditions tighten (the report was published in April prior to the Fed’s June rate hike), one-in-five firms are likely to default, which rises to 22 percent if rates continue to rise.

A separate signal of distress flickers into focus when one considers the sectors most at risk. Add up energy, real estate and utilities and you get to about half of the at-risk debt. And we wonder why Boston Fed President Eric Rosengren is perturbed about commercial real estate (CRE) and the risks it poses to the banking system.

A few bullets on CRE:

  • Smaller banks with less than $50 billion in assets hold $1.2 trillion of the $3.8 trillion in outstanding CRE debt. Larger banks are relatively less exposed, with $767 billion. This begs the question why the Fed chose this year to not stress test the smaller banks?
  • Bank holdings of CRE have risen nine percent over the last year; multifamily is up 12 percent.
  • Despite skyrocketing rents, multifamily prices have risen so much faster that “cap” rates (net operating income divided by the property price) have sunk to a 16-year low.

Why deviate to a CRE chit-chat in the middle of a corporate bond discussion? In so many words, financing is financing. Whether it’s the capital markets the Fed has kept wide open or banks, companies need access to sources of leverage, especially in times of need and extra especially in times of illiquidity. Stressed smaller banks in particular will be inhibited in their ability to extend lifelines to smaller companies in the coming years.

Speaking of illiquidity but not of small banks, over the past seven years, assets on the biggest banks’ balance sheets have fallen from $5 trillion to $3 trillion. Zero in on corporate bond inventories and you find that dealer holdings have collapsed by 75 percent since the onset of the financial crisis.

Who’s taken up the slack? Whom, pray tell, do you, Joe Q Bond Fund Manager, ping when you need to offload a few billion in bonds? Let’s just say the nontraditional entrants who provide bond market liquidity during the next rout won’t be nearly as polite when it comes to maintaining market stability and pricing. They might even behave a bit like vultures. The more you need to sell, the lower the price.

For this neat noose secured round our necks, we have the regulators to thank. Will bond investors sing along to the greatest hit that has yet to be released by those Rocking Regulatory trio of Dodd, Frank & Basel? Tossing tomatoes onto the stage will more likely be the case.

In the event you’ve begun to sweat, you might want to reach for more than a Kleenex. In a normal world, the bulk of the risk inherent in owning bonds was credit-related. But years of distortive low-interest rate policy have flipped bonds’ risk/return dynamic on its head. Using Barclays US-dollar Aggregate Corporate Bond Index, ‘duration’ now accounts for 90 percent of the risk of holdings bonds, with the balance related to credit; that’s up from 37 percent in 2013. Think of duration as your bonds’ sensitivity to interest rate risk. Kind of gives a whole new meaning to no sudden moves.

Thank heavens for geographic diversification? Ah, you must refer to those essential emerging markets (EM) bond holdings, a must have for any discerning investor. No doubt, they’re the ‘it’ girl. Dollar-denominated EM debt sales were already up 160 percent through May over 2016 to $160 billion, marking the fastest annual start to the year since 1999.

Let’s just say the Bank of International Settlements (BIS) isn’t quite so enthusiastic. The BIS is often referred to as the central bank to central banks. In its estimation, there is a total of $3 trillion in dollar-denominated EM credit worldwide. The BIS’ chief economist Claudio Borio warned in the BIS’ recently released annual report that, “dollar funding remains a potential pressure point in the international monetary and financial system.”

The IMF concurred, warning that in a tightening environment, “the weak tail of emerging economy firms” would be highly vulnerable. The report added that, “A sustained reversal of capital inflows would put pressure on countries with high external financing and/or low reserve adequacy.”

At least China’s got that going for it, as in $3 trillion in foreign reserves. The problem is that only a trillion is considered to be truly liquid, while another trillion is earmarked to build that expanse of infrastructure connecting China to the western world once and for all. After all, you don’t become dominant by being isolationists. Oops, well you get the point.

