In some ways, this is a boring time in insurance investing.  A lot of companies seem cheap on a book and/or earnings basis, but they have a lot of capital to deploy as a group, so there aren’t a lot of opportunities to underwrite or invest wisely, at least in the US.

Look for a moment at two victims of the Financial Stability Oversight Council [FSOC]… AIG and Metlife.  I’ve argued before that the FSOC doesn’t know what it is doing with respect to insurers or asset managers.  Financial crises come from short liabilities that can run financing illiquid assets.  That’s not true with insurers or asset managers.

Nonetheless AIG has Carl Icahn breathing down its neck, and AIG doesn’t want to break up the company.  They will spin off their mortgage insurer, United Guaranty. but they won’t get a lot of help from that — valuations of mortgage insurers are deservedly poor, and the mortgage insurer is small relative to AIG.

As I have also pointed out before AIG’s reserving was liberal, and recently AIG took a $3.6 billion charge to strengthen reserves.  Thus I am not surprised at the rating actions of Moody’s, S&P,  and AM Best.  Add in the aggressive plans to use $25 billion to buy back stock and pay more dividends over the next two years, and you could see the ratings sink further, and possibly, the stock also.  The $25 billion requires earning considerably more than what was earned over the last four years, and more than is forecast by sell-side analysts, unless AIG can find ways to release capital and excess reserves (if any) trapped in their complex holding company structure.

AIG plans to do it through (see pp 4-5):

  • Reducing expenses
  • Improving the Commercial P&C accident year loss ratio by 6 points
  • Targeted divestitures (United Guaranty, and what else gets you to $6 billion?)
  • Reinsurance (mostly life)
  • Borrowing $3-5B (maybe more after the $3.6B writedown)
  • Selling off some hedge fund assets to reduce capital use. (smart, hedge funds earn less than advertised, and the capital charges are high.)

Okay, this could work, but when you are done, you will have reduced the earnings capacity of the remaining company.  Reinsurance that provides additional surplus strips future earnings out the the company, and leaves the subsidiaries inflexible.  Trust me, I’ve worked at too many companies that did it.  It’s a lousy way to manage a life company.

Expense reduction can always be done, but business quality can suffer.  Improving the Commercial lines loss ratio will mean writing less business in an already overcompetitive market — can’t see how that will help much.

I don’t think the numbers add up to $25 billion, particularly not in a competitive market like we have right now.  This is part of what I meant when I said:

…it would pay Carl Icahn and all of the others who would be interested in breaking up AIG to hire some insurance expertise.  Insurance is a set of complex businesses, and few understand most of them, much less all of them.  It would be easy to naively overestimate the ability to improve profitability at AIG if you don’t know the business,  the accounting, and how free cash flow emerges, if it ever does.

They might also want to have a frank talk with Standard and Poors as to how they would structure a breakup if the operating subsidiaries were to maintain all of their current ratings.  Icahn and his friends might be surprised at how little value could initially be released, if any.

Thus I don’t see a lot of value at AIG right now.  I see better opportunities in MetLife.

MetLife is spinning off their domestic individual life lines, which is the core business.  I would estimate that it is worth around 15% of the whole company.  In the process, they will be spinning off most of their ugliest liabilities as far as life insurance goes — the various living benefits and secondary guarantees that are impossible to value in a scientific way.

The main company remaining will retain some of the most stable life liabilities, the P&C operation, and the Group Insurance, Corporate Benefit Funding, and the International operations.

I look at it this way: the company they are spinning off will retain the most capital intensive businesses, with the greatest degree of reserving uncertainty.  The main company will be relatively clean, with free cash flow being a high percentage of earnings.

I will be interested in the main company post-spin.  At some point, I will buy some MetLife so that I can own some of that company.  The only tough question in my mind is what the spinoff company will trade at.  Most people don’t get insurance accounting, so they will look at the earnings and think it looks cheap, but a lot of capital and cash flow will be trapped in the insurance subsidiaries.

There is no stated date for the spinoff, but if the plan is to spin of the company, a registration statement might be filed with the SEC in six months, so, you have plenty of time to think about this.

Get MET, it pays.

One Final Note

I sometimes get asked what insurance companies I own shares in.  Here’s the current list:

Long RGA, AIZ, NWLI (note: illiquid), ENH, BRK/B, GTS, and KCLI (note: very illiquid)

In general, I tend not to go in for macro themes.  Why?  I tend to get them wrong, and I think most investors also get them wrong, or at least, don’t get them right consistently.

I do have one macro theme, and it has served me well for a long time, though not over the past two years.  I was using the theme as early as 2000, but finally articulated it in 2006.

At that time, I was running my equity strategy for my employer, as well as in my personal account.  They used it for their profit sharing plan and endowment.  They liked it because it was different from what the firm did to make money, which was mostly off of financial companies, both public and private.  They didn’t want employees to worry that their accrued profit sharing bonuses would be in jeopardy if the firm’s ordinary businesses got into trouble.  In general, a good idea.