The BIS estimates that Chinese corporate debt is 169 percent of its GDP. Would you believe that eye-watering and disconcerting figure is realistically on the light side? My good friend Leland Miller sagely suggests one apply the apropos grain of salt to what Chinese statisticians generously refer to as ‘GDP.’ So round down the denominator, way down. Add in the fact the corporations might not be fessing up to what their liabilities really are (who wants to be Debbie Downer?) and or never repay it so why report it? So round up the numerator, way up.

And, you guessed it, who in the world can say with any authority how buried in debt Chinese corporations are? So there’s that lovely black box to ponder.

The takeaway is that ‘bonds’ just ain’t what they used to be. Don’t be comforted by your broker telling you they help you diversify or that they carry bullet proof credit ratings. Sit him or her down instead and warn of the real risks of swollen durations, of bonds of all stripes slipping into rusty junkyards, of our portfolios’ safest holdings crossing over, and not in the good way those country hits do for us pop enthusiasts.

Do yourself a favor. Have a listen to Body like a Back Road. It’s easy enough to find in your car, on that mean machine at the gym, or wherever you prefer to slow down and have a listen. You’ll be grateful you did as summer drags on, closing your eyes and imagining the luxury of going 15 in a 30. It beats the heck out of what your bonds are apt to do when inclement weather hits, which will feel more like going 100 in a 50 on bald tires. And who wants to listen to that?

DiMartino Booth, Housing in America: Movin’ on Up

Housing in America: Movin’ on Up

While exceptional exceptions exist, history’s shown superb sitcom sequels to be scant.

With any luck, you’ve long since forgotten the abysmal attempts of “AfterMASH,” “The Brady Brides,” “The Love Boat: The Next Wave,” and possibly the worst of the bunch, “Jonie Loves Chachi.” These small screen sideshows failed to give us Good Times, nor did they endear us to characters we still hold dear – Benson, Frasier, Laverne, Shirley, Maude, Mork and the lovely Mindy.

These disastrous debacles did anything but invite us to sing along to their opening songs. There was no, Movin’ on Up to the east side, to a deluxe apartment in the sky. Ah, The Jeffersons, which premiered in 1975 and ran for 11 seasons. Rolling Stone Magazine ranked it the fifth-best TV spin-off of all time. Think of it as the gift that All in the Family kept giving as only the brilliant creator of both George and Archie, Norman Lear, could deliver.

The beauty of The Jeffersons was the ease with which its characters elicited laughter. No longer was it 1971, when Archie Bunker’s angry sarcasm resonated so clearly with American viewers, whose own tempers were still flaring from the searing ‘60s. By 1975, we were all in the need of George Jefferson’s victory walk across the screen and the derision it elicited from Florence, the housekeeper who gave new meaning to cynically caustic comebacks.

It’s worth asking how valid the premise of The Jeffersons would be today. What are the odds a successful, entrepreneurial dry cleaner from Queens could pull up stakes and relocate to a luxury apartment at 185 East 85th Street in the Park Lane Towers? You tell me: units are available in the building with monthly rents starting at a cool $18,200.

Granted, this is an extreme example. According to Axiometrics, the national average annual rental rate is $1,304. While that figure is a record in dollar terms, there is much better news in the underlying trend of rental inflation. In May, effective annual rent growth rate was 2.2-percent, a level that’s held steady for the past six months. Critically, the rate has more than halved since its record pace of 5.2-percent was clocked in September 2015.

Chances are we will see a continued leveling off in rental inflation. Apartment construction is running at its highest level in at least 25 years. Nearly 600,000 units are currently under construction nationwide. Deliveries are forecast to be 102,000 in the third and fourth quarters, up appreciably from the average 82,000 per quarter in 2016 and early 2017. Looking out over the horizon, one million units will hit the market in the next three years.

This should be welcome news for renters. (Do you sense a however coming your way?) However, the vast majority of new construction in recent years has been in luxury units. That helps explain why half of would-be renters cannot afford to set out on their own – that $1,300-plus monthly pill is too big to swallow based on the affordability standard of 30 percent of income.

That’s assuming, mind you, you draw a decent salary. According to a recent report detailed in the Washington Post, no city in America has low enough rents on two-bedroom apartments for someone earning minimum wage to call home. All of 12 counties nationwide boast rents low enough for minimum-wage earners to let, that is if they can confine their belongings into a one-bedroom unit.

If you thought location mattered most when it came to buying, think again; it’s an even more critical determinant of rents. The minimum hourly wage you’d need to afford to rent in some counties in Georgia is $11.46. Meanwhile, across the country in the San Francisco Bay Area, you’d need to be raking in $58.04 an hour. Good luck with that commute teachers and nurses!

The report went on to say that things have only gotten worse since the Great Financial Crisis. In the eight years through 2015, average inflation-adjusted apartment rents rose by six percent while that of real wages fell by four percent. The upshot: some 11.2 million US households spend over half their income just to put a roof over their heads.

As big as that ‘however’ was, there’s an even bigger caveat that follows: Demographics suggest demand for apartments will only continue to increase in the coming years. Some 4.6 million MORE apartments will need to come online between now and 2030. That’s according to a fresh study jointly commissioned by the National Multifamily Housing Council and the National Apartment Association (Caution: Always consider potential bias of source).

It’s helpful to provide some context. The 4.6-million-unit figure is not altogether shocking against the backdrop of the million new renter households that have formed in every single one of the last five years, a record run rate as coming-of-age Millennials competed with downsizing Baby Boomers for apartments.

The question comes down to whether this momentum can be sustained. Will we really see annual construction of at least 325,000 new apartments for the next 12 years to satisfy this forecasted demand? It’s highly doubtful. It would require the massive imbalance that’s favored apartments over single-family construction to persist, which we know won’t be the case as the homeownership rate appears to have finally bottomed and begun to recover.

More to the point, Baby Boomers’ vacated homes don’t magically vanish into thin air keeping supply and demand in some beautiful balance only a realtor’s imagination could conjure. Every one of their homes sold adds to the supply that’s been ‘depleted’ in recent years by deep-pocketed private equity buyers who’ve swarmed markets from coast to coast to find a home for all that dry powder in their kegs.

Let’s be clear, Boomers have clearly indicated they’d prefer to sit tight, to age in their home sweet homes. Buy Home Depot stock and call it a day? That tall ‘buy’ order requires suspended animation, as in the presumption that recession will be held at bay indefinitely.

The reality of Boomer home sales won’t come into full view until we’re bearing the brunt of the next downturn. That cataclysmic catalyst will kill the optionality of aging in home. Millions of retirees on fixed incomes will buckle under the strain of their deflating retirement savings and skyrocketing property taxes, forced up to stem the bleed of underfunded pensions, which will also blow up at the intersection of Demographics and Recession Boulevards.

Wait. Go back to that part about private equity and their massive inventories of also-aging single-family rentals. Rest assured, these fly boys are not in it for the long haul despite what their propaganda purports. It’s just not in their DNA. Yes, the single-family-rental business is established. Heck, they’ve got bonds backed by these investment-cum-income properties that trade in the secondary market.

That’s all good and well until surging supply corrodes the collateral backing those securities. At that point, the big boys will do what they do best at the first whiff of a sell signal. They’ll hit the bid and hit it again to liquidate their portfolios ahead of the little guys who unwittingly followed them into the next-best-thing business.

So you’ve got supply conjuring more supply yet…which brings us back to apartment rents and some good news for that ‘lost’ generation, the Millennials. Believe it or not, these no-longer-youngsters will procreate. Furthermore, they will not cotton to raising their families in apartments, even of the George and “Weezie” Jefferson deluxe variety.

So there is good news in the making, if you can indulge one more ‘however’. At last check, student loans had not been forgiven in wholesale fashion. Top this with the fact that the average new home sales price hit $351,000 in 2015, a neat 40 percent rise from 2009. Holding hands with this dynamic household budget-buster duo is mortgage lending standards, which have been too tight for far too long. Taken together, Millennials could no sooner afford Boomers’ McMansions than a man in the moon.