At the end of the year, I needed to give a presentation to all of the employees on how I had been managing their money.  Because my strategies had been working well, it would be an easy presentation to make… but as I looked at the prior year presentation, I felt that I needed to say more.  It was at that moment that the macro theme that i had been working with became clear to me, and I called it: Our Growing World.

The idea is this: in a post-Cold War world where most economies have accepted the basic idea of Capitalism to varying degrees, there should be growth, and that growth should create a growing middle class globally.  This middle class would be less well-off than what we presently see in America and Western Europe, at least not initially, but would manifest itself in a lot of demand for food, energy, and a variety of commodities and machinery as the middle class grew.

Now, I never committed everything to this theme, ever.  Maybe one-third of the portfolio was influenced by it, on averaged.  Most of what I do was and still is more influenced by my industry models, and by bottom-up stock-picking.

That said, the theme has a cyclical bias, and cyclicals have been kicked lately.  I still think the theme is valid, but will have to wait for overinvestment and overproduction in certain industries to get rationalized globally.  Were this only a US problem, it might be easier to deal with because we’re far more willing to let things fail, and let the bankruptcy process sort these matters out.  Governments in the rest of the world tend to interfere more, particularly if it is to protect a company that is a “national champion.”

But the rationalization will take place, and so until then in cyclical industries I try to own financially strong companies that are cheap.  They will survive until the cycle turns, and make good money after that.  That said, the billion dollar question remains — when will the cycle turn?

More next time, when I write about my industry model.

Photo Credit: Paul Saad

Photo Credit: Paul Saad || What’s more cyclical than a mine in South Africa?

This is the first of a series of related posts.  I took a one month break from blogging because of business challenges.  As this series progresses, I will divulge a little more about that.

When I look at stocks at present, I don’t find a lot that is cheap outside of the stocks of companies that will do well if the global economy starts growing more quickly in nominal terms.  As it is, those companies have been taken through the shredder, and trade near their 52-week lows, if not their decade lows.

Unless an industry can be done away with in entire, some of the stocks an economically sensitive industry will survive and even soar on the other side of the economic cycle.  At least, that was my experience in 2003, but you have to own the companies with balance sheets that are strong enough to survive the through of the cycle.  (In some cases, you might need to own the debt, and not the common equity.)

The hard question is when the cycle will turn.  My guess is that government policy will have little to do with the turn, because the various developed countries are doing nothing to clear away the abundance of debt, which lowers the marginal productivity of capital.  Monetary policy seems to be pursuing a closed loop where little incremental lending gets to lower quality borrowers, and a lot goes to governments.

But economies are greater than the governments that try to milk them.  There is a growing middle class around the world, and along with that, a growing need for food, energy, and basic consumer goods.  That is the long run, absent war, plague, resurgent socialism, etc.

To give an example of how markets can decouple from government policy, consider the corporate bond market, and lending options for consumers.  The Fed can keep the Fed funds rate low, but aside from the strongest borrowers, the yields that lesser borrowers borrow at are high, and reflect the intrinsic risk of loss, not the temporary provision of cheap capital to banks and other strong borrowers.

It’s more difficult to sort through when accumulated organic demand will eventually well up and drive industries that are more economically sensitive.  Over-indebted governments can not and will not be the driver here.  (Maybe monetary policy like the 1970s could do it… what a thought.)

So, what to do when the economic outlook for a wide number of industries that look seemingly cheap are poor?  My answer is buy one of the strongest names in each industry, and then focus the rest of the portfolio on industries with better current prospects that are relatively cheap.

Anyway, this is the first of a few articles on this topic.  My next one should be on industry valuation and price momentum.  Fasten your seatbelts and don your peril-sensitive sunglasses.  It will be an ugly trip.

I get letters from all over the world.  Here is a recent one:

Respected Sir,

Greetings of the day!

I read your blog religiously and have gained quite a lot of practical insights in financial field. Your book reviews are very helpful and impartial.

I request you to write blog post on dollar pegs in Middle East and under what conditions those dollar pegs would fall.

If in case you cannot write about it, kindly point me to some material which can be helpful to me.

Thanks for your valuable time.

Now occasionally, some people write me and tell me that I am outside my circle of competence.  In this case I will admit I am at the edge of that circle.  But maybe I can say a few useful things.

Many countries like pegging their currency to the US dollar because it provides stability for business relationships as businesses in their country trade with the US, or, with other countries that peg their US dollar, or, run a dirty peg of a controlled devaluation.  Let me call that informal group of countries the US dollar bloc. [USDB]

The problem comes when the country trading in the USDB begins to import a lot more than they export, and in the process, they either liquidate US dollar-denominated assets or create US dollar-denominated liabilities in order to fund the difference.

Now, that’s not a problem for the US — we get a pseudo-free pass in exporting claims on the US dollar.  The only potential cost is possible future inflation. But, it is a problem for other countries that try to do so, because they can’t manufacture those claims out of thin air as the US Treasury does.