That is, unless Millennials are in a position to leap frog prior generations and jump right in to move-up market. How so?  Despite what the realtors tell you, there will be ramifications that emanate from the largest age cohort in America failing to fulfill their designated role as first-time homebuyers in the current recovery. Millennials’ power-in-numbers will force the closure of the price gap between entry-level, move-up-to-after-second-child-born, and die-in homes.

You might be thinking the resurgence of affordability (Yes, Virginia, that is good news), and the home-price and rent declines it necessitates, will not be welcome news all around. Lower selling prices will obviously sting sellers.

The only advice on offer:  write in a complaint to your local Federal Reserve representative. It was failed Fed policy that created this fine mess in the first place.

Don’t see the connection?

Do any of us truly buy into the notion that private equity could have assumed the role of buyer of first resort had the Fed not lingered too long in its capacity of lender of last resort? Of course not! As for all of that luxury apartment construction, you try making the IRR work out for low-yielding properties in a zero-interest-rate environment.

The sad fact is buying and renting have never been so prohibitively, preciously priced. We can safely add that to the laundry list of obscene outgrowths of too-low-for-too-long monetary policy. You know, it sure would be nice if some Fed staffer could concoct a convincing model that shows how detrimental income inequality is to long-term macroeconomic growth prospects. Is it too intuitive for intellectuals to infer that housing is the biggest line item in an average household’s budget?

There is one last ‘however’ before we turn our attention to counting the words in today’s Fed statement.

As the headlines have heralded, one-percent down payments and subprime mortgage lending have finally staged a comeback. While such news is no doubt a relief to the politicians who are already agitating about the midterm elections (homeownership trumps baby-kissing every day of the week), easing lending standards should not be viewed as a palliative at this stage in the cycle, before prices come off their high boil.

We still have millions of conscientious subprime-mortgage homeowners who have never missed a payment in our midst, millions who are still underwater over a decade after home prices peaked the last time around, millions who remain imprisoned in homes they should have never qualified to buy. As they’ve learned the hard way, it’s impossible to Move on Up if you Dig in Too Deep.

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The Demographic Divide: A Police State of Mind

The Demographic Divide: A Police State of Mind

Fake news is so old.

How else did, “I am prepared to veto any bill that has as its purpose a federal bailout of New York City to prevent a default,” become, “DROP DEAD” way back in October, 1975? Oh, those hellbent headline writers. Whatever will they think of next? Besides, the Daily News headline worked wonders, if infuriating die hard New Yorkers was the objective.

The insult so unhinged one William Martin Joel that he soon found himself saying goodbye to Hollywood and headed back to his native New York by way of a Greyhound bus on the Hudson River Line. Had the songwriter and singer we’ve all come to know and love as Billy Joel not been on that bus, he’d have never been inspired to pen the classic New York State of Mind, an anthem to the City only Sinatra himself can claim to have bested in his time.

So thank you, President Ford for refusing to treat the “insidious disease.” At least that’s how he characterized New York’s profligate spending ways. Without the media’s dramatization of Ford’s ire, the world would have been robbed of some of the most poetic lyrics ever written. And, by the way, a feasible blueprint for the years to come as some budget-strapped cities run their tills dry.

In the unique case of New York City in the late 1970s, federal assistance accompanied fiscal reforms. The details of the détente should thus be de rigueur study materials for the judicial and legislative arms of so many at-risk municipalities nationwide.

At the risk of feigning any pretense of legal expertise, municipal bankruptcies come down to the limitations of the federal government’s power to provide relief to ‘units of states,’ whether they be cities, counties, taxing authorities, municipal utilities or school districts.

Though a variety of other state-led interventions have been successfully deployed, many of us are most familiar with voluntary Chapter 9 bankruptcy filings, permitted by half the states and employing the powers of the judiciary in conjunction with creditor workouts. Jefferson County, Alabama and Stockton, California may ring mental bells. But it is 2013’s record $18 billion Detroit, Michigan Ch. 9 filing that reset precedent on how engaged the bankruptcy courts can be.