Now in the Middle East it used to be easy for many countries there because of all the crude oil they produced.  Crude oil goes out, goods and US dollar claims come in.  Now it is reversed, as the price of crude is so low.  Might this have an effect on the currencies of the Middle East.  Well, first let’s look at some currencies that float that are heavily influenced by crude oil and other commodities: Australia, Canada, and Norway:

Commodity Currencies

As oil and commodities have traded off so have these currencies.  That means for pegged currencies the same stress exists.  But with a pegged currency, if adjustments happen, they are rather large violent surprises.  Remember the old saying, “He lied like a finance minister on the eve of the devaluation,” or Monty Python, “No one expects the Spanish Inquisition!”

That’s not saying that any currency peg will break imminently.  It will happen later for those countries with large reserves of hard currency assets, especially the dollar.  It will happen later for those countries that don’t have to draw on those reserves so rapidly.

Thus my advice is threefold:

  1. Watch hard currency reserve levels and project future levels.
  2. Listen to the rating agencies as they downgrade the foreign currency sovereign credit ratings of countries.  When the ratings get lowered and there is no sign that there will be any change in government policy, watch out.
  3. Watch the behavior of wealthy and connected individuals.  Are they moving their assets out of the country and into hard currency assets?  They always do some of this, but are they doing more of it — is it accelerating?

Point 3 is an important one, and is one seemingly driving currency weakness in China at present.  US Dollar assets may come in due to an excess of exports over imports, but they are going out as wealthy people look to preserve their wealth.

On point 2, the rating agencies are competent, but read their writeups more than the ratings.  They do their truth-telling in the verbiage even when they delay downgrades longer than they ought to.

Point 1 is the most objective, but governments will put off adjustments as long as they can — which makes the eventual adjustment larger and more painful for those who are not connected.  Sadly, it is the middle class and poor that get hit the worst on these things as the price of imported staple goods rise while the assets of the wealthy are protected.

And thus my basic advice is this: gradually diversify your assets into ones that will not be harmed by a devaluation.  This is one where your government will not look out for your well-being, so you have to do it yourself.

As a final note, when I wrote this piece on a similar topic, the country in question did a huge devaluation shortly after it was written.  Be careful.

December 2015January 2016Comments
Information received since the Federal Open Market Committee met in October suggests that economic activity has been expanding at a moderate pace.Information received since the Federal Open Market Committee met in December suggests that labor market conditions improved further even as economic growth slowed late last year.Shades up labor conditions.  Shades down economic growth.
Household spending and business fixed investment have been increasing at solid rates in recent months, and the housing sector has improved further; however, net exports have been soft.Household spending and business fixed investment have been increasing at moderate rates in recent months, and the housing sector has improved further; however, net exports have been soft and inventory investment slowed.Shades household spending down.
A range of recent labor market indicators, including ongoing job gains and declining unemployment, shows further improvement and confirms that underutilization of labor resources has diminished appreciably since early this year. A range of recent labor market indicators, including strong job gains, points to some additional decline in underutilization of labor resources.Shades labor employment up.
Inflation has continued to run below the Committee’s 2 percent longer-run objective, partly reflecting declines in energy prices and in prices of non-energy imports.Inflation has continued to run below the Committee’s 2 percent longer-run objective, partly reflecting declines in energy prices and in prices of non-energy imports.No change.
Market-based measures of inflation compensation remain low; some survey-based measures of longer-term inflation expectations have edged down.Market-based measures of inflation compensation declined further; survey-based measures of longer-term inflation expectations are little changed, on balance, in recent months.Shades current and forward inflation down.  TIPS are showing lower inflation expectations since the last meeting. 5y forward 5y inflation implied from TIPS is near 1.53%, down 0.18% from September.
Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability.Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability.No change. Any time they mention the “statutory mandate,” it is to excuse bad policy.
The Committee currently expects that, with gradual adjustments in the stance of monetary policy, economic activity will continue to expand at a moderate pace and labor market indicators will continue to strengthen.The Committee currently expects that, with gradual adjustments in the stance of monetary policy, economic activity will expand at a moderate pace and labor market indicators will continue to strengthen.Shifts language to reflect moving from easing to tightening.
Overall, taking into account domestic and international developments, the Committee sees the risks to the outlook for both economic activity and the labor market as balanced. Sentence dropped.
Inflation is expected to rise to 2 percent over the medium term as the transitory effects of declines in energy and import prices dissipate and the labor market strengthens further.Inflation is expected to remain low in the near term, in part because of the further declines in energy prices, but to rise to 2 percent over the medium term as the transitory effects of declines in energy and import prices dissipate and the labor market strengthens further.CPI is at +0.7% now, yoy.

Shades inflation down in the short run due to energy prices.

The Committee continues to monitor inflation developments closely.The Committee is closely monitoring global economic and financial developments and is assessing their implications for the labor market and inflation, and for the balance of risks to the outlook.Says that they watch every economic indicator only for their likely impact on labor employment and inflation.
The Committee judges that there has been considerable improvement in labor market conditions this year, and it is reasonably confident that inflation will rise, over the medium term, to its 2 percent objective. Dropped sentence.
Given the economic outlook, and recognizing the time it takes for policy actions to affect future economic outcomes, the Committee decided to raise the target range for the federal funds rate to 1/4 to 1/2 percent.Given the economic outlook, the Committee decided to maintain the target range for the federal funds rate at 1/4 to 1/2 percent.No real change.
The stance of monetary policy remains accommodative after this increase, thereby supporting further improvement in labor market conditions and a return to 2 percent inflation.The stance of monetary policy remains accommodative, thereby supporting further improvement in labor market conditions and a return to 2 percent inflation.No real change.  They don’t get that policy direction, not position, is what makes policy accommodative or restrictive.
In determining the timing and size of future adjustments to the target range for the federal funds rate, the Committee will assess realized and expected economic conditions relative to its objectives of maximum employment and 2 percent inflation.In determining the timing and size of future adjustments to the target range for the federal funds rate, the Committee will assess realized and expected economic conditions relative to its objectives of maximum employment and 2 percent inflation.No change.
This assessment will take into account a wide range of information, including measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial and international developments.This assessment will take into account a wide range of information, including measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial and international developments.No change.  Gives the FOMC flexibility in decision-making, because they really don’t know what matters, and whether they can truly do anything with monetary policy.
In light of the current shortfall of inflation from 2 percent, the Committee will carefully monitor actual and expected progress toward its inflation goal. The Committee expects that economic conditions will evolve in a manner that will warrant only gradual increases in the federal funds rate; the federal funds rate is likely to remain, for some time, below levels that are expected to prevail in the longer run. However, the actual path of the federal funds rate will depend on the economic outlook as informed by incoming data.In light of the current shortfall of inflation from 2 percent, the Committee will carefully monitor actual and expected progress toward its inflation goal. The Committee expects that economic conditions will evolve in a manner that will warrant only gradual increases in the federal funds rate; the federal funds rate is likely to remain, for some time, below levels that are expected to prevail in the longer run. However, the actual path of the federal funds rate will depend on the economic outlook as informed by incoming data.No change.  Says that they will go slowly, and react to new data.  Big surprises, those.
The Committee is maintaining its existing policy of reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities and of rolling over maturing Treasury securities at auction, and it anticipates doing so until normalization of the level of the federal funds rate is well under way. This policy, by keeping the Committee’s holdings of longer-term securities at sizable levels, should help maintain accommodative financial conditions.The Committee is maintaining its existing policy of reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities and of rolling over maturing Treasury securities at auction, and it anticipates doing so until normalization of the level of the federal funds rate is well under way. This policy, by keeping the Committee’s holdings of longer-term securities at sizable levels, should help maintain accommodative financial conditions.Says it will keep reinvesting maturing proceeds of agency debt and MBS, which blunts any tightening.
Voting for the FOMC monetary policy action were: Janet L. Yellen, Chair; William C. Dudley, Vice Chairman; Lael Brainard; Charles L. Evans; Stanley Fischer; Jeffrey M. Lacker; Dennis P. Lockhart; Jerome H. Powell; Daniel K. Tarullo; and John C. Williams.Voting for the FOMC monetary policy action were: Janet L. Yellen, Chair; William C. Dudley, Vice Chairman; Lael Brainard; James Bullard; Stanley Fischer; Esther L. George; Loretta J. Mester; Jerome H. Powell; Eric Rosengren; and Daniel K. Tarullo.Changing of the guard of regional Fed Presidents, making them ever so slightly more hawkish, and having no effect on policy.

Comments

  • Policy stalls, as their view of the economy catches up with reality.
  • The changes for the FOMC is that labor indicators are stronger, and GDP weaker.
  • Equities fall and bonds rise. Commodity prices rise and the dollar falls.  Maybe some expected a bigger move.
  • The FOMC says that any future change to policy is contingent on almost everything.
  • The key variables on Fed Policy are capacity utilization, labor market indicators, inflation trends, and inflation expectations. As a result, the FOMC ain’t moving rates up much, absent much higher inflation, or a US Dollar crisis.

The Word of God is powerful, as it says in Hebrews 4:12.  That’s why even those that do not believe the Bible will use it on occasion to buttress their positions, whether it is:

  • Cults that use Psalm 46:10a (“Be still, and know that I am God”) to tell people that they are really God themselves.
  • Muslims that try to tell us that the promise of the Holy Spirit in John 14:15-27 really promised Mohammed.
  • Advice columnists that can only misapply the verse, “Judge not, that you be not judged.” (Luke 6:37)
  • Liberation theologians that appeal to the Exodus as a motif for taking revolutionary action to overthrow oppression.
  • Lenin, quoting Paul, “If any man will not work, he shall not eat.” (2Thessalonians 3:10)
  • Satan, who quoted Psalm 91:11-12 to Jesus in Luke 4:10-11.