Suffice it to say, default via the court system is a lengthy process and most lucrative for the lawyers retained. In relative terms, New York City’s effective default occurred in a New York Minute. After the banks cut off New York City in the spring of 1975, the State created an emergency financial control board and a borrowing entity to provide immediate relief to the city. Rather than “default,” the city declared a “moratorium” on $1.6 billion in obligations, a hotly debated designation. A thorny rose it nevertheless was.

In December 1975, with the financial management wrested out of the city’s control, Congress passed and Ford signed into law legislation allowing the Treasury to extend loans to the city to keep it up and running. Future New York state and city revenues were promised to repay the loans and spending reforms that had been intractable were implemented by force.

Looking back at the 40th anniversary of the extraordinary federal-led intervention, American Enterprise Institute’s Alex Pollock applauded Ford’s staunch stance: “That’s what happens when you run out of money and the music stops. Intensely needed reforms of the city’s spending and financial controls actually did follow.”

Why raise the specter of federal assistance if it’s patently apparent other means can be deployed in today’s modern municipal era? The crush of retiring Baby Boomers will keep Uncle Sam up at night for years as he struggles to keep federal entitlements solvent. Why even consider federal involvement in municipal pensions that are at least backed by some semblance of assets? The answer comes down to demographics.

Forty years ago, Baby Boomer were entering their prime earning years. Opportunity in the land of America was expanding at a rapid clip. The level of education was rising among those entering the workforce vis-à-vis their older counterparts at the same time women were growing the overall workforce (just under half of women worked then; today it’s 70 percent). In the simplest terms, the size of the pie was growing.

Today, roughly 10,000 Boomers exit the workforce every day, which should present an opportunity in and of itself for Millennials to backfill the depleting workforce. Census data tell a different story. In 2016, median personal income for workers aged 24 to 34 was $35,000. In modern dollar terms, that same age cohort was earning $37,000 in 1975.

It’s difficult to square lower earnings with the educational makeup of the labor force. In 1975, 23 percent of young workers had earned a bachelor’s degree. Forty years on, 37 percent have achieved the same. Shouldn’t that improvement have lifted per capita earnings?

It comes down to comparative advantage. Back then, it was easy enough for a younger, better-educated worker to displace an older, less-educated and therefore less-qualified older worker. Today’s workforce is largely educated and intent on working longer; it’s stickier and less tractable. At the same time, the double governors of technological innovation and globalization have reduced the aggregate demand for warm bodies.

At the risk of getting buried in the weeds, there are more workers exiting the workforce than there are those joining it. Those making way for the exits are otherwise known as ‘retirees.’ It is at this critical juncture that municipal finance re-enters the picture.

As has been written on these pages, over the past few years, public pensions have been reducing the stated returns they anticipate their portfolios generating on investments. These reduced expectations necessarily trigger the need for higher contributions on the part of state and local governments.

That’s exactly what took place last year. The Census’ 2016 Annual Survey of Public Pensions found that state and local government contributions rose by 6.5 percent to $191.6 billion from 2015’s $179.7 billion. By contrast, earnings on investments, which include both realized and unrealized gains, tumbled 67.9 percent to $49.9 billion from $155.5 billion in 2015.

Meanwhile, the number of pensioners collecting checks marched upwards to 10.3 million people, up 3.3 percent over 2015. The benefits they received last year rose even more, by 5.4 percent to $282.9 billion from $268.5 billion in 2015. And finally, total pension assets fell 1.6 percent to $3.7 trillion from $3.8 trillion the prior year.

In the event you sense you’ve been felled by death by numbers, back out to the big picture. Paid benefits exceeded contributions to the tune of $40 billion in 2016 against the relentless backdrop of an increasing number of Boomers retiring (in 2014, there were 9.9 million receiving benefits).