The same is true of Vermont Royster when he wrote “In Hoc Anno Domini,” which has been run on the Wall Street Journal Editorial Page in late December every year since 1949.  In that piece, he cites the Bible seven times, but always in a way that twists it.  He takes the Bible out of context to support his view of politics.

The Bible says a lot about politics, but that is not its primary thrust.  For the rest of this piece, I will show how Mr. Royster abuses Scripture.  After describing the one-world tyranny of Rome, he writes:

Then, of a sudden, there was a light in the world, and a man from Galilee saying, Render unto Caesar the things which are Caesar’s and unto God the things that are God’s.

He cites Matthew 22:21, Mark 12:17, and/or Luke 20:25.  In the full context, Jewish leaders ask Jesus whether it is right to pay taxes to Caesar or not.  The question was a trap, because the Zealots and Jewish authorities had opposite positions on the question.  Jesus answer rebukes everyone, because he implies, “Yes, pay taxes to Caesar, but don’t give Caesar the allegiance that is due to God.”

Jesus was not directly opposed to the political rule of Caesar; indeed, the early church did nothing to protest the rule of Caesar, even as they were persecuted by the Roman Empire.  Royster continues:

“And the voice from Galilee, which would defy Caesar, offered a new Kingdom in which each man could walk upright and bow to none but his God. Inasmuch as ye have done it unto one of the least of these my brethren, ye have done it unto me. And he sent this gospel of the Kingdom of Man into the uttermost ends of the earth.”

Here he cites Matthew 25:40 and Acts 1:8. Without any support, Royster says that Christ defied Caesar, and offered a Kingdom where all men would not have to bow to Caesar, or anyone else.  Is this the same Jesus that said “You have heard that it was said, ‘An eye for an eye and a tooth for a tooth.’  But I tell you not to resist an evil person. But whoever slaps you on your right cheek, turn the other to him also.   If anyone wants to sue you and take away your tunic, let him have your cloak also.  And whoever compels you to go one mile, go with him two.” (Matthew 5:38-41)  Here Jesus encourages submission to the Romans, who would occasionally shake Jews down, and make them carry burdens.  They certainly did many evil things to the Jews.

Royster misapplies Matthew 25:40 and Acts 1:8 – Jesus did not come to bring political and economic freedom to the common man.  His gospel was not one of political liberation, but that He was the Messiah, the Lamb of God, who came to take away the sin of the world. (John 1:29)  That was the message that the apostles would take to the ends of the Earth, at the cost of their lives.  Royster then adds:

So the light came into the world and the men who lived in darkness were afraid, and they tried to lower a curtain so that man would still believe salvation lay with the leaders.

But it came to pass for a while in divers places that the truth did set man free, although the men of darkness were offended and they tried to put out the light. The voice said, Haste ye. Walk while you have the light, lest darkness come upon you, for he that walketh in darkness knoweth not whither he goeth.”

Royster alludes to John 8:32 and cites John 12:35, both out of context.  When Jesus said, “And you shall know the truth, and the truth shall make you free.” in John 8:32, it was in the context of believing all of the teachings of Jesus.  It’s not the truth in abstract that makes one free, but the truth as taught Jesus, who said, “I am the way, the truth, and the life. No one comes to the Father except through Me.” (John 14:6)  Also, it is neither political nor economic freedom, but freedom from sin.

When Jesus said in John 12:35, “Then Jesus said to them, ‘A little while longer the light is with you. Walk while you have the light, lest darkness overtake you; he who walks in darkness does not know where he is going.’” he was speaking of His upcoming death on the cross for the forgiveness of sin.

Royster continues:

“Along the road to Damascus the light shone brightly. But afterward Paul of Tarsus, too, was sore afraid. He feared that other Caesars, other prophets, might one day persuade men that man was nothing save a servant unto them, that men might yield up their birthright from God for pottage and walk no more in freedom.”

He alludes to Acts 9 and Genesis 25.  In Genesis 25, Esau trades away his birthright (inheritance) for a bowl of pottage (stew).  Esau is not trading away something political or economic.  He would have been the inheritor of the promises made to Abraham, which undergird salvation.  He gives up on the faith of Abraham.

Royster says some more and then closes with:

“And so Paul, the apostle of the Son of Man, spoke to his brethren, the Galatians, the words he would have us remember afterward in each of the years of his Lord:

Stand fast therefore in the liberty wherewith Christ has made us free and be not entangled again with the yoke of bondage.”

He cites Galatians 5:1Galatians 5 summarizes Paul’s argument, and says that if you try to go back to keeping the Law in order to be saved, rather than accept Jesus’ sacrifice for sin in faith, you will go to Hell.  You will not be saved from your sins.

The liberty that Paul speaks of is freedom from sin, and ultimately freedom from the penalty for sin – it is not economic or political liberty.