Microcosm this demographic dynamic to the extreme example of Chicago. In 2015, the latest year for which we have full data, some $999 million was paid out to 29,296 recipients. That compares to the $90 million in investment income generated by the two employee pension funds that year. Back out the timeline a decade – in 2006, these two pensions held a combined $8.5 billion in assets. Since then the two funds have generated $3.1 billion in investment returns but paid out $8.511 billion to retirees.

Chicago Mayor Rahm Emanuel recently proposed raising new city employees’ contribution to help fill the gulf of underfunding but Illinois’ Governor quickly vetoed the measure declaring Emanuel was, “trying to fix a drought with a drop of rain.”

Projections suggest that one of the two funds will be cash flow negative by 2023; the other will run short by 2025. If all else remains the same, a big IF with risky asset prices trading at frothy high valuations, property taxes would need to be doubled to cover the coming shortfalls.

Many Cook County taxpayers are forsaking a wait-and-see approach. Chicago was the only large city in America to lose population last year, its resident count dropped at nearly double the rate of 2015.

As convenient as it might seem to excoriate the Windy City, there are plenty of other major cities deep in hock. According to a Moody’s report, though Chicago does indeed top the list, Dallas is the second-most underfunded city followed by Phoenix, two magnets for nomads in search of lower costs of living. Rounding out the top ten list are Houston, Los Angeles, Jacksonville, Detroit, Columbus, Austin and Philadelphia.

In other words, running and hiding in lower tax haven hamlets will be even more challenging in coming years. According to a Milliman report, 2015 marked the first time retirees outnumbered active employees in the nation’s 100 largest public pensions; there were 12.6 million retirees covered by the toils of 12.5 million workers.

Look back no further than 2012 to appreciate how the trend has accelerated; in that year retirees numbered 10.5 million vs. 12.3 million active employees. Absent a surge in state and local payrolls, further fiscal deterioration is poised to persist.

To take the case of the case of the country’s largest pension, the California Public Employees’ Retirement System, in 20 years’ time, retirees supported by the plan will be roughly double the number of active workers. CalPERS won’t be alone in this predicament.

Again, it comes down to the demographic divide that’s opened up since President Ford was in office. In the 1970s, the typical public pension’s active employees outnumbered retirees by a factor of four-to-five times; today that ratio is 1.5-to-1 and continues to fall as Boomers retire in droves and Millennials fail to fill the yawning gap.

After a grisly year that ended with a tally of 4,000 homicides, Chicago has begun to coordinate with federal authorities to control a crime wave driven by gangs’ unencumbered access to firearms. The last thing the city can withstand is further cuts to public service funding. By the same token, taxpayers have already begun to vote with their feet as rising taxes and foundering pensions promise to beget more tax hikes to come.

It’s plain that the last thing any of us want to see is a Police State of any kind. But the growing risk is that the next recession and deflating asset prices could well alter the rules of engagement between federal and state authorities on more levels than any of us care to envision.

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ICYMI.ddb, In Case You Missed It — August 4, 2017

In Case You Missed It — May 12, 2017

Dear friends,

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.

Danielle


Click Here to buy Fed Up:  An Insider’s Take on Why the Federal Reserve is Bad for America.

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Is the Fed’s Balance Sheet Headed for the Crapper?

Never underestimate the resourcefulness of a great plumber.

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.

Bloomberg: Heed the Fed’s Balance Sheet Banter

Heed the Fed's Balance Sheet Banter, DiMartino Booth, Money Strong, Fed Up

Dear friends,

How is it exactly that we’ve journeyed from Uber-Doveville to life on Tightening Row? My answer is, “You tell me.” In the space of one election, Fed officials have metamorphosed from crying for fiscal stimulus to opining that the economy doesn’t really need all that much help after all from fiscal authorities.

The outlook has, in fact, improved so much that the unheard of, the sacrosanct, is now reasonable. Yes, if you have to ask, I speak of the precious balance sheet that was protected as is it were the very Ark itself. It, too, now is fair game to shrink.