Summary and Request

Vermont Royster, for whatever reason, used the Bible and a Christmas motif to justify his political views.  When he first wrote it in 1949, there were worries that totalitarianism would take over the world.  I understand the fear.  There is a greater thing to fear, though, as Jesus said in Luke 12:4-5: “And I say to you, My friends, do not be afraid of those who kill the body, and after that have no more that they can do. But I will show you whom you should fear: Fear Him who, after He has killed, has power to cast into hell; yes, I say to you, fear Him!”

This is the prime message of the Bible, together with the promise that those that trust in Jesus will inherit eternal life, and be spared Hell.

I am not against political or economic freedom, and neither is the Bible.  It is good to promote those.  Indeed, Protestantism gave birth to strong forms of both freedoms that we benefit from today.

That said, it is wrong to publish the distortions of the Bible that Vermont Royster concocted, and even worse to do it yearly.  Editors of the Wall Street Journal, please cease doing that.

Photo Credit: Alfred Shum

Photo Credit: Alfred Shum

At this time of year, people often do holiday posts.  I’ve never done that.  I’m going to do it this time, and then probably never do it again.

Close friends of mine know that at the Merkel household, we are Christians that don’t celebrate Christmas.  The main reason is that it is a human holiday, and not a God-appointed one.  There are other reasons, too, but that is a topic for another place.

I write this because of an editorial that has been published in the Wall Street Journal since 1949.  It’s called “In Hoc Anno Domini.”  It was written by a longtime editor of the Wall Street Journal, Vermont Royster, in a time where many in the US feared Communism and other forms of totalitarianism.

In that editorial, he cites the Bible seven times without attribution, and every time takes the part of the Bible out of its context to support economic and political freedom, and oppose totalitarianism.  It’s horrible from an intellectual standpoint, because the Bible is not trying to say anything like that at that point.  I could write an essay showing how the Bible encourages economic and political freedom, and opposes totalitarianism, but I would quote very different Scriptures, but do so in their proper context.  But you may as well get Lex Rex by Samuel Rutherford, which influenced Locke and many others.

I’ve looked around the web, and I have yet to find a critique of this editorial.  I find many posts praising it, probably because its rare to hear something that sounds vaguely Biblical in a major publication.  But to me, it really grates.  Here’s why:

Many people may have a favorite author, or a personal hero who writes a book.  Well, imagine that someone quotes and makes significant allusions to your hero’s book and does so in a way that ruins the original meaning, and replaces it with a meaning of far lesser value very different from the original meaning.  How would you feel?

Well, I feel annoyed, and my response to that editorial will be in the next blog post.  If you don’t like Christian reasoning, skip the next post.  A reduced version of it will be submitted to the Wall Street Journal as a letter to the editor.

The remainder of this post republishes “In Hoc Anno Domini” with a few explanatory notes, to point out what Royster was citing, and clarify some of the language from the King James Version of the Bible.  (An excellent translation, but the English is dated.)

With no further ado, here is an annotated version of “In Hoc Anno Domini” (In the Year of Our Lord)  My comments are marked with a DM.

=-=–==-=-=–=-=-=-=-=-==-=-=-=–=-=-=-=-==-=-=-=-=-=-=-=-=-=-=-=-=-=-=-=-=-=-=-=-=-=-=-=-=-=-=-=-

When Saul of Tarsus set out on his journey to Damascus the whole of the known world lay in bondage. There was one state, and it was Rome. There was one master for it all, and he was Tiberius Caesar.

Everywhere there was civil order, for the arm of the Roman law was long. Everywhere there was stability, in government and in society, for the centurions saw that it was so.

But everywhere there was something else, too. There was oppression—for those who were not the friends of Tiberius Caesar. There was the tax gatherer to take the grain from the fields and the flax from the spindle to feed the legions or to fill the hungry treasury from which divine Caesar gave largess to the people. There was the impressor to find recruits for the circuses. There were executioners to quiet those whom the Emperor proscribed. What was a man for but to serve Caesar?

There was the persecution of men who dared think differently, who heard strange voices or read strange manuscripts. There was enslavement of men whose tribes came not from Rome, disdain for those who did not have the familiar visage. And most of all, there was everywhere a contempt for human life. What, to the strong, was one man more or less in a crowded world?

Then, of a sudden, there was a light in the world, and a man from Galilee saying, Render unto Caesar the things which are Caesar’s and unto God the things that are God’s.

[DM: Citing Matthew 22:21, Mark 12:16, or Luke 20:25]

And the voice from Galilee, which would defy Caesar, offered a new Kingdom in which each man could walk upright and bow to none but his God. Inasmuch as ye have done it unto one of the least of these my brethren, ye have done it unto me. And he sent this gospel of the Kingdom of Man into the uttermost ends of the earth.

[DM: citing Matthew 25:40 and Acts 1:8, but the phrase “Kingdom of Man” is nowhere in the Bible – it should be the Kingdom of heaven or Kingdom of God. Geek note: the book of Daniel uses the phrase “Kingdom of men” in chapters 4-5, but was used to show that God ruled over all, even Babylon.]