If it looks like double tightening and sounds like double tightening, well then, by golly that’s what it is. The economic recovery is now so durable it can not only handle rising interest rates but an absent Fed in the Treasury and mortgage-backed securities in which it’s been ever present since the zero bound was hit back in 2008.

Yes, it is time to pinch yourself or ask if politics is so blatant as to be conspicuous in its very presence. For an explanation of this cryptic concoction, please read an opinion piece published yesterday.

Heed the Fed′s Balance Sheet Banter

https://www.bloomberg.com/view/articles/2017-01-23/heed-the-fed-s-balance-sheet-banter

Best,

Danielle

 

Venezuela Burning

Venezuela Burning

Sometimes art imitates life. “I know it was you, Fredo. You broke my heart. You broke my heart!” So said Michael Corleone to his older brother just after gripping his face and delivering a kiss of death. The infamous scene was based on the real life events of January 1, 1959. The occasion? A New Year’s celebration in downtown Havana and the moment in history when Fidel Castro overthrew the dictatorship of Fulgencio Bautista. The chillingly memorable scene from the 1974 classic Godfather II foretells the retribution for Fredo Corleone’s ultimate deceit.

At other points in time, life imitates art. So it was with an inaugural speech on February 2, 1999, some 40 years after Bautista fled Castro and Cuba, when Venezuelan President Huge Chavez betrayed his predecessor, Rafael Caldera. Caldera had granted Chavez amnesty and released him from prison in March 1994 following Chavez’s incarceration stemming from a failed 1992 coup attempt sanctioned by none other than Fidel Castro himself. Now it was the traitor doing the kissing.

It is fitting that Caldera, who died in December 2009, did not live to see the Venezuela of today, a sad failed state reflective of the very man he helped bring to power. After all, Caldera had publically defended the unsuccessful coup attempt. In his words, “We cannot ask people with hunger to immolate themselves for a democracy that has not been able to give them enough to eat.” Those words, spoken February 4, 1992, would help to elect Caldera to a second term as Venezuela’s president in 1994. It had been 20 since the end of his first presidential term.

Today Venezuelan children are dying of hunger. Premature babies perish as electrical outages snuff the incubators critical to their survival. Those wracked with disease cannot receive the treatment they must have to battle their ailments; diabetics and cancer patients die unnecessarily every day. In the worst cases, as has been documented by numerous media outlets, hospitals have become menaces in and of themselves with operating theatres unfit for use. Patients die in pools of their own blood.

Such is the inconceivable reality of the politically-divided, drought-ridden country that rests upon the world’s largest oil and iron ore reserves. How has Venezuela spiraled so far out of control in the wake of the commodities supercycle that built modern-day China, one that filled the coffers of resource-rich exporters worldwide?

A bit of history helps explain how events have tragically aligned. As is the case with many regime changes, Caldera entered office just as financial crisis was descending. Banco Latino had failed before his term had even begun and was followed by the failure of 10 more banks. Deposits were lost and the government had to step in to provide aid to the financial sector.

The economic devastation that followed was severe. An exchange rate policy imposed by the government caused prices to skyrocket, rendering the necessary supplies to conduct business prohibitively expensive. More than seventy thousand small and medium-sized companies went into bankruptcy.

To staunch the deepening crisis, Caldera reneged on a campaign vow to never accept monies from the International Fund (IMF). Of course, no aid is granted without demands. Satisfying those demands planted the seeds for the rise of the Chavez socialist experiment and the inevitable crisis ignited.

The IMF’s requirements resulted in a 70 percent devaluation of the bolivar, the liberalization of interest rates and the continued privatization of the nation’s industries. On the flipside, fuel prices also rose by 800 percent, devastating much of the populace already reeling from inflation that had put the basic necessities of food and clothing out of their reach.

No doubt, the imposition of economic strictures in Venezuela laid the groundwork for the rise of socialism. The income divide was readily apparent to this Caracas resident in the summer of 1995. The occasion for said residency was an internship at Sivensa, a steel giant that happened to be on the receiving end of the push to privatize firms.