So the light came into the world and the men who lived in darkness were afraid, and they tried to lower a curtain so that man would still believe salvation lay with the leaders.

But it came to pass for a while in divers places that the truth did set man free, although the men of darkness were offended and they tried to put out the light. The voice said, Haste ye. Walk while you have the light, lest darkness come upon you, for he that walketh in darkness knoweth not whither he goeth.

[DM: “divers” means various.  Cites John 12:35]

Along the road to Damascus the light shone brightly. But afterward Paul of Tarsus, too, was sore afraid. He feared that other Caesars, other prophets, might one day persuade men that man was nothing save a servant unto them, that men might yield up their birthright from God for pottage and walk no more in freedom.

[DM: Alludes to Acts 9 and Genesis 25]

Then might it come to pass that darkness would settle again over the lands and there would be a burning of books and men would think only of what they should eat and what they should wear, and would give heed only to new Caesars and to false prophets. Then might it come to pass that men would not look upward to see even a winter’s star in the East, and once more, there would be no light at all in the darkness.

And so Paul, the apostle of the Son of Man, spoke to his brethren, the Galatians, the words he would have us remember afterward in each of the years of his Lord:

[DM: An apostle is never referred to as an “apostle of the Son of Man” in the Bible.]

Stand fast therefore in the liberty wherewith Christ has made us free and be not entangled again with the yoke of bondage.

[DM: citing Galatians 5:1]

This editorial was written in 1949 by the late Vermont Royster and has been published annually since.

 

Photo Credit: andrew wertz || Half a house is better than none...

Photo Credit: andrew wertz || Half a house is better than none…

I am usually not into financial complexity, but I ran into a service today called Point that could be useful for some people if they need credit and:

 

  • you have a well maintained property in a neighborhood that has appreciation potential
  • you have a strong credit history
  • you have household income that covers your debt obligations (and some)
  • you have built up some equity in your home. After Point funding, you should still own at least 20% of the equity in your home
  • you live in one of the areas where Point is currently available
  • we reach agreement with you on a fair value for your property
  • you will sell the home within the term of your Point Homeowner Agreement or you will be in a position to repay Point at the end of the term

This is taken from Point’s website

The basic idea is that you sell a fraction of the equity/ownership of your home to Point.  You will still have to maintain it and service all of the debt on the home, but beyond that, you can live in your home rent-free.  When you sell the property, Point gets its share of the sales price.  According to the Bloomberg article:

With Point, credit scores can be less than 620, but homeowners must have at least 25 percent to 30 percent equity in their houses. Point adjusts the cost of its investment based on the owner and the property, taking a larger percentage of price appreciation from riskier customers. Should the homeowner not pay Point, the firm has the right to sell the home to recoup its investment and take its portion of the gains.

Those who decide not to sell their homes have to pay the company back at the end of the 10-year period, similar to a loan, with an annual effective interest rate that’s capped at about 15 percent, comparable to rates on some credit cards or unsecured consumer debt. Annual percentage rates at LendingClub range from 5.32 percent to almost 30 percent on three-year personal loans.

Point is investing in properties it expects to appreciate in value, initially focusing on California, with plans to fund homeowners in other states next year, according to a company marketing document.

Repayment with appreciation occurs at the earlier of the end of a 10-year term, sale of the property, or the will of the owner to buy out Point’s stake at the appraised value.

So, what could go wrong?

Personally, I like the idea of selling an equity interest because it delevers the owner.  The owner does not have to make any additional payments.  He forfeits some appreciation of the property, and faces either a need for liquidity or a sale of the property 10 years out.  (The 10-year limit is probably due to a need to repay Point’s own property investors.)

Possible issues: you might not like the price to buy out Point should you ever get the resources to do so.  You may not want to sell the property 10 years out if you realize that you can’t raise the liquidity to buy out Point.  If you do sell your home, you will incur costs, and may have a hard time buying a similar home in the market that you are in with the proceeds.

But on the whole, I like the idea, and think that it could become an alternative to reverse mortgages in some markets where properties are appreciating.  An alternative to that odious product would be welcome.

Full disclosure: I don’t have any financial dealings with Point.  I just think it is an interesting idea.

 

As I was reading today, I ran across a quotation from Stanley Fischer, Vice-Chairman of the Federal Reserve.  It was from an interview on CNBC in April 2015.  I went to get the original source, and here it is:

Still, Fischer emphasized that a tightening would be slight.

“We have to ask what will go wrong,” he said. “I say that if we get this in proportion, we’re going to be changing monetary policy from the most extremely expansionary we’ve been able to do in all of history, to an extremely expansionary monetary policy.”

Fischer added that the expected increase of a quarter of a percent would be the lowest rates had ever been if not for the recent move to zero.