The drive into Caracas from the airport on Venezuela’s coast was unforgettable, and yet, as we neared the capital, unspeakable. Such was the unmistakable depth of wretchedness and poverty being endured by those many thousands who existed amid the squalor of makeshift slums barely clinging to the hillsides outside the city. Anyone seeing the stark contrast between the luxurious and carefree lifestyle enjoyed by the elegantly-dressed but impervious Caracanyan haves, who danced their nights away while living in the shadow of those Godforsaken slums, would have to question what was to come. The words, “This cannot end well,” came to mind.

Over 20 years later, things are not ending well, and they do indeed appear to be ending. One company after another has shuttered as the government has cut off lines to the basic foodstuffs needed to produce the goods that stock supermarket shelves. And airlines have been forced to pull up wheels and abandon their routes in and out of the country given the $5.3 billion in un-patriated airline revenues the government has effectively frozen via currency controls. Isolation is descending and fast.

The hope is that the rising opposition can prevail and effect a peaceful transition. In spite of that opposition’s multitude of imprisoned leaders, about half of the four million signatures required to oust President Nicolas Maduro are already in hand.

Amid all of this is the fear is that the government’s latest decision to satisfy the country’s debt obligations, at the expense of providing the needed funding to address the overwhelming humanitarian crisis, will throw the country into civil war. Foreign reserves are quickly dwindling to the $10 billion mark, one-quarter of what they were as recently as 2009. Meanwhile, PDVSA, the state’s oil behemoth, is said to be pursuing debt exchanges with its oil servicers, desperate measures designed to buy time that’s fast running out.

And yet, if Maduro’s government can stall the referendum vote to January 10th, current law dictates that the vice president can waltz in and replace him, no fresh elections triggered. So more of the same as opposed to a true change in leadership.

Some have speculated that a neighboring country could ride to Venezuela’s rescue. The chances of that benign outcome, however, are slim as noted by numerous Latin American economists. They cite the weakened economies of the region’s leaders, Argentina and Brazil, as impediments to a white knight scenario unfolding.

It must also be noted that Mother Nature has piled onto the devastation. Venezuela is a country that has traditionally relied on hydropower. That makes the historic drought ravaging the country all the more destabilizing as over two-thirds of the nation’s electricity is rationed.

Venezuela has not been completely abandoned. On May 29th, a shipment of emergency medical supplies to fight the Zika virus arrived courtesy of China, a country whose ties with Venezuela have strengthened since their status was raised to that of ‘strategic partnership’ in 2014.

China’s efforts notwithstanding, the severity of the unfolding catastrophe suggests nothing short of a full blown, coordinated international relief effort is needed. Both the United States and the IMF come to mind, both abominations in the eyes of the current leadership.

The time for politicking, though, has long come and gone rendering the intensity of Maduro’s resolve to remain alienated from the western world nothing short of traitorous. The president literally has the blood of his fellow countrymen and women on his hands.

Such is the result of corruption followed by the imposition of broken economic models followed by yet more corruption. At some point, as Margaret Thatcher famously predicted of all socialist regimes, Venezuela would simply run out of other people’s money to spend, which appears to be the case today.

And so it goes as the rest of the world looks on with the hopes that Venezuela follows in the footsteps of its neighbors to the south who have begun to reject similarly broken economic and political models rather than stand by and watch their countries burn.

As for Venezuela’s forsworn enemy to the north, judiciaries here should take note of rising U.S. crime rates and the potential for more trouble in our own streets. Idleness, whether forced or chosen, combined with entitlement, can lead to nothing good. You can only placate the masses with an ever-expanding welfare state and misguided monetary policy that fails to grow the workforce while enriching the haves for so long before things turn.

For us, there may not be an overtly dramatic crescendo of unrest, with Michael delivering to Fredo the symbolic kiss of death. But be that as it may, we’ve still been betrayed by those in power. Yes, perhaps a betrayal of the subtlest sort, but a betrayal just the same with an inevitable, still unknown, price to pay.