This is the same mistake that Ben Bernanke made when he talked about the “taper” back in 2013, and the same error that Janet Yellen is making now. At any given point in time, there is a schedule of interest rates going out into the future that reflects the future path of rates that the Fed controls.  This isn’t perfect because almost none of us can borrow at those rates, but if credit spreads don’t vary much, movements in the schedule of rates, driven by expectations of monetary policy, affect business actions.

This implies two things:

  1. Direction matters more than position in monetary policy.  If expectations have moved from “zero for a long time” to “over 1% by the end of next year,” that is a large shift in expectations, and should slow business down as a result.
  2. As a result, you can look at the Treasury curve as a proxy for the effectiveness of monetary policy.

On that second point, I have collected the Treasury yield curves since the middle of 2015 on the days after monetary policy announcements.  Here they are, so far:

Maturity

1MO3MO6MO123571020

30

6/18/20150.000.010.080.260.661.031.652.082.352.863.14
7/30/20150.050.070.150.360.721.071.622.022.282.662.96
9/18/20150.000.000.100.350.690.971.451.832.132.582.93
10/29/20150.020.070.210.330.751.051.531.902.192.602.96
12/17/20150.180.230.480.691.001.331.732.052.242.572.94

You can see the impact of the FOMC tightening out to five years, maybe seven.  After that, there is no effect, so far, except to say that the yield curve is already flattening, and that the Fed my end up stopping much sooner than many expect — including the FOMC and their “dot plot” which expects a 2%+ Fed funds rate in 2017, and 3%+ in 2018.  Unless the long end of the yield curve reprices up in yield, there is no way those higher Fed funds rates will happen.

Which brings me back to Stanley Fischer.  He’s a smart guy, perhaps the smartest on the Fed Board.  Maybe he meant there was no way rates could rise much for a long time.  If that’s the case, he may be way ahead of the curve.  Only time will tell.

 

If you always overestimate, and don't change, what does that imply?

If you always overestimate, and don’t change, what does that imply?

Since the FOMC started providing their estimates on economic aggregates four years ago, I’ve been simplifying them, and posted a weighted average to cut through the clutter of their releases.  From the above graph, you can see one thing that is consistent:  They overestimate GDP.  Far from seeing GDP over 3%, GDP has come in squarely in the 2% range.

It may even be that this is slowly wearing on the participants, who have progressively lowered their initial estimates of future GDP over time.  You can see that in the initial estimates of GDP 2014-2018, and also the decline in long-term GDP moving from 2.5% to 2.0% in four short years.

The FOMC is no different than the rest of us — they are subject to groupthink and playing catch-up.

Unemp

You can give them a little more credit on unemployment.  At least things are going the way they would like.  That said, improvement in the unemployment rate has exceeded their estimates, while GDP has fallen under their estimates.

They live in a bubble, so please don’t tell them that labor measures don’t correlate so tightly with the economy as a whole.  I mean, in the long run, the correlation is high and significant, but as far as short-term policy goes, the relationship has a lot of noise, particularly amid globalization and improvements in technology.

PCE

Same applies to the PCE inflation rate… they think they can get inflation going (whether truly desirable or not).  So where is it?  Federal Reserve, you say you have the vaunted powers to create and destroy inflation.  If you can do something, do it.

My guess is that the Fed won’t do it.  As with most central banks, they have engaged in a game where they increase some aspects of internal credit, and in a way where precious little if any leaks out to the unfavored wretches with no access.

On the short-term bright side, they absorb government debt, which makes it easier for the US Government to keep our taxes low.  On the dim side, central banks buying lots of government debt has tended to backfire in the past.

FF

Finally, the FOMC participants have overestimated for the last four years the need and willingness to tighten monetary policy.

Can we agree that QE really didn’t do that much, and that the unemployment rate pretty much solved itself, aside from losing a lot workers permanently?  These graphs behave the way a bunch of “true believers” would think their great power should  work, and them slowly give in to reality annually, but not permanently.

Anyway, consider these articles post-Fed tightening:

Fed Ends Zero-Rate Era; Signals 4 Quarter-Point Increases in 2016 Bloomberg)

This article is too excited, the math of the FOMC indicates more like 3 quarter-point moves.  Also note that the FOMC is not very permanent about their views, plans, or whatever.

The Fed and Wall Street Differ on How High Rates Will Go (Bloomberg)

Wall Street, correctly looking at the past says that the Fed has moved slower than they said they would.  Why should it be any different now?

Fed Raised Rates Without a Hitch, and It Only Took $105 Billion (Bloomberg)

Too triumphalist about the first tightening.  Wait for the cost of funds to catch up at the banks.

Fed Hikes, but Some Rates Veer Lower (WSJ) Subtitle: Yields on Treasurys drop after central-bank move

That’s part of what I would tell you to watch — if the yield curve flattens quickly, the FOMC will not do so much, most likely.  They will still keep going till something blows up.

One final note, and one that I don’t have a link for… Moody’s suggested in a macroeconomic note that yield spreads on junk debt are too high for the FOMC to tighten much.  Nice thought, though we are in an unusual situation for both Fed funds and junk debt.  That rule may not apply